Traders today
universally believe inflation is dead, that there is no persistent
decline in the purchasing power of money. That?s what government
price indexes around the world are indicating. But this false
notion is one of recent years? main Fed-conjured illusions. Price
inflation is the result of rising money supplies, and they have been
skyrocketing. Serious risks are mounting that they will spill into
price levels.
As simple as money
seems, it is very complex in both theory and practice. We all
understand the idea of working to earn money to buy goods and
services. But the seminal treatise on money, the legendary
economist Ludwig von Mises? ?The Theory of Money and Credit?
published in 1912, weighed in at 445 pages! Money is a topic
that endlessly preoccupies elite central bankers with doctorates in
economics.
Money is
ultimately a commodity, its value determined by its own
fundamental supply and demand. If demand exceeds supply for any
given currency, its price will rise relative to other currencies.
As this money grows more valuable, it takes relatively less to buy
goods and services. The persistent increase in the purchasing power
of money, resulting in a persistent decrease in general price
levels, is deflation.
Today systemic
deflation is assumed and feared by traders around the world. They
look at the various price indexes published by governments, which
show either slowing increases in general price levels or slight
decreases. They worry incessantly that the former disinflation will
decay into the latter deflation. So the idea that there are big
risks of serious inflation breaking out is hyper-contrarian
heresy, widely ridiculed.
Yet think about
the commodity of money. Deflation requires demand growth to exceed
supply growth, which is clearly not happening. In this era of
extreme central-bank easing globally, money supplies all over the
world are literally skyrocketing! With supply growth
radically outpacing demand growth, the only possible ultimate
outcome has to be big inflation. There is always a reckoning for
huge monetary expansion.
Central banks have
been conjuring vast amounts of new money out of thin air to
buy bonds, the blatant debt monetization now pleasantly euphemized
as ?quantitative easing?. The resulting exploding money supplies
guarantee each unit of currency is going to be worth less. With the
money supplies growing far faster than the real-world pool of
goods and services on which to spend it, serious inflation is
inevitable.
Inflation is the
persistent increase in general price levels driven by the persistent
decline in money?s purchasing power. And given the extreme,
wildly-unprecedented, and record levels of money printing the US
Federal Reserve has executed in recent years, Americans are facing a
major inflationary episode in the coming years. Excessive
central-bank money printing throughout history always leads to
serious inflation.
The Fed started
sowing the seeds for this coming inflation back in late 2008. That
year the US stock markets suffered their first full-blown panic
in a century.
In just 21 trading days leading into late October 2008, the flagship
S&P 500 stock index plummeted 30.0%! The first two weeks of this
alone witnessed an astounding 25.9% free fall, handily exceeding the
formal stock-panic metric of a 20% drop in 2 weeks.
The US Federal
Reserve was founded in late 1913, largely in response to the last
true panic seen in US stock markets in 1907. So this central bank
had never weathered a stock panic before, and its central bankers
were utterly terrified. They feared we were on the verge of a new
Great Depression due to the wealth effect. When Americans?
perceived wealth declines due to market selloffs, their spending
falls in sympathy.
For all their
power, central banks really only have two tools available. The
great newsletter writer Franklin Sanders describes them as
?liquidity and blarney?. Central banks can either print money, or
talk about printing money. And with the Fed literally panicking in
late 2008, it spun up the printing presses with a vengeance. This
is readily apparent in this first chart of the narrowest US money
supply.
This is called the
monetary base, or M0 (M-zero). While the definitions of the various
money-supply measures vary in different countries, the monetary base
includes money in circulation, money in bank vaults, and reserves
banks hold with the Fed. Here?s the US monetary base and its annual
growth rate charted over the past third-of-a-century or so. Note
the radical disconnect seen during late 2008?s stock panic.
