A Deep Dive Into Inflation & Fed Policy, Plus Consequences!
This chart that I've put together has the basic economic figures that factor into calculating prices that consumers encounter in the economy. The equation to calculate economic prices is as follows:
Price = (Money Supply X Money Velocity) / Real DGP
or
P=(MV)/Y
Here is the breakdown of each graph on the chart:
Blue Graph = Money Supply (M)
Yellow Graph = Money Velocity (V)
Grey Graph = Real GDP (Y)
Red Graph = US Consumer Debt
Black Graph = Consumer Price Index (US Inflation)
With this chart, we can visualize why (until February 2020) the US Federal Reserve had problems reaching it's 2% core inflation target, even after adding nearly $5 Trillion to the money supply during QE1, QE2, and QE3. The reason is that money velocity has been falling, but real GDP has been rising. So, when we think of the equation P=(MV)/Y, you can see that as M has gone up, V has fallen, and Y has risen in a way that has kept the equation relatively stable.
Plugging the numbers into the equation:
P = (16298 X 1.43) / 21729
P = 1.07
With a price figure of 1.07, we can see why prices are currently relatively stable, with consumer prices at about 107% (roughly 7% YOY) despite the Trillions that have been printed by the Fed.
So, why aren't we seeing more significant price inflation? And will we ever see an inflationary response from the Federal Reserve's seemingly LIMITLESS printing? Well, one way that could happen, is if we had a substantial decline in real GDP, and we're actually seeing that right now on a global level. Countries all around the world are experiencing massive declines in real GDP, due to the global economic gridlock resulting from the coronavirus. The question is, how much will GDP fall? If GDP falls substantially, it could result in an increase in consumer prices. However, you can see how the blue graph is spiking, as the Fed prints Trillions in an attempt to stimulate the economy. The printing may offset inflation pressures generated the drop in real GDP, if it's proportionate.
With that said, printing to offset inflation due to collapsing GDP is a rabbit hole or sorts, because there is no identifiable breaking point between acceptable inflation and hyperinflation — especially when central bank printing is this aggressive. It's not like with 9.99% inflation, it's just "inflation," and then at 10% you trigger a runaway effect.
It seems as though the Fed could soon find itself in a very bad situation. If we continue printing this aggressively, we could find ourselves at a point where the Fed needs to decide between stimulating the economy (which currently seems like a never-ending objective) or combating inflation.
The other thing worth considering is the Fed's other primary weapon of economic defense — adjusting the Federal Funds Rate. Currently, the Federal Funds rate is basically at zero percent. So, they can't cut rates without going negative. That could be part of the reason why they've printed $4.7 Trillion already this year. I wouldn't be surprised if we see negative rates though, especially if the economy continue to collapse.
Finally, the orange graph is the total public debt in the US, minus several multi-trillion dollar liabilities, such as mortgages, social security, and medicare. The personal debt of US citizens, excluding the aforementioned figures, is about $77 Trillion. When you include mortgages, social security, and medicare liabilities, you get the total "unfunded liabilities" debt of the US, which is a staggering $137.3 Trillion. That's ONLY the US. If you include other countries, the figures may reach as high as a Quadrillion dollars in liabilities. Extreme debt acquisition is a systemic problem in the global economy, and it is at an increasingly high level of risk, as the debts continue to rise and the global economy experiences significant problems.
So, while the Fed can print money to stimulate the economy, there is a delicate balance that they must maintain to control inflation, especially as we experience a collapse in GDP during this recession. I've seen estimates that GDP could fall as much as 25% this year, which is unprecedented. Eventually, inflation WILL present itself. As the money velocity (yellow graph) continues it's steady decline, and the economy slides deeper into recession, falling GDP could force the Fed to expand the money supply by tens of Trillions more, in order to maintain price stability in the economy.
However, I don't fear the Fed's actions as much as I fear the orange graph on this chart. We are in a debt based economy, which clearly can't function without the constantly rising acquisition of new debt. If the Fed simply loses control of interest rates (as we've already seen briefly in the overnight repo market) debt liability and defaults could surge to a point that is like nothing witnessed in modern day finance. Jerome Powell has said that the Fed would expand the money supply to support the markets "indefinitely." I'm failing to understand how that will have a happy ending.
I'm The Master of The Charts, The Professor, The Legend, The King, and I go by the name of Magic! Au revoir.
