Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.”
Most people parrot Friedman because the quote sounds good.
The actual quote is: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
M2 Weekly Chart Percent Change From Year Ago
Last Five Weekly Readings
- 2022-11-07: 0.3 Percent
- 2022-11-14: 0.0 Percent
- 2022-11-21: -0.1 Percent
- 2022-11-28: -0.4 Percent
- 2022-12-05: -0.7 Percent
Is Inflation Always a Monetary Phenomenon?
If you insist that increases in money supply constitute inflation, then you must also insist that we are in a period of deflation right now.
Does it feel like it?
I have been waiting for this moment for a long time just to ask these questions.
I was sure money supply growth would go negative because the Fed’s balance sheet unwind would shrink money supply as measured by M2.
Quoting Friedman
People love that Friedman quote, but ask anyone: How do you measure money? Is it M1, M2, MZM, or M3? Expect blank stares.
Then ask them how they measure inflation. If it’s by prices, not increases in money supply, then their answers are inconsistent.
What About Velocity?
At the time Friedman made his claim, he believed the velocity of money was relatively constant or stable in a narrow band.
Velocity was relatively stable then. It isn’t now. Few are aware of that major difference.
Changing Definitions
The 1971 Webster definition of inflation was an increase in money supply and credit.
The Fed, academia, and governments managed to change the definition to hide asset and credit bubbles.
The Fed seldom if ever discusses money supply or total credit. That is on purpose.
Total Credit Market Debt
TCMDO is $92 trillion. Data is through the third quarter of 2022.
How the heck is that supposed to be paid back?
From 2006-2009, using a credit view of inflation, I confidently predicted deflation and it happened.
Will it happen again?
I say yes, but when is the key question. This is not 2008. We do not have the degree of housing liar loans and people walking away from debt.
But we do have masses of zombie corporations that will go bust and all their debt with them.
Housing Bubble Deflation 2007-2010 Flashback
That’s one hell of a deflation flashback to the housing bubble bust.
We had an unprecedented 4 consecutive quarters of declining credit year-over-year and a 5th quarter that was flat.
Credit deflation was likely much worse but in March of 2009 the Fed suspended mark-to-market accounting of bank credit.
We also had an an enormous asset bubble bust and the CPI was negative for 8 consecutive months. That’s deflation by any sensible measure.
At the time, however, I was routinely mocked for my deflation take because M2 was still positive. Well now it isn’t.
Is the US in a Period of Deflation Right Now?
The answer depends on what one means by inflation, deflation, and money. If you insist on a M2 measure, there is only one possible answer, and that is yes.
If you point at the CPI or grocery prices today while pointing out M2 yesterday, what does that say about you?
If you view things from the perspective of asset bubbles then heck yes, deflation has started. It also has a long way to go.
If you look at things from a credit perspective, you have a much better leg to stand on if you say there is still inflation.
Deflation In the Batter’s Box
It’s asset bubble and credit deflations that are the most damaging.
Of course, it’s periods of credit inflation and cheap interest rates that sponsor asset bubbles followed by credit writeoffs.
To control inflation, the Fed has popped another asset bubble, largely of its own making.
Deflation, via another credit bubble bust, is in the batter’s box.
The Fed would pivot if it causes a credit event, but how low will asset prices go first?
Regardless, if you think either M2 or the CPI is the thing that matters most, you are wrong no matter what the Fed says.
The credit picture is more important than either of them. So are deflating asset bubbles. The latter is what led to a credit bust in the housing bubble period and it can easily happen again.
Meanwhile, the Fed is hell bent on destroying asset prices to control inflation. Good luck with that.
How Did We Get Here?
Why the Fed is in this position for the third time since 2000?
The short answer is the Fed is clueless about what inflation is, how to measure it, and what’s really important.
The Fed only looks at consumer inflation. It ignored (make that sponsored) asset and credit bubbles in a perpetually foolish effort to promote routine consumer price inflation of 2 percent.
But the Fed can only make money cheap, it cannot control where money goes. The money (credit expansion) went into assets especially housing.
Case-Shiller Home Price Index
CS National ,Top 10 Metro, CPI, OER Index Levels
Chart Notes
- OER stands for Owner’s Equivalent Rent. It it the price one would pay to rent a home, unfurnished and without utilities.
- Home prices wildly disconnected from the CPI in 2000 and in 2013. The disconnect accelerated in 2020.
The Fed ignored all three occasions hoping to make up for “lack of inflation”. The Fed “succeeded” beyond it’s wildest dreams.
For discussion, please see Home Prices Sink in Every Major Market, What About Year-Over Year?
In late 1990s the Fed ignored obvious bubbles and the DotCom mania. Then to bail out banks in the wake of the DotCom bust, the Fed either purposely or ignorantly blew a massive housing bubble.
My chart shows a clear disconnect in housing. The Fed ignored soaring home prices that on the pretense that homes are not a consumer expense and thus not in the CPI.
The Fed made the same mistake, using the same faulty logic in the entire 10-year period from 2012 on.
The Fed wanted to make up for lack of inflation as measured (idiotically) by the CPI.
Historical Perspective on CPI Deflations: How Damaging are They?
Hello Fed, it’s not consumer inflation that matters, it’s inflation that matters.
I have been making that case ever since 2006, to no avail. To become a decision maker at the Fed you have to believe total silliness instead of reality.
I have referred to this article before but now is a great time for a refresher course.
Please consider Historical Perspective on CPI Deflations: How Damaging are They?