That event that
forever changed global markets thanks to central banks? extreme
reactions started in September 2008. During the 28.7 years before
that beginning in 1980, the average annual growth rate in the
monetary base ran 6.2%. That?s the baseline for normal monetary
conditions. But in late 2008 when the Fed joined stock traders
in panicking, it ramped its money printing up to
stupendously-extreme levels.
The Fed rushed to
inject liquidity into the system, creating vast torrents of new
money out of thin air to try to stave off the feared depression.
In just 4 months leading into December 2008 centered on that
epic stock panic, the Fed had catapulted its monetary base 101%
higher! It peaked at a staggering annual growth rate near 117%
in May 2009. The money supply was exploding, a wildly-unprecedented
event.
While these epic
panic expansion rates didn?t last, the Fed never unwound its
extreme money creation! Instead it followed its initial QE1
bond-monetization campaign with QE2 and QE3 in subsequent years,
each of which greatly boosted the monetary base. When central banks
buy bonds, they don?t use money that already exists. Instead new
money is literally created out of thin air with the stroke of
a keyboard.
So thanks to the
Fed?s enormous quantitative easing of the post-stock-panic
era, the monetary base has exploded from $847b
in August 2008 to $4099b today! That extreme 4.8x increase was
fueled by an incredible average
annual M0 growth rate of 27.8% in the 7.1 years since the
stock panic. The critical question traders need to ask is whether
such record money creation can magically have no inflationary
consequences.
Price inflation is
the result of money supplies growing faster than the
underlying pool of goods and services in the real economy on which
to spend it. And there is absolutely no way the US economy today is
roughly 5x larger than it was in late 2008, like the monetary base.
That means there is a giant overhang of excess money out there
threatening to flood into the real economy and drive up price
levels.
The Fed
intentionally injected this epic monetary inflation into the
system. It wanted to artificially lower interest rates to boost
economic activity, to stop the stock panic?s wealth effect from
cratering the US economy. So it bought trillions of dollars
of bonds. The Fed monetizations of US Treasuries enabled the
massive government
overspending of the Obama years, ?financing? that
Administration?s record deficits.
This vast monetary
inflation indirectly led to the extraordinary post-panic
stock-market
levitation. The extremely-low interest rates created by the
Fed?s enormous bond buying led US corporations to borrow way over a
trillion dollars to buy back their own stocks. Instead of
growing their businesses, companies took advantage of the gross Fed
distortions to manipulate their earnings per share higher
through vast buybacks.
There is zero
doubt the Fed?s extreme money-supply expansion of recent years led
to great inflation in bond and stock prices. With relatively far
more money chasing relatively far less investments, their price
levels were bid dramatically higher. The colossal inflation of
asset prices by the Fed and other major central banks is
undisputed. Markets would look far different today if the Fed
hadn?t quintupled its monetary base!
It?s ironic how
traders today fully understand how bond and stock prices would be
far lower without the Fed?s extreme money printing, yet deny the
threat of inflation. Once central banks unleash new money, they are
powerless to control where it flows. Eventually money-supply
expansions always permeate into general price levels. And despite
what the government price indexes claim, this is already happening.
When the Fed
conjures new dollars out of thin air to buy US Treasuries, what does
the government do with this new money? Rapidly spends it.
The money the Fed used to buy those government bonds immediately
goes to Americans in the form of redistribution transfer payments,
direct government salaries, and government purchases of
private-sector goods and services which indirectly pay countless
others.
This brand-new
government money is then soon spent by its ultimate recipients on
their own goods and services, bidding up general price levels.
All that money the Fed has printed hasn?t just magically stayed in
the bond markets segregated from the real economy, it was already
injected right in almost as soon as it was wished into existence.
Traders who buy into the deflation myth simply don?t understand
money.
Much if not most
of the Fed?s incredible $3.3t monetary-base expansion since late
2008 is already out there in the real US economy. This is
a ticking time bomb threatening money-supply-growth-fueled
widespread general inflation. And contrary to
government-price-index claims of persistent disinflation or
deflation, this serious inflation the Fed has unleashed is already
becoming apparent to the observant.
