One of the primary complaints about the Fed's action of increasing their balance sheet is that the increase in money will lead to inflation. In essence, an increase in the supply of money inherently devalues it (increased supply = lower value). However, this theory runs into two problems. First, the money has to get into circulation and then, second, be exchanged. Put another way, if the Fed prints the money and then the banks don't lend it and consumers don't spend it, the devaluation of the currency can't occur. That lack of transmission of the Fed's policy is exactly what is occurring right now.
First, let's look at the YOY percentage change in monetary aggregates:
The three charts show the year over year percentage change in M1, MZM and M2, respectively. All three show that money is flooding the system: M1 is increasing at about a 15% YOY clip, MZM at 8.5% and M2 at about 9.3%; So -- why has there been no commensurate increase in inflation?
There are two answers to that. First, the "money printing" is getting stopped at the banks. The Fed is purchasing assets from financial intermediaries and giving them money in return. But lending has been very weak during this expansion.
Above is a chart of total loans and leases at commercial banks. Notice that the figure is right at pre-recession heights -- and this is after almost two years of quantitative easing. And while we've seen an increase over the last few years, it is hardly a strong rise. Let's look at the chart in logarithmic scale, which further highlights the situation:
The slope of the curve for the latest expansion (rise/run) is very low. It's slightly above the level seen after the 1990 recession and the 2000 recession, but below that seen over the last 40 years. Put another way, loans just aren't being made, meaning the "money printing" is not being transmitted through the financial intermediary system.
And the multi-decade low in velocity tells us that consumers aren't spending what money is getting into the economy, but instead hoarding cash:
The velocity of M1 (top chart), MZM (middle chart) and M2 (bottom chart) all show that the speed at which money moves through the economy is at or near multi-decade lows.
Let's put these two pieces of data together. First, while the Fed is technically flooding the system with money, this is not leading to inflation as there has been no respective increase in lending. As such, inflation cannot be transmitted into the system. And what money is getting into the system is being hoarded by consumers rather than being spent.
So, the complaints that "money printing will lead to inflation and devaluation of the dollar (read: Ron Paul acolytes) are unfounded.
5 comments:
Some of your charts use a logarithmic Y axis, some use a linear. I think hiding rates of change in this regard by not being consistent is disingenuous when you use differently plotted charts to argue the same point. I just don't understand the purpose behind this inconsistency, hence the speculation. Can't you just pick one or the other?
Comparing two charts with divergent rates of change then manipulating them to create same rates of change... why?
Log or Linear, pick one, no?
You had me until, "And what money is getting into the system is being hoarded by consumers rather than being spent."
I don't see as many consumers hoarding money as much as I see the corporations with huge cash balances failing to put it into good use for fear of another economic collapse. Consumers and corporations are not the same entity, don't you think?
M1 has just returned to "normal", non-bubble levels (consistent with the 1980's and 1990's). M2 is at the lower end of its long-term range. It is only M3 velocity that seems to be abnormally low in a historical sense.
The problem with your conclusion is that the complaints about inflation are definitely unfounded NOW but not necessarily at some point in the future. If/when monetary velocity picks up, will the Fed be able to quickly and decisively contract the money supply to adjust? While technically they may have the tools to do this, many would argue that realistically there is a pretty good chance that it won't happen. Someone like Volcker had the strength to take the long view and say "f*** you" to politicians and the market, but he's the exception.
When the fed increases reserves for the banks via QE, the banking system can releverage. This results in more money available to lend or chase assets. Over the past years, lending in the US has continued to decline for the most part, except govt student loans. More money has been available, however, to chase assets. There is simply more money available now by far relative to the number of assets available to purchase. So the value of stocks, bonds, and commodities have gone up. Also, money has found its way abroad via large US banks or swaps or whatever. ONe reason China had to tighten was because the fed was creating inflation that was finding its way into emerging markets (like it also had in the last boom from 2003 into 2008).
So it's not just about money finding its way to consumers and them spending it. There is much more to it than that. Note that in the US there were some of the highest annualized inflation rates in 2011 and into 2012 of the past 30 years - matched only in some months in 2006, some months in 2008, and maybe some months in 2004. Otherwise it was the highest of the past 30 years. Krugman always ignores that fact by citing only core inflation, rather than the headline inflation rate. He is wrong in doing that. MOst economists were wrong by not including the huge runup in home prices in their inflation metrics in that last month (as it used to be included in the cpi before 1994).
In the last sentence in the post above I meant to say in "the last business cycle", not the last month.
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