Thursday, October 24, 2013

The Turning Point for Inflation

I recently posted an article on the dropping velocity of money, a rather odd occurrence given that the Federal Reserve has been pumping and dumping as much "cash" as the system can handle in an effort to stimulate economic growth.   Various measures of the money supply have increased dramatically over the past five years since the Fed began QE 1 in November 2008 especially when one looks back at their growth rate back to the mid-1970s.

Here's what has happened to M1:

Here is the percentage change of M1 on a year-over-year basis:

As you can see, on average, M1 has grown at a far higher rate since the end of the Great Recession than it has since the mid-1970s and it has done so for a far longer period of time.  At its post-Great Recession peak in October 2012, M1 was growing at a rather frightening 22.5 percent on an annual basis, a record level of growth when looking back to the mid-1970s.

Here's what has happened to M2:

Here is the percentage change of M2 on a year-over-year basis:

While the growth in M2 was not as dramatic as the growth in M1, it still grew at an elevated rate of around 10 percent for a nine month period between August 2011 and June 2012 and has since dropped back to the still rather high level of 6.7 percent on a a year-over-year basis.

Now, why should we be concerned about all of this?  Right now, the velocity of money is very low meaning that all the money that the Fed is "printing" is not being spent as many times as it normally would as shown on this graph:

In fact, M2 is being spent at historically low levels looking all the way back to the late 1950s.

Now that we have that behind us, the problem will occur when consumers decide that they want to spend all of that wonderful money that Mr. Bernanke and his merry band of bankers have printed, toiling long hours over their overheated printing presses (kind of conjures up a Dickensian novel, doesn't it?).  When (if) consumers start spending and demand for goods and services rises, all of those dollars will be chasing a finite number of goods and services, pushing inflation (CPI) out of its current rather tame range as shown here:

A recent brief by Dr. Steven Cunningham, Chief Economist at the American Institute for Economic Research suggests that the economy may be showing the initial signs of inflation in the economy.  He notes that several key factors in the private sector are creating fuel for inflation as follows:

1.) The rise in overall capacity utilization:  As shown on this graph, overall capacity utilization has grown to its post-Great Recession high of 77.8 percent:

The current level of utilization is up markedly from its 45 year low of 66.9 percent experienced in June 2009.  Once overall capacity utilization reaches 80 percent or more, inflationary pressures tend to build in the economy.

2.) The rise in the producer price index (PPI):  As shown on this graph, the PPI is now very close to its highest level since the end of the Great Recession and is around the the level seen as the recession set in during 2009:

In fact, the PPI has risen from a low of 168.1 in March 2009 to its current level of 204.3, a rather substantial gain.  August 2013 saw the PPI for finished goods (mainly energy and consumer foods) rise by an annualized rate of 3.7 percent.  Finished energy prices rose by 10.5 percent on an annualized basis and finished consumer food prices rose by 7.3 percent on an annualized basis, led by a 26.9 percent increase in fresh and dry vegetable prices.

The saving grace has been consumer spending.  As shown on this graph, consumer spending has been dropping for much of the past year, however, it seems to have stabilized or risen slightly since April 2013:

While consumer confidence has not reached the levels seen during previous recoveries, it is in the neighbourhood of the highest levels it has seen since 2008 as shown here:

As economists point out, it takes both demand and money to create inflation.  The money has already been created, thanks to the Fed, with the monetary base up an annually compounded rate of 36.3 percent over the past year alone.  Banks are now holding 3500 percent of their reserve requirements rather than the 1 or 2 percent that they normally hold, showing that they are not lending at anything that would approach their normal lending rate.  This tells us that there is a huge potential buildup of both lending and money circulation that could take place.  When that happens, it could happen very quickly and the pressure could result in severe inflationary pressures in the economy.  Everything is in place for the next round of high inflation, the only thing missing is consumer demand.  It's just a matter of waiting until consumers have the confidence and desire to consume and decide that they want to borrow and spend at the same time as banks decide that they want to make money lending to consumers.  Then all inflation hell could break loose.


  1. How can the average American consume when (I don’t know the number) but most of the people I know live roughly pay check to pay check? The stagnant wages have created this issue. All the money is concentrated at the top with the lower portion not having much extra to spend other than on things of importance.

  2. At some point, spending is going to have to resume simply because things break down, as they are meant to (planned obsolescense). People will be stuck financially but the banks will be happy to help 'cause they'll be able to lend all this pent-up money. They will lend this "fake" money (printed but backed by nothing) and in return they'll get real money from the working Joe. The game will resume, wether the sheeple and debt slaves like it, or want it, or not. What might change the game is that people eventually stop pursuing happiness through stuff; others start up businesses that build useful things of quality for a simpler living arrangement; things like that.

    So, we might yet see bubbles again from some sectors of the economy, the top 1% getting richer and the average person of course, getting poorer. Then another crash or recession - they seem to be cyclic, then the whole thing starts up again. Just look at the short history of fracking...

  3. While charts can be very enlightening I caution those looking at them that they can also be very deceiving, the scale and what they don"t show is very important. While proving the surge in new money these charts may understate the feel of how much the money supply has grown in relation to the past.

    After much thought I have come to the conclusion that while inflation is not showing up in a big way the seeds have been planted, and the number of them is somewhat shocking. Inflation lurks beneath the surface and is hidden away in the dark corners of our future. Want to know where the real cost of things is going, just look at the replacement cost from recent storms and natural disasters. More about this "hidden" inflation in the post below,

  4. Of course high inflation is coming. That is what the FED and the GOV is trying to make. Why? Because it is the easiest way to create the perception of growth. Remember the official inflation numbers are manipulated down. Inflated prices push the GDP higher. Although the real GDP might be falling, the inflated one will be seen as rising.

  5. It appears that the money supply is not lying idle in the US banks. It is diverted and put to work in the developing countries.
    They are the ones where the money grows. US businesses and people simply cannot provide comparable returns. This is why everything is quiet and nothing changes in the US. All the changes are in the developing countries.

    All the talk coming from Fed barely creates a stir in the US markets. But look at the reaction in India, China and Brazil. It's staggering.

    The question now: how will this money tsunami sloshing around the globe affect the US, and when?