Think of your and
your family?s own financial situation, your personal economy. Has
your cost of living been rising or falling in recent years? Are you
having to pay more for virtually everything you need and want to
live? Are your tax costs, housing costs, education costs, medical
costs, utility costs, food costs, and entertainment costs rising or
falling? Everyone I talk with is already seeing sharp real-world
inflation.
Pretty much
everything we buy on an ongoing basis is getting more expensive.
With vastly more dollars in circulation in recent years thanks to
extreme Fed money printing, the purchasing power of each has
declined considerably if not dramatically. While there are
certainly exceptions, most Americans are all too painfully aware
that general price levels are relentlessly rising. Maintaining
lifestyles requires more money.
The price indexes
published by governments around the world are woefully inadequate
for measuring prevailing price levels. Prices are just inherently
difficult to measure. Our consumption patterns are constantly
changing, with endless substitutions as prices and tastes evolve.
Any basket of goods and services used to measure prices is soon
obsolete, with a constant measuring rod impossible to achieve.
And governments
actively obscure general-price-level increases as well for
political reasons, muddying the picture. Higher reported inflation
is bad for politicians? job security. It leads to lower
stock-market levels and thus greater electorate dissatisfaction.
Provocatively, stock-market changes leading into US presidential
elections are one of
the most powerful
predictors of their outcome! Incumbents lose when stocks
weaken.
Higher reported
inflation levels also cost governments big money in transfer
payments, many of which are linked to their own government?s
inflation gauge. The more governments have to raise things like
welfare and pension payments to keep pace with reported inflation,
the less money politicians have to spend on things that can win them
votes. So governments have vast incentives to lowball reported
inflation.
And they do. The
US?s definitive inflation gauge that traders swear by is the
Consumer Price Index published monthly by the Labor Department. It
is showing zero inflation right now, a stark contrast to the
actual experiences of Americans! This next chart shows the broad
MZM (money of zero maturity) money supply, overlaid by its own
annual growth rate and that of the CPI. Their great disconnect
remains glaring.
Not surprisingly
with the monetary base soaring thanks to the Fed?s extreme debt
monetizations of recent years, the broad MZM money
supply has surged massively as well. Since August 2008, MZM has
exploded $4.9t higher! While this is in line
with M0?s $3.3t growth, it is much smaller
in percentage terms at a 56% gain compared to 384% because MZM
was larger to start with. But this is certainly an anomaly.
The narrow
monetary base directly supports the broad MZM money supply. Between
1981 and August 2008 when M0 averaged $450b, MZM averaged $3615b.
This rough comparison suggests each dollar of monetary base
supports about 8 dollars of broad money supply. In one of fiat
money?s complicating factors, the monetary base is multiplied into a
larger money supply by the fractional-reserve banking system.
When money is
deposited in banks, the banks are allowed to lend out much more than
deposited. They only need to keep reserves for a small fraction of
their deposits, multiplying the money supply. Eventually as the
Fed?s vast recent monetary-base expansion is absorbed, it has the
potential to support a colossal MZM of
$32.9t! That?s a staggering 2.4x above today?s levels. That
would unleash an inflation superstorm.
But back to
today?s reported-inflation situation, the US government?s CPI is
claiming no inflation right now despite
MZM still surging over 7% per year. Since
expanding money supplies drive increases in general price levels,
and MZM continues to grow rapidly, how on earth can there be zero
inflation in the US today? It doesn?t make any sense that a
fast-ramping money supply isn?t driving purchasing-power losses.
But this
disconnect is a temporary anomaly, not some new era where prices are
somehow divorced from the money supplies which determine them. The
government reporting that inflation doesn?t exist sure
doesn?t mean it doesn?t exist. And more and more Americans are
waking up to this, unable to reconcile Wall Street?s
price-index-fueled deflation worries with their own personal
experiences of endlessly-rising prices.