***This information is not a recommendation to buy or sell. It is to be used for educational purposes only.***
-JD-
Price = (Money Supply X Money Velocity) / Real DGP
or
P=(MV)/Y
Here is the breakdown of each graph on the chart:
Blue Graph = Money Supply (M)
Yellow Graph = Money Velocity (V)
Grey Graph = Real GDP (Y)
Red Graph = US Consumer Debt
Black Graph = Consumer Price Index (US Inflation)
With this chart, we can visualize why (until February 2020) the US Federal Reserve had problems reaching it's 2% core inflation target, even after adding nearly $5 Trillion to the money supply during QE1, QE2, and QE3. The reason is that money velocity has been falling, but real GDP has been rising. So, when we think of the equation P=(MV)/Y, you can see that as M has gone up, V has fallen, and Y has risen in a way that has kept the equation relatively stable.
Plugging the numbers into the equation:
P = (16298 X 1.43) / 21729
P = 1.07
With a price figure of 1.07, we can see why prices are currently relatively stable, with consumer prices at about 107% (roughly 7% YOY) despite the Trillions that have been printed by the Fed.
So, why aren't we seeing more significant price inflation? And will we ever see an inflationary response from the Federal Reserve's seemingly LIMITLESS printing? Well, one way that could happen, is if we had a substantial decline in real GDP, and we're actually seeing that right now on a global level. Countries all around the world are experiencing massive declines in real GDP, due to the global economic gridlock resulting from the coronavirus. The question is, how much will GDP fall? If GDP falls substantially, it could result in an increase in consumer prices. However, you can see how the blue graph is spiking, as the Fed prints Trillions in an attempt to stimulate the economy. The printing may offset inflation pressures generated the drop in real GDP, if it's proportionate.
With that said, printing to offset inflation due to collapsing GDP is a rabbit hole or sorts, because there is no identifiable breaking point between acceptable inflation and hyperinflation — especially when central bank printing is this aggressive. It's not like with 9.99% inflation, it's just "inflation," and then at 10% you trigger a runaway effect.
It seems as though the Fed could soon find itself in a very bad situation. If we continue printing this aggressively, we could find ourselves at a point where the Fed needs to decide between stimulating the economy (which currently seems like a never-ending objective) or combating inflation.
The other thing worth considering is the Fed's other primary weapon of economic defense — adjusting the Federal Funds Rate. Currently, the Federal Funds rate is basically at zero percent. So, they can't cut rates without going negative. That could be part of the reason why they've printed $4.7 Trillion already this year. I wouldn't be surprised if we see negative rates though, especially if the economy continue to collapse.
Finally, the orange graph is the total public debt in the US, minus several multi-trillion dollar liabilities, such as mortgages, social security, and medicare. The personal debt of US citizens, excluding the aforementioned figures, is about $77 Trillion. When you include mortgages, social security, and medicare liabilities, you get the total "unfunded liabilities" debt of the US, which is a staggering $137.3 Trillion. That's ONLY the US. If you include other countries, the figures may reach as high as a Quadrillion dollars in liabilities. Extreme debt acquisition is a systemic problem in the global economy, and it is at an increasingly high level of risk, as the debts continue to rise and the global economy experiences significant problems.
So, while the Fed can print money to stimulate the economy, there is a delicate balance that they must maintain to control inflation, especially as we experience a collapse in GDP during this recession. I've seen estimates that GDP could fall as much as 25% this year, which is unprecedented. Eventually, inflation WILL present itself. As the money velocity (yellow graph) continues it's steady decline, and the economy slides deeper into recession, falling GDP could force the Fed to expand the money supply by tens of Trillions more, in order to maintain price stability in the economy.
However, I don't fear the Fed's actions as much as I fear the orange graph on this chart. We are in a debt based economy, which clearly can't function without the constantly rising acquisition of new debt. If the Fed simply loses control of interest rates (as we've already seen briefly in the overnight repo market) debt liability and defaults could surge to a point that is like nothing witnessed in modern day finance. Jerome Powell has said that the Fed would expand the money supply to support the markets "indefinitely." I'm failing to understand how that will have a happy ending.
I'm The Master of The Charts, The Professor, The Legend, The King, and I go by the name of Magic! Au revoir.
***This information is not a recommendation to buy or sell. It is to be used for educational purposes only.***
-JD-