A large increase in the money supply will always lead to large increases in prices somewhere in the economy. However, monetary inflation affects different prices in different ways at different times, so the pertinent question is: which prices? The answer to this question is important from the perspective of almost everyone and is always obvious with the benefit of hindsight, but it is often difficult to determine ahead of time. Also, depending on which prices are affected the inflation will sometimes be widely perceived as a problem and at other times be widely perceived as a benefit or a non-issue.
Due to the dramatic differences in the general perception of inflation that stem from the specific details of inflation-related price rises, in the US there has been no correlation over the past several decades between the amount of monetary inflation and the extent to which "inflation" is perceived as a problem. As evidence we present the following bar chart showing the compound annual growth in the US True Money Supply (TMS) during each decade since the 1960s. Of particular interest, the 1970s is widely considered to be a decade when "inflation" was out of control, but our chart shows that the money supply grew at a much faster average pace during the supposedly 'disinflationary' 1980s than during the 1970s. Also, during the first 4 years and 5 months of the current decade the US money supply grew almost twice as fast as it did during the 1970s, and yet very few people perceive a US inflation problem at this time.
The lack of correlation between the amount of monetary inflation and the general perception of "inflation" leads to a lack of correlation between the general perception of a Fed Chairman's performance and his/her actual performance. Paul Volcker is the best example. Volcker is generally considered to have been a hard-nosed inflation-fighter, but based on annual rate of growth in the money supply he currently holds the record as the most inflationary Fed Chairman of the past 60 years. Ben Bernanke is in second place, followed by Arthur Burns (Fed chief during most of the 1970s), Alan Greenspan, and then William McChesney Martin (Fed chief during the 1950s and 1960s). Refer to the following bar chart for specific details.
Note: The chart omits George Miller, who was Fed Chairman for only 17 months during 1978-1979, and Janet Yellen, who only recently took over from Ben Bernanke.
On a related matter, Volcker is widely regarded as a hard-nosed inflation fighter simply because a commodity-price collapse got underway within 6 months of his August-1979 appointment as Fed Chairman. However, thanks to the steep decline in the money-supply growth rate that began in late-1977 and the fact that the US had spent the 6 months prior to August-1979 in monetary deflation, a commodity price collapse was 'baked into the cake' when Volcker took the helm of the Fed. Whoever was appointed Fed Chairman in August 1979 would now have the credit for having ended the "great inflation" of the 1970s, almost regardless of what actions they took.
Finally, it's actually a problem that the rapid money-supply growth of the past 5 years has not yet led to general concern about "inflation". It all but guarantees that the Fed will continue to react to economic and/or stock-market weakness by pumping up the money supply, especially since the new Fed Chair clearly believes that the central bank can create jobs and economy-wide prosperity by adjusting monetary levers and the price of credit. The likely result will be an economic bust within the next few years that dwarfs what happened during 2007-2009.
Will the Fed end its current money-pumping program this year?
The FOMC meeting on 17-18 June was another non-event, as it came and went with no surprises and minimal effect on the financial markets. As widely expected, the Fed continued along the $10B/meeting "tapering" path. Given the absence of signs that the Fed is about to deviate from this path and the broadening recognition that QE is not helping, it's time to revisit the question: Will the Fed follow through on the commitment to end its money-pumping this year?
Earlier this year we thought that the answer was no. More specifically, we thought that the Fed's "tapering" would terminate prematurely during the third quarter. For example, in our 2014 Yearly Forecast, which was published in January, we wrote:
"The economic data will probably be OK during the first few months of 2014, but if commercial-bank credit growth continues at its present slow pace then by the third quarter of this year there will probably be enough stock market weakness and enough signs of economic deterioration to prompt the Fed to step away from its "tapering" plan."
And in the 14th April Weekly Update, we wrote:
"The Fed began to reduce the rate at which it creates new dollars a few months ago and plans to turn off its 'money pump' before the end of this year. We think that by July-August of this year the Fed will be sufficiently worried about how the stock market and the economy are faring to prematurely end its "QE tapering", but in the meantime there will be a further scaling-down of the Fed's so-called "monetary accommodation"."
The US economy has been sluggish during the first half of this year; however, the senior US stock indices have continued to grind upward. The S&P500 Index is only up by around 6% since the beginning of the year, but it just made a new high. Its upward trend is therefore intact. Although a significant (10%+) decline is likely within the next two months, the fact that it is taking longer than expected for the stock market to top-out suggests that equities won't get weak enough soon enough to jolt the Fed from its "tapering" path.
As an aside, the inability of the economy to 'gain traction' is an inevitable consequence of the Fed-engineered monetary deluge of the past several years. This is because the flood of new money prevented markets from clearing, discouraged saving (the necessary initial step in the growth process), and caused resources to be wasted on projects, businesses and other investments that would not have been viewed as economically viable if not for the central-bank suppression of interest rates.
The stock market's resilience is undoubtedly due in part to an increase in the pace of commercial bank credit creation. The current 3.8% year-over-year (YOY) rate of growth in commercial bank credit is low by historical standards, but it is up from only 1.2% at the beginning of this year (note the up-tick on the chart displayed below). Importantly, in the process of expanding their balance sheets at a faster pace the commercial banks have, to date, created enough new money to more than offset the Fed's reduced pace of money pumping. This has pushed the YOY rate of growth in US True Money Supply (TMS) up from 7.0% at the end of December-2013 to 8.2% at the end of May-2014. It is therefore fair to say that monetary conditions in the US are easier today than when the Fed commenced its QE "tapering".
So, getting back to the question of whether the Fed will scale down the current QE program to zero as originally planned, our answer is now: yes, it probably will. Thanks to the up-tick in commercial-bank credit growth and the extension of the stock market's upward trend, the Fed probably won't be pressured by its unwavering devotion to bad economic theories to provide additional monetary 'support' until after this year's QE "tapering" has run its planned course.
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