Traders have duped
themselves into believing that the most extreme central-bank money
printing in world history will have no inflationary consequences, a
ridiculous notion. They think that these trillions of dollars of
newly-created money can be magically fenced into the bond and stock
markets, where they love to see price inflation. They believe
mushrooming money supplies won?t spill into the underlying real
economy.
But history has
proven over and over that big central-bank money printing always
leads to big real-world inflation. There can be no other
possible outcome as relatively more money chases relatively less
goods and services, bidding up their prices. The faster the supply
of anything grows, the less each unit of the existing supply is
worth. Money has never been an exception to these ironclad laws of
supply and demand.
There will
absolutely be a reckoning for the Fed?s extreme post-panic money
printing, serious adverse consequences for prevailing price levels.
The Fed either has
to fully
normalize its balance sheet to where it would have been without
the epic debt monetizations, or serious inflation is inevitable
sooner or later here. And the Fed will never muster the courage to
materially unwind its incredible bond purchases.
If the Fed had not
panicked in late 2008 and kept the monetary base on its normal
trajectory, it would be down around $1.1t today. So a full
normalization would require an astounding
$3.0t of bond selling by the Fed! When central
banks sell bonds that they created money to buy, that new money
vanishes back into oblivion. So if the Fed sold $3t in bonds, even
over many years, it would unleash a market apocalypse.
Bond prices would
collapse, sending interest rates soaring. That would utterly
devastate much of the real economy reliant on debt financing, led by
housing. Stock markets would fall for years on end as both
higher-yielding bonds sucked capital away and higher borrowing costs
weighed on corporate profits and sales. The Fed has painted itself
so far into a corner that it can never fully normalize its vast
monetizations.
And that means the
only possible outcome is the near-quintupling of the US
monetary base in 7 years is going to lead to serious general price
inflation in the years to come. That?s the way monetary expansion
has always worked historically, even though this process takes some
time to fully run its course. And investors and speculators alike
today wrongly fearing the deflation boogeyman are woefully
unprepared for inflation.
History?s
strongest asset in inflationary times, which are always unleashed by
excessive central-bank money printing, is gold of course.
Gold thrives when currency values are falling thanks to
rapidly-growing money supplies. Investors start shunning cash as
its purchasing power drops, and park capital in gold to preserve
their purchasing power. This rising investment demand leads to
surging gold prices.
And with gold so
deeply out of favor in recent years thanks to the Fed?s
extraordinary QE-fueled
stock-market
levitation, investors remain
radically
underinvested in gold. This gives gold enormous upside as
deflation worries eventually yield to the real threat of
serious inflation the Fed has unleashed. Gold and its leading ETF,
the GLD SPDR Gold Shares, will thrive as prudent portfolio
diversification returns to favor.
But the greatest
gains in the gold sector by far in inflationary times will come from
the left-for-dead stocks of its miners. Despite gold miners?
low costs and
recent
fundamentally-absurd price levels, traders have abandoned them
on the
historically-false belief that Fed rate hikes are terrible for
gold. So as gold mean reverts higher in the coming years, its gains
will be dwarfed by the uplegs in the best of the gold stocks.
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The bottom line is
the Federal Reserve has nearly quintupled the monetary base in just
7 years since 2008?s stock panic. This extreme money printing can?t
be unwound without collapsing the bond and stock markets and causing
interest rates to skyrocket, something the Fed will never risk. So
it has no choice but to let the money supply remain near its
vastly-inflated levels today, a harbinger of serious price
inflation.
Such vast amounts
of new money really lower the purchasing power of existing money.
With relatively more money chasing relatively fewer goods and
services, higher general price levels are guaranteed. Gold has
always been the best asset to own after excessive central-bank money
printing. And when the world?s traders realize inflation is the
real threat, not deflation, they will start flocking back to the
yellow metal.
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