Follow The Bottom Violation
-
Jan
23
More on Velocity, the Multiplier, and Inflation
There has been a tremendous amount of discussion since my last article regarding the amount of money the Fed is putting into the economy — specifically, what is happening to that money, and what it means in relation to the global collapse of asset prices. While all the comments and exchanges have been engaging (and even, at times, colorful), there have been some particularly compelling counter-arguments to my position that the increase in the amount of money in the economy, along with a collapse in long-term Treasuries, is going to result in huge price and rate spikes in the near future.Here are a few among the most weighty:
1. The Fed is expanding the money supply, but the increase is more than off-set by a retraction of credit, as well as asset prices. And while price and rate increases are surely coming at some point, they probably won’t appear for a long time, nor will they be very dramatic.
2. We have been using our homes as sources of cash, and because the real estate market retreated so dramatically, the loss of that source should be considered a reduction in the total money supply — which also helps offset any printing the Fed is doing.
3. The velocity of the money that the Fed has put into the economy is very low, so it doesn’t really matter how much money the Fed prints — people aren’t getting it anyway. Therefore, we shouldn’t expect high rates or prices anytime soon.
I’ll start with the last argument, if only to re-iterate my point that no matter what side of the debate you’re on, I think we all agree the velocity of money has declined to historic levels. Nonetheless, I think we also agree that at some point velocity is going to pick up — that the dollars being manufactured by the Fed are going to get into the economy one way or another; certainly Ben Bernanke and his cohorts are going to use every tool at their disposal to ensure that outcome. I believe velocity is going to pick up sooner, rather than later, because that’s what the Fed wants, and because I believe rates and prices are going to start rising much earlier than expected — fueled by a collapse in Treasuries.
It’s true — as so many people have pointed out — that the de-leveraging process has cost the globe tens of trillions of dollars in asset-losses. Likewise, while I’m not sure that looking at houses as “cash” is exactly correct, per se, there is no doubt that many American consumers (and consumers the world over) used the artificially inflated equity in their homes to fuel much of the excess of the last two decades. Further, the calamitous decline in housing prices might actually give rise to a plausible argument that concomitant loss of spending power that came from those loans — coupled with asset-losses themselves — dwarfs the amount of new money the Fed has introduced into the system over the last year.
The people who have been pointing out this disparity between what has been lost and what has been printed, however, are looking at the new cash in the system as a static sum, and that is a mistake. They are failing to account for the fact that we operate in a fractional reserve banking system; any money printed by the Fed, once trickling into the economy, gets amplified many times over. So it’s not reasonable just to look at the amount of currency being printed as fixed — it must be looked at for its potential expansionary effect. Yes, the velocity of money is low, but when the Fed finds success at bringing it higher, the money supply will be increased exponentially.
But there’s one more part of this story we need to consider: just as some people might want to stretch the definition of the money supply to include such things as houses, and just as these same people want to talk about the destruction of asset prices relative to the amount of currency in circulation, we need to consider what will happen when things turn. The entire objective of the Fed is to spur economic growth through easy money. Simply put, the Fed wants people buying assets again, and more to the point, the Fed has explicitly targeted the housing market.
So at the same time all this new money is finding its way into the economy, asset prices will presumably be increasing. If we use the standard definition of “deflation” being tossed around like a beach ball on a Sunday afternoon, we are being asked to believe that we are in a deflationary environment — that the collapse in asset prices justifies the printing of so much money, because the former so overwhelms the latter. But if you’re going to make that argument, then you have no choice but to accept the not-so-equal and opposite reaction of the reversal; the already expanded money supply will be further increasing its presence through the multiplier effect at exactly the same time asset prices are rebounding. And if falling asset prices are deflationary, then surely rising asset prices are inflationary, right?
As you know, I don’t subscribe to these definitions of inflation and deflation (more about my definitions here), but for those who do, you have a lot to think about.
So I again point out that this is uncharted territory — an incredibly rare confluence of events: yields have nowhere to go but up. The government will have a difficult time finding buyers for new debt. An unprecedented amount of money, and potential money, is in the system, waiting only for velocity to return — which the Fed will all but guarantee through current policy. And finally, as a result — and also at the behest of the Fed — we will see a return to the easy money and mal-investment that got us into this mess in the first place.
But it won’t work this time; our currency and our credit are quickly running out of fuel, and no amount of easing, printing, or borrowing will replenish it.
Having trouble with RSS? Click here.
Disclosures: Paco is long TBT, UCO, and gold. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.
You can buy his novel Discipline wherever books are sold.
4 Comments so far
Partners
No disclosures?
I don’t have any positions relating to the article!
Thanks for posting your blog articles on SA, your articles and the commentary is helping me sort things out in my own mind.
I’m not an investment analyst or economist, I’m just a technology worker. But for most of my waking hours over the past six months (way too many hours, actually) I’ve been reading, and thinking, and trying to sort things out. And I’ve reached pretty much the same conclusions that you have.
The question that has been occupying my attention of late is; When will the treasury bubble burst?
Most people, both domestic and not, think the dollar is as good as gold. I think it’s this mindset that is behind the recent flight to the “safety” of US treasuries. There ARE signs, though, that this is changing – the movement of gold and silver since the crash, and the FXY chart. FXY is the most interesting to me because I think it’s telling us, (I’m guessing a bit here), that Asians increasingly suspect the dollar. The Yen is the only fiat currency I’ve come across that is rising versus the fiat dollar since the crash.
Peter Schiff has been predicting that the “decoupling” of the sound, wealth creating creditor economies from the debtor economies
will come when the former realize that the latter’s IOUs are not going to be fulfilled. If the treasury bubble hasn’t burst before this occurs then it will surely happen when this occurs. But the question is, will this happen quickly, or will it occur over perhaps years or even decades?
Do you have any thoughts on this?
Thanks for posting your blog articles on SA, your articles and the commentary is helping me sort things out in my own mind.
I'm not an investment analyst or economist, I'm just a technology worker. But for most of my waking hours over the past six months (way too many hours, actually) I've been reading, and thinking, and trying to sort things out. And I've reached pretty much the same conclusions that you have.
The question that has been occupying my attention of late is; When will the treasury bubble burst?
Most people, both domestic and not, think the dollar is as good as gold. I think it's this mindset that is behind the recent flight to the “safety” of US treasuries. There ARE signs, though, that this is changing – the movement of gold and silver since the crash, and the FXY chart. FXY is the most interesting to me because I think it's telling us, (I'm guessing a bit here), that Asians increasingly suspect the dollar. The Yen is the only fiat currency I've come across that is rising versus the fiat dollar since the crash.
Peter Schiff has been predicting that the “decoupling” of the sound, wealth creating creditor economies from the debtor economies
will come when the former realize that the latter's IOUs are not going to be fulfilled. If the treasury bubble hasn't burst before this occurs then it will surely happen when this occurs. But the question is, will this happen quickly, or will it occur over perhaps years or even decades?
Do you have any thoughts on this?