Posted on 02/10/2010 10:34:26 AM PST by blam
Watch Out: ISM Inflation Reading Soars To Multi-Year Highs
Joe Weisenthal
Feb. 10, 2010, 12:46 PM
Here's a chart that should be causing some consternation to Ben Bernanke. It's the ISM's Commodity Survey, via Bespoke, and it shows a surge in commodity prices the likes of which we haven't seen since the middle of 2008.
[snip]
(Excerpt) Read more at businessinsider.com ...
But it’s the spectacular recovery induced by the infinite wisdom of his holiness, Sir Benster Bernanke, that has caused the value of everything to rise, and the seas to fall.
Hang the monetarists! We Are G-d!
< / Keynesianism >
Things are slow, but prices go up. I can’t figure it out. Apparently, a lot of other people can’t either.
I don’t know if you are being sarcastic or truthfully in a quandry, so I’ll show the folks on the string approximately how this works.
Milton Friedman, the most prominent modern proponent of Monetarism, suggests that the following equation roughly holds over time:
(M x V) = (P x Q)
M = Money Supply (How many physical and virtual dollar bills are in circulation)
V = Velocity of Money (How fast banks lend, etc.)
P = Price Level (When it goes up, that’s inflation)
Q = Quantity Produced (usually GDP)
This is realtively simple Monetarism V2.0. There are layers of more sophisticated versions, but this one will do nicely to explain.
Here’s approximately what is going on with each of those variables today, IMHO:
M = Money Supply = Bernanke has been printing money as fast as possible. So M is INCREASING MASSIVELY.
V = Velocity = Banks have not been lending very fast, holding onto cash to shore up their balance sheets; other lenders are fearful of business conditions in the U.S. (read: 0bamanomics). So V is SLOW.
Q = Quantity = GDP growth rates of between -3% and +5% are effectively NOTHING in comparison to the massive flood of cash Bernanke is printing. So let’s call this one SLIGHTLY INCREASING.
If M is MASSIVELY INCREASING, and
If V is SLOW but not moving around very much (accelerating or decelerating), and
If Q is Slightly Increasing
Then: What must happen to P?
Let’s do some math.
Let’s say that before the printing presses started going to town, we make up some number to put that formula in balance.
(M x V) = (P x Q)
Old Balance:
(100 X 10) = (50 x 20)
Bernanke Changes the Money Supply dramatically, the Velocity slows down some, and we get a slight uptick in GDP:
(180 x 8) = (??? x 21)
What must happen to P for this equation to be in balance?
Class: Solve for P.
P = 68.
Remember that before Ben got ahold of the printing presses, P was 50. Now P is 68. 68 / 50 = 136%, or 36% inflation.
Markets sense that too many dollars (M) are chasing too few goods (Q). Therefore the price (P) of things is going up in spite of the fact that the economy is not growing much (Q) and the velocity of money isn’t changing much (V).
Summary: Bernanke has printed so many dollars that dollars are cheap, everything else is expensive in comparison, and therefore prices rise.
Can you say “Zimbabwe” or “Weimar”?
We’re not there.....yet. But Ben is a monetary whore. He’ll put out to anyone for any reason any time.
no wait...
When excess dollars are printed (see 2003 - 2006), those dollars have to chase something, and the madness of crowds (plus Congress + Fannie / Freddie + Bush + Banks + Fraudsters + cast of thousands) all agreed that Real Estate was the ultimate asset. Huge inflows and rising prices caused even more people to think big in real estate. Can you say “tulips?”
Busts follow booms.
When in comparison to the rosy days of 2007 the Velocity of money (see “V” in my post above) falls effectively to Zero during the panic, then you won’t get a rise in P, in spite of how much money “M” is pumped into the system.
Time-series wise, this is all explicable. The continuing problem at the Fed seems to be an unwillingness to reign in M early enough to avoid another bout of inflation / bubble pumping.
I say we’re pumping up the next bubble right now. Just don’t know whether it’s Asian Stocks, or Gold, or what.
One, the equation is from Irving Fisher, not Friedman.
Two, velocity is not remotely constant, and in fact is nothing but a fudge factor and has no economic reality.
Three, GDP is a measure of value added not transactions. Thus the fudge factor becomes the "income velocity" not a transactions velocity. And no, it isn't determined by "how fast banks lend".
