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Free Money and Inflation

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February 22, 2012 – Comments (0)

Board: Macro Economics

Author: WendyBG

Notehound just wrote a good post about free money (that is, money created out of thin air by central banks) being like feeding stray cats. The banks would rather borrow at low interest from the central banks than "hunt" for loans in the free market.

When I look at the charts of the money supply, it's really scary. The money supply is growing much faster than GDP.

I charted GDP and M1 from 1/1/2000 to the present. It's clear that the Federal Reserve gradually increased M1 during the early 2000s to help recovery from the 2001 recession. Once the recovery appeared to be solid, the Fed kept M1 stable until the financial crisis in 2008.

During the 2004-2008 period of stable M1, GDP grew, which gave prosperity with low inflation.

http://dl.dropbox.com/u/45054803/GDP%20%26%20M1.xlsx

During the 2008-2009 recession, GDP dipped. Then GDP recovered.

The Fed exponentially increased M1 from 2008 to the present.

GDP growth from 4/1/09 to 10/1/2011 was 10%, while M1 growth was 37%.

The Fed funds (short-term) rate is zero, while the Fed is controlling the long-term rate by buying 90% of 30 year Treasury bonds.

What prevents rampant consumer price inflation?

Consumer price inflation is relatively low because disposable personal income has stalled. Bank lending into the real economy is low and the velocity of money in the real economy is low and dropping.

http://research.stlouisfed.org/fred2/series/A229RC0

Where is all this free money going?

The free money is going into the financial markets, propping up stock, bond and commodity prices. There is little crossover between the financial markets and the consumer markets -- except for commodities.

With the Nightly News blaring about rising gas prices, speculators are again buying oil futures. We may see a replay of 2007, where speculative investments in oil inflated a bubble which dramatically increased gas prices and worsened the 2007 recession.

Unless TPTB take quick action to smack down speculation in oil, this may repeat in 2012.

Wendy

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