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
The Bank of International Settlements (BIS) took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings.
Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.
Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.
Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.
The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation.
Paying Attention to the Wrong Things
Instead of paying attention to credit growth and asset bubbles, every Fed member is in an echo chamber following useless economic metrics like inflation expectations, the Phillip’s Curve, and all sorts of other silliness.
For discussion, please see Inflation Expectations are Crashing. So What? It Doesn’t Matter.
Worse yet, in their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations.
And here we are, with asset bubble deflation at hand with the Fed wringing its hands over the wrong things, after finally succeeding in creating the CPI inflation that it no longer wants.
Forget about M2, for now. Watch TCMDO instead. If credit collapses, the economy and the Fed is in deep trouble.
By the way, please note M2 money supply is $21.4 trillion while total credit owed TCMDO is $92.2 trillion.
Will these converge? Which way, how, and when?
This post originated on MishTalk.Com.
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Mish
My mind is blown. What is the relation between the fed policy /banks: and all the money printed during covid given directly to the people. It seems as long as the covid trillions are floating around in peoples grubby hands the money will pool. I feel i understand crashing demand lowering oil and wage pressure at the cost of employment(at some pt). But unless the government removes by taxing then destroys that money. Its just gonna drive prices of somethings up permeant. Help me out. Keep it simple. .
The Fed ceased publishing M-3, its broadest money supply measure, in March 2006. The SGS M-3 Continuation estimates current M-3 based on ongoing Fed reporting of M-3’s largest components (M-2, institutional money funds and partial large time deposits) and proprietary modeling of the balance. See the Money Supply Special Report for full definitions.
In February 2021, the Fed redefined its narrowest M-1 Money Supply measure back to May 2020, to incorporate the bulk of Non M-1 M-2, with headline M-1 now covering 93% of total M-2, instead of the prior 28%. In order to preserve the information reflected in the most liquid measures of M-1, ShadowStats uses the Basic M-1 Money Supply in its charts and Table here. The original Money Supply measure, Basic M-1 is defined as Currency plus Demand Deposits (checking accounts). That circumstance is reviewed in pending ShadowStats Benchmark Commentary No. 1459. A fully updated Money Supply Special Report will follow. Please contact johnwilliams@shadowstats.com for further details or any questions.
Only price increases generated by demand, irrespective of
changes in supply, provide evidence of inflation. There must be an increase in
aggregate demand, AD, which can come about only as a consequence of an increase in
the volume and/or transactions velocity of money (M*Vt). The volume of money flows
must expand sufficiently to push prices, up, irrespective of the volume of
financial transactions consummated, the exchange value of the U.S. $, and the flow of goods
and services into the market economy.
Money
should be defined exclusively in terms of its means-of-payment attributes. The present array of interest-bearing
checking accounts has confused the distinction between means-of-payment
accounts (the primary money supply) and saving-investment accounts and created
a dilemma as to what portion, if any, of these interest-bearing accounts should
be considered as savings.
accounts, destroying deposit classifications, which isolated money intended for
spending, or means-of-payment money, from the money held as savings, or the
demand for money (reciprocal of velocity).
Virtually all demand drafts
cleared through “total checkable deposits”. See G.6 Demand Deposit Turnover
release. But Powell deemphasized the role of money in the economy.
account; i.e., deposit classifications are analyzed in terms of monetary flows
(MVt). Obviously, no money supply
figure standing alone is adequate as a “guide post” to monetary policy.
money in the economy directly by purchasing assets, mainly from non-bank
financial companies.
deposits those companies hold (in place of the assets they sell). Those
companies will then wish to rebalance their portfolios of assets by buying
higher-yielding assets, raising the price of those assets and stimulating
spending in the economy”
appraisal of loan collateral (the artificial suppression of interest rates), which depends upon Gresham’s
law: “a statement of the least cost “principle of substitution” as applied to
money: that a commodity (or service) will be devoted to those uses which are
the most profitable (most widely viewed as promising), that a statement of the
principle of substitution: “the bad money drives out good”.
The 2008 intervention couldn’t create inflation. The 2020 central bank policies were designed to cause inflation. The difference is huge. Experts, such as central bankers, knew. Intention
LOL. And Dr. Philip
George subtracts “OLD” from M1.
Nothing’s changed in over a century. From the standpoint of monetary authorities,
charged with the responsibility of regulating the money supply, none of the
current definitions of money make sense. The definitions include numerous items
over which the Fed has little or no control (e.g., MMMFs and large TDs), including many the Fed
need not and should not control (currency).
are numerous degrees of “moneyness”, thus confusing liquidity with money (money
is the “yardstick” by which the liquidity of all other assets is measured). The
definitions also ignore the fact that some liquid assets (time deposits) have a
direct one-to-one, relationship to the volume of demand deposits (DDs), while
others affect only the velocity of DDs. The former requires direct regulation;
the latter simply is important data for the Fed to use in regulating the money
supply.
metropolitan areas, higher in 133 areas, and unchanged in 21 areas, the U.S. Bureau of
Labor Statistics reported today. A total of 150 areas had jobless rates of less than
3.0 percent and 2 areas had rates of at least 10.0 percent. Nonfarm payroll employment
increased over the year in 95 metropolitan areas and was essentially unchanged in 294
areas. The national unemployment rate in November was 3.4 percent, not seasonally
adjusted, down from 3.9 percent a year earlier.
Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.”
Most people parrot Friedman because the quote sounds good.