People choose some level of money balances they wish to hold. The level changes with the cycle and with major financial events.
Four, what's money? High powered, the Fed's balance sheet? Total assets? Something in between?
In all deflations, the main driver is a change in the level of desired money balances - "deleveraging" or a large drop in "money velocity".
Guess what level of money creation is required to keep the price level broadly stable when demand for money soars? Enough to fully meet the demand, and let everyone reach the level of money balances (out of their full assets I mean) they wish to reach.
The Fed's balance sheet is higher by $1 trillion than before the crisis. It made that full move by the end of October 2008. It has barely moved since then, net. There has been no ongoing high powered money creation since that money-demand spike and the Fed's move to meet it.
Asset values fell $15 trillion in the crisis, 15 times the move in money and in the opposite direction. They have since retraced a third of that. But still remain lower than before the crisis, by a factor an order of magnitude larger than the change in money.
Before the crisis, the portion of total household assets held in money or near money form (CDs etc) was 10%. Now it is about 15%. There is no sign that people consider this too high and are itching to spend it back to 10%.
Total debt growth in the last year was 2.3%. The normal rate would be 6-7% (post WW II average 7.5%).
Next to the claim that velocity is largely constant over time. It is hopelessly false empirically. Measured income velocity of broad money falls continually with time in any growing economy.
To see this, it suffices to notice that people's desired portion of assets held in money form, is the item that is broadly stable in the long term, though it can and does fluctuate cyclically in the short term (time scale years to a decade). Next to notice that total assets rises slightly faster than nominal GDP. (Some capital deepening, income from capital taking a slightly higher portion of total income, etc).
And um, just one little problem, GDP rises faster than prices, the difference being the entirety of real economic growth.
Ergo, the expectation that prices will rise as fast as broad money, implies they will rise as fast as assets, and as fast as the nominal economy, which implies there is no real economic growth.
Needless to say, this is nonsense. Fisher's nonsense.
Modern monetarism differs from naive Fisher quantity theory precisely by recognizing there is no mechanical relationship between money and income, only one that first passes through consumer preferences about holding money balances. And mathematically, everyone who understands the mere possibility of real economic growth, ought to know as a theorem that broad money "velocity" cannot be stable with time, but must fall with time, continually.
Velocity ought to be dropped an outright fiction. At bottom it is a fudge factor given a name out of mechanics by Fisher, in a failed theory going on 90 years old.
Friedman was an actual economist, and does not fit the cartoon of him drawn by those today who conflate his position with that of the Austrians, or with demanding tight money at all times. He was an admirer of Benjamin Strong, whom the Austrians blame for the great depression for his supposedly reckless looseness. he believed that if Strong had been alive to deal with the crisis by aggressive monetary ease through open market operations, the bulk of the great depression would have been avoided. He despised the contemporary tight money liquidationists of the Mellon variety, and held them largely responsible for the Fed's failings in the 30s.
The Fed has been right at every turn of this cycle since 2004. They were arguably too loose too long in 2002 to 2004. But that is par for the course, and they were not egregiously more wrong in this cycle than in any other. Everyone got amply warning from them to stop the madness by 2005, and failed to heed it, as usual.
The cycle is always with us and no, it is not all the Fed's fault. If right now they are supposedly blowing the next bubble, then Friedman himself was all for blowing them, because they are following his prescription for the 30s.
I'll take Bernanke, Strong, and the real Friedman, over those pretending to speak for the latter, any day and twice on Sundays.
Incidentally, this does not mean Friedman himself was right about everything - quite the contrary. He over emphasized the importance of strictly monetary factors and was tone deaf about financial structures and the inherent instability of the credit mechanism. He was empiricist enough that in his work on the depression, he faithfully records the sea change in the demand for money (and especially for currency as opposed to deposits), that makes nonsense of the Fisher "velocity" theory. But he did not properly trace it to a ineradicable instability in credit, which even Bagehot already understood.
The velocity of money is down by multiple factors. I’d be surprised if the product on the left isn’t lower than it was in 2007.
The key, and the difficulty, is reducing the money supply when V goes back up. But right now, banks are lending, so the money isn’t multiplying.
You have a nice day!
There are only $900 Billion real, physical paper Dollars in circulation.
The rest is credit. We have a credit-based economy.
