Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Want To Earn A Safe 5% In Fixed Income? Buy Preferred Stocks - 24th April 19
Can Gold Price Rise Without a Rate Cut?  - 24th April 19
Silver’s Next Big Move - 24th April 19
How Can a College Student Invest Wisely? - 24th April 19
Prepare For Unknown Stock Market Price Action As New Highs Are Reached - 23rd April 19
Silver Plays a Small but Vital Role in Every Portfolio - 23rd April 19
Forecasting 2020s : Two Recessions, Higher Taxes, and Japan-Like Flat Markets - 23rd April 19
Gold and Silver Give Traders Another Buying Opportunity - 23rd April 19
Stock Market Pause Should Extend - 21st April 19
Why Gold Has Been the Second Best Asset Class for the Last 20 Years - 21st April 19
Could Taxing the Rich Solve Income Inequality? - 21st April 19
Stock Market Euphoria Stunts Gold - 20th April 19
Is Political Partisanship Killing America? - 20th April 19
Trump - They Were All Lying - 20th April 19
The Global Economy Looks Disturbingly Like Japan Before Its “Lost Decade” - 19th April 19
Growing Bird of Paradise Strelitzia Plants, Pruning and Flower Guide Over 4 Years - 19th April 19
S&P 500’s Downward Reversal or Just Profit-Taking Action? - 18th April 19
US Stock Markets Setting Up For Increased Volatility - 18th April 19
Intel Corporation (INTC) Bullish Structure Favors More Upside - 18th April 19
Low New Zealand Inflation Rate Increases Chance of a Rate Cut - 18th April 19
Online Grocery Shopping Will Go Mainstream as Soon as This Year - 17th April 19
America Dancing On The Crumbling Precipice - 17th April 19
Watch The Financial Sector For The Next Stock Market Topping Pattern - 17th April 19
How Central Bank Gold Buying is Undermining the US Dollar - 17th April 19
Income-Generating Business - 17th April 19
INSOMNIA 64 Birmingham NEC Car Parking Info - 17th April 19
Trump May Regret His Fed Takeover Attempt - 16th April 19
Downside Risk in Gold & Gold Stocks - 16th April 19
Stock Market Melt-Up or Roll Over?…A Look At Two Scenarios - 16th April 19
Is the Stock Market Making a Head and Shoulders Topping Pattern? - 16th April 19
Will Powell’s Dovish Turn Support Gold? - 15th April 19
If History Is Any Indication, Stocks Should Rally Until the Fall of 2020 - 15th April 19
Stocks Get Closer to Last Year’s Record High - 15th April 19
Oil Price May Be Setup For A Move Back to $50 - 15th April 19
Stock Market Ready For A Pause! - 15th April 19
Shopping for Bargain Souvenirs in Fethiye Tuesday Market - Turkey Holidays 2019 - 15th April 19
From US-Sino Talks to New Trade Wars, Weakening Global Economic Prospects - 14th April 19
Stock Market Indexes Race For The New All-Time High - 14th April 19
Why Gold Price Will “Just Explode… in the Blink of an Eye” - 14th April 19

Market Oracle FREE Newsletter

Top 10 AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

If Inflation Is a Monetary Phenomenon, Is U.S. Hyperinflation a Clear and Present Danger?

Economics / Inflation Aug 20, 2009 - 01:01 AM GMT

By: Paul_L_Kasriel

Economics

Best Financial Markets Analysis ArticleWe hear a lot of concern that the Fed's mushroomed balance sheet over the past two years is setting the stage for a 1970s' style inflation here. So long as we have a fiat (a.k.a. Chrysler?) monetary standard, the threat of hyperinflation always lurks. But is the stage currently being set for such an eventuality? I do not think so.


Chart 1 shows the behavior of changes in the M2 money supply over the past 50 years on a year-over-year basis. After the Lehman crisis in the summer of 2008, M2 growth accelerated sharply. By January 2009, the year-over-year growth in M2 reached 10.1%. Although not quite matching the 13-1/2% M2 growth often reached in the 1970s, if sustained, 10% M2 growth certainly would have the potential to push inflation significantly higher. Although the year-over-year growth in M2 has decelerated to 8.4% in July, that rate of growth if sustained, could still pack plenty of inflationary punch. So, why am I still not worked up about the potential for a 1970s' style of inflation?

Chart 1

Take a look at Chart 2, which plots the behavior of the M2 money supply on a six-month annualized basis. After the spike to 15.2% annualized growth in February of this year, in the six months ended July, annualized M2 growth was only 2.7%. Barring another surge in M2 growth, this sharp six-month deceleration in M2 growth implies a continued deceleration in year-over-year M2 growth and, thus, a reduced likelihood of a repeat of the 1970s high-inflation environment.

Chart 2

How is it that the explosion in assets on the Fed's balance sheet from approximately $901 billion at the end of July 2007 to approximately $2 trillion at the end of July 2009 (see Chart 3) has not resulted in a sustained explosion in M2 money supply growth? Because of the extraordinary increase in excess, or idle, cash reserves on the books of banks. As shown in Chart 4, banks' excess reserves soared from only $1.6 billion in July 2007 to almost $733 billion in July 2009. So, about 64% of the increase in Fed assets in the two years ended July 2009 was accounted for by the increase in idle cash reserves sitting on the books of banks. A further 8.5% of the two-year increase in Fed assets was accounted for by an increase in currency in our pockets and/or squirreled away in our safe deposit boxes (see Chart 5). This dramatic increase in the demand for "folding money" was likely the result of an extreme case of risk aversion rather than a preparation for a shopping splurge (other than for canned goods and ammo, perhaps).

Chart 3

Chart 4

Chart 5

Why have banks allowed idle cash reserves to pile up on their balance sheets? Several reasons. For starters, the Fed now pays them a nominal rate of interest to hold these idle reserves. But this is not the main cause of soaring excess reserves. The principal reasons are lack of capital and lack of demand from borrowers who might be able to stay current on loans. The banking system has experienced sharp losses in the past year and is about to experience a second wave of losses. These losses deplete bank capital. Without adequate capital, the banking system cannot create new credit. At the same time that banks are strapped for capital, they also are strapped for loan customers who are judged creditworthy (see Chart 6).

Chart 6

But, a year from now, the banking system is likely to be better capitalized and the demand for bank credit from creditworthy borrowers is likely to be rising. This is when we will have to start to be more concerned about that mountain of excess reserves sitting on the books of banks being "activated" to create new credit to the nonbank sector. If the Fed does not take steps to adequately neutralize these excess reserves, then the inflationary game will be on. I do not currently know how adroit the Fed will be in neutralizing excess reserves. Evidently those who are forecasting a return to 1970s style inflation do know. More power to them.

Paul Kasriel is the recipient of the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy

By Paul L. Kasriel
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2009 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Paul L. Kasriel Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules