Inflation and the US money supply: mixed signals

 

Despite official denials, the rate of inflation isn't dropping nearly as much as the powers that be would like us to believe.  The "official" rate is also several times lower than the real rate, as we've discussed many times in the past in these pages.  The trouble is, commenters are focusing on one or other aspect of inflation that suits their point of view, and ignoring others.

Take the US money supply, frequently referred to as M2.  Reuters recently reported it was falling at "the fastest rate since the 1930's".

Money supply has now been shrinking year-on-year since December, an unprecedented development in modern times that should make investors sit up and take notice - growth, asset prices and inflation could all weaken.

It is largely a consequence of the reversal of the liquidity generated by massive post-pandemic fiscal and monetary stimulus, the Federal Reserve shrinking its balance sheet via quantitative tightening, falling bank deposits, and weak demand for and provision of credit.

All else equal, it is a sign the Fed has no need to raise interest rates further. Given the lag of one to two years between money supply changes and the impact on asset prices and inflation, it may even be a sign that the U.S. central bank should be cutting rates.

Fed data on Tuesday showed that M2 money supply, a benchmark measure of how much cash and cash-like assets is circulating in the U.S. economy, fell a non-seasonally adjusted 2.2% to $21.099 trillion in February from the same period a year earlier.

. . .

M2 measures the nation's overall stash of cash, coins, bills, bank deposits, and money market funds, and is basically the broadest measure of cash and cash-like liquid assets.

There's more at the link.

That sounds fine and dandy, doesn't it?  However, prices aren't falling to match the reduction in our money supply - in fact, in many cases, they're increasing faster than ever.  Why?

The answer is very simple:  imported inflation.  We import many of our basic requirements, including consumer goods such as clothing, appliances, tires, pet food, medications, etc.  We have to pay for them in dollars - but the value of the dollar against some (not all) other currencies has stagnated, if not fallen precipitously, as the Fed has continued to print them like there's no tomorrow.  Therefore, a manufacturer who makes a widget costing 100 thingummys (his local currency) wants to get 100 thingummy's worth of US dollars for it.  Unfortunately, the exchange rate has gone against the dollar:  so, where one thingummy used to fetch a dollar on the foreign exchange market, now it fetches two (inflated, weaker) dollars.  Thus, a US importer that used to buy widgets for $100 apiece now has to pay 200 dollars for them - and that dollar price increase is passed on to the US consumer at every stage in the process from manufacturer, through importer, to distributor, to wholesaler, to retailer.

Even when the value of the dollar against another currency has remained stable, that other currency has often been buffeted by supply chain problems, shortages of goods and services, and other issues.  Many governments have fallen into so much foreign debt that they can no longer service it (see the recent debt crisis in Sri Lanka for one example).  Such problems also affect what goods are available, and their prices are bid up by those competing for them.  Therefore, we still pay higher in dollars for what we need, because if we don't, other countries will.

There's also the problem of prioritization of expenditure.  Consumers - be they businesses or individuals, factories or households - have to decide where their dollars are going to be spent.  A whole lot of consumers have less dollars to spend, so they've cut back on non-essential purchases and buy only what they absolutely must have to deal with their day-to-day needs.  This can also reduce the M2 money supply figure, because the amount of money actually in circulation - i.e. in daily use - is reduced.  Instead of spending it, consumers are hoarding it against future hard times.  (I think most of us are doing that wherever possible, increasing our emergency funds or "rainy day stash" - I know I am!)

As an example, look at the US used car market.  Prices are so high as to be out of reach for many buyers;  so they aren't buying.  Instead, they're allocating that money to other needs, and/or saving it against future hard times.  That's putting great pressure on vehicle sellers, some of whom (like Carvana) have hit serious financial problems.  For such sellers, news of a tightening US money supply isn't good news at all - it may be a death knell for some of them.

So, sure, the internal US inflation rate (official or unofficial) may be going down slightly;  but in terms of what we buy internationally, that doesn't help a bit, because the value of our currency continues to deteriorate.  For every dollar the Fed prints or generates digitally, the value of all the dollars in circulation declines fractionally - and for the past few years, the Fed has printed money like there's no tomorrow.  It's created our inflation problem out of whole cloth.

That problem won't be solved until all the accumulated loss of value of the dollar has worked its way through the international financial system - and there's a long, long way to go before that happens.  Indeed, if the rumors about "Operation Sandman" are correct, the US dollar's position as the world's reserve currency is under grave threat.  Fareed Zakaria is very blunt in his assessment of the risks if that status is lost.  If it does, the value of our dollars will collapse - and I don't want to think about what that might mean for inflation.

We already know, of course.  It happened to Weimar Germany in the 1920's . . . it's happened to other nations such as Zimbabwe, Venezuela and Sri Lanka since then . . . and it can happen again - to us.  Let's hope and pray we can avoid that.

Peter