The money supply is 90% credit, 10% cash. Fretting about the 10% tail means that you’ve been distracted away from the 90% dog.
Has credit expanded or contracted?
The rest doesn’t matter.
You’re right. Velocity is quite slow; and my numbers were chosen for simplicity of explanation and math, not having anything to do with what has actually occurred.
I admitted up-front the simplification I made in my initial explanation. There are about 5 layers of complexity I left off, so I could keep the whole explanation close to layman’s terms. The gentleman asked a simple question about how prices can go up when the economy sucks. Monetarism V2.0 (with it’s ADMITTED shortcomings,) adequately explained to the gentleman that Money Supply and Velocity and Quantity matter, so that Prices need not only rise because of improved economies.
I agree with you that Velocity essentially stopped October, 2008. Velocity remains down. Some day it will pick back up.
It appears that the market is building in inflationary expectations for when velocity picks up. They’re betting (see graph above, gold, etc.) on an actually fruitful recovery at some point that will show Bernanke’s loosening to have been too much. The idea of inflationary expectations reconciles over time much of the differences between my simplistic explanation for the gentleman, and JasonC’s unhinged attack, among which many of his points have merit. (Apparently the price of lithium is impacting his budget).
So, my main point remains that the Fed, due to political pressure and Bernanke’s carreer long unwillngness to tighten money early enough in an expansion, leads to bubbles. Bubbles burst.
I liked the loose money policy of 18 months ago. I think tightening is somewhat overdue (2-3 months?); many monetary market signals are flashing yellow. This is arguable; I’m arguing for earlier tightening to help avoid another bubble / burst cycle. I might be wrong; but that’s a judgment thing. Coin flipping might be more effective at this point than relying on Bernanke.
Probably the biggest miss is not Fed policy today (quite arguable), but the Treasury, both Administrations and Congress effectively doubling their bets on moral hazard. Too Big To Fail. Fannie / Freddie blank checks. FHA. Monetizing the debt. Autos. AIG. Etc.
(Standing by for another unhinged attack from my good friend JasonC)
It’s been 25 years, but there are layers of what is considered money supply. These are hazy recollections:
M1 is just printed paper money.
M2 includes demand deposits.
M3 includes cash-like instruments...
I don’t know where the cash that sits in bytes on computers only is counted.
and so on. What with the shenanigans at the Treasury and Fed these days, I’m totally lost as to how to do the counting. But when the Treasury and the Fed sell and buy from one another additional trillions of dollars, methinks that’s purposeful monetary expansion. I could get around to understanding and explaining, but I have a real job.
Good perspective on credit. From that perspective, there may be virtually nothing the Fed can do when everyone stops lending, like last year.
And as I explained to the original questioner in FReepmail, who’d start a business or take a new risk under 0bamanomics? Credit won’t expand (reasonably well) until he’s (at least politically) defeated.
I’ze jess a simple dude....don’t knows very much ‘bout this here e-conomy thingie.
I’ze lookin’ at the newz last year and saw them printing presses goin’, and I says to myself, “gosh that be one humungous hunka cash. Ain’t gonna be worth shinola in a bit.”
So’s I take a buch o my cash an put ‘em into gold mining funds, E-Merging markets, and Oil. Where them thar printing presses cudn’t hurt me so bad.
Whatcha know! Them buggers went wild! Think I booked to cash about 78%, 50%, and 40% respectively.
Bought me some new furniture and a year fer my kid at one a dem fancy colleges back east.
Jes a stoopid dude ain’t got no idear for mony supply.
But glad to be learnin’ so much from y’all.
And there was nothing "unhinged" about my previous post. The claim that Bernanke is a "money whore" is however, unhinged. He is a student of Friedman and his policies conform to Friedman's prescriptions for the present economic situation.
Next, since nobody here is apparently numerate and instead relies on ideology and sound bites as a substitute for financial or economic thought, a little monetary history of the post war period.
Since 1959, broad money defined as "money of zero maturity" has expanded at an average annual rate of 7.2%. This is in line with total asset growth, and only marginally faster than growth in the nominal economy.
Narrow money, on the other hand, the M1 that the Fed directly controls, has expanded at only a 5% annual rate. Moreover, since the late 1980s, the start of 1988 to be specific about it, there has been a noticable change in the behavior of M1. Up to that date, it grows at a 6% average annual rate. Since that date, it has grown under 4% on average (3.93% to be precise). While MZM has continued to grow at a 7.7% annual rate, marginally above its long term post war trend.
In short, all the evidence is (1) broad money growth exceeds narrow money growth secularly (2) broad money growth tracks total assets and the whole (nominal) economy (3) narrow money growth has been slower than broad and than the whole economy, and this difference has been especially pronounced since the late 1980s. The Fed has been systematically *tighter* on the monetary reins in the 20 years since 1988 than in the 30 years prior to that.
Long term interest rates (as measured by the 10 year treasury) were 9% at the start of 1988. They are 3.7% now. In the 10 years before that date, CPI inflation averaged 6.4%. In the most recent 10 year period it ran 2.6%. The systematically tighter Fed control of M1 since the late 1980s has resulted in a secular fall in the average rate of inflation and an even larger fall in the secular level of long term interest rates.
Modern commentators regard the Fed as horribly loose because they are not looking at the growth of the money stock it directly controls, they are instead looking at the low level of interest rates. Some are mislead into looking at broad money, which grows (full cycle average) as fast as the economy regardless. Mostly, men raised to believe themselves entitled to 8-9% interest risk free plus capital appreciation from secularly falling interest rates, are bummed out about the punk returns on offer with long rates below 4%.
But the reason long rates are secularly lower is not overly easy monetary policy. They are the result of the success of the Fed's greater narrow money tightness since the mid 1980s in demolishing inflation expectations and with it the inflation premium component of long term loan rates.
Those longing for the era of high risk free interest rates of course predict renewed inflation continually. They cannot imagine that rates this low can be anything but monetary recklessness. But this is due to sticky expectations about nominal interest rates set by their typical level in the generation that just ended.
Similarly the financial markets have benefited hugely from the tailwind to the values of all long dated income streams due to continually falling long term interest rates, since their panic spike levels of the late 1970s and early 1980s. That move down will never be repeated, and all of the expectations for financial returns learned during the period when it was happening, are hopelessly unrealistic. You can't ride the long rate drop from 15% to 4% all over again to minus 11 (or even to 1%, for a similar multiple expansion from 25 to 100 times, instead of 7 to 25).
The Fed is not recklessly easy. There is no great hyperinflation around the corner. There is nothing horribly unsustainable about past debt growth or broad money growth - though the long period of broad money growing faster than narrow did increase leverage throughout the financial system. That reflected asset values and broad money continuing to rise at the old typical rates despite a systematically *tighter* control of M1 by the Fed, since the mid 1980s.
These are the actual facts of recent monetary experience. You will hear them nowhere, because they do not further the inflationary brainstorm of the commodity spectulators, or damn the hated Fed, or blame financial capitalism for everything, nor predict its speedy destruction in a Marxist holocaust.
Sober reality is not exciting enough for political purposes.
M1 is currency plus checkable demand deposits.
M2 includes savings accounts and small CDs used by retail savers.
MZM (the new M3) includes money market accounts and bank CDs over $1 million, typically used by corporations.
The first is the sum that banks must hold reserves against by law, and is therefore controlled by the Fed as maxed by a multiple of its own sheet. Though it can be lower than that maximum (and right now is, by a long way, since the banks are capital constrained, not reserve constrained).
The second is approximately the money supply of the banks and pretty accurately corresponds to what the FDIC ensures. The third is the whole pool of liquid near-money instruments, regardless of their regulation or insured status.
The Fed only controls M1. Indirect incentive effects from its actions can of course still influence the other two, but they are basically determined by the actions of the commercial banks and their customers. By design, when there are willing savers, banks can expand the broader money aggregates without any "by your leave" from the Fed.
Note also that there are "money market instruments" that do not qualify as MZM, because they are not "zero maturity", but short time and non-bank. Commercial paper of 3 months or less, treasury bills, and the like, are not considered "money" in any of these aggregates. A money market mutual fund deposit that indirectly holds such securities is considered MZM broad money, because it can be withdrawn on demand, but even short "time" loans like that are not. CDs are considered part of money, even though they are similar "time" savings instruments, because they are liabilities of the banking system, not third party issuers.
Anyway, just points of information to correct your hazy recollections.
‘m with you.
The need is to look beyond today or even 90 days. inflation is by design.
It is
Boo!
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