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US money pumping by
decade and Fed chairman
A large increase in the
money supply will always lead to large increases in prices somewhere in the
economy. However, monetary inflation affects different prices in different
ways at different times, so the pertinent question is: which prices? The
answer to this question is important from the perspective of almost everyone
and is always obvious with the benefit of hindsight, but it is often
difficult to determine ahead of time. Also, depending on which prices are
affected the inflation will sometimes be widely perceived as a problem and at
other times be widely perceived as a benefit or a non-issue.
Due to the dramatic differences in the general perception of inflation that
stem from the specific details of inflation-related price rises, in the US
there has been no correlation over the past several decades between the
amount of monetary inflation and the extent to which "inflation" is
perceived as a problem. As evidence we present the following bar chart
showing the compound annual growth in the US True Money Supply (TMS) during
each decade since the 1960s. Of particular interest, the 1970s is widely
considered to be a decade when "inflation" was out of control, but
our chart shows that the money supply grew at a much faster average pace
during the supposedly 'disinflationary' 1980s than during the 1970s. Also,
during the first 4 years and 5 months of the current decade the US money
supply grew almost twice as fast as it did during the 1970s, and yet very few
people perceive a US inflation problem at this time.
The lack of correlation between the amount of monetary inflation and the
general perception of "inflation" leads to a lack of correlation
between the general perception of a Fed Chairman's performance and his/her
actual performance. Paul Volcker is the best example. Volcker is generally
considered to have been a hard-nosed inflation-fighter, but based on annual
rate of growth in the money supply he currently holds the record as the most
inflationary Fed Chairman of the past 60 years. Ben Bernanke is in second
place, followed by Arthur Burns (Fed chief during most of the 1970s), Alan
Greenspan, and then William McChesney Martin (Fed
chief during the 1950s and 1960s). Refer to the following bar chart for
specific details.
Note: The chart omits George Miller, who was Fed Chairman for only 17 months
during 1978-1979, and Janet Yellen, who only
recently took over from Ben Bernanke.
On a related matter, Volcker is widely regarded as a hard-nosed inflation fighter
simply because a commodity-price collapse got underway within 6 months of his
August-1979 appointment as Fed Chairman. However, thanks to the steep decline
in the money-supply growth rate that began in late-1977 and the fact that the
US had spent the 6 months prior to August-1979 in monetary deflation, a
commodity price collapse was 'baked into the cake' when Volcker took the helm
of the Fed. Whoever was appointed Fed Chairman in August 1979 would now have
the credit for having ended the "great inflation" of the 1970s,
almost regardless of what actions they took.
Finally, it's actually a problem that the rapid money-supply growth of the
past 5 years has not yet led to general concern about "inflation".
It all but guarantees that the Fed will continue to react to economic and/or
stock-market weakness by pumping up the money supply, especially since the
new Fed Chair clearly believes that the central bank can create jobs and
economy-wide prosperity by adjusting monetary levers and the price of credit.
The likely result will be an economic bust within the next few years that
dwarfs what happened during 2007-2009.
Will the Fed end its current money-pumping program this year?
The FOMC meeting on 17-18 June was another non-event, as it came and went
with no surprises and minimal effect on the financial markets. As widely
expected, the Fed continued along the $10B/meeting "tapering" path.
Given the absence of signs that the Fed is about to deviate from this path
and the broadening recognition that QE is not helping, it's time to revisit
the question: Will the Fed follow through on the commitment to end its
money-pumping this year?
Earlier this year we thought that the answer was no. More specifically, we
thought that the Fed's "tapering" would terminate prematurely
during the third quarter. For example, in our 2014 Yearly Forecast, which was
published in January, we wrote:
"The economic data will probably be OK during the first few months of
2014, but if commercial-bank credit growth continues at its present slow pace
then by the third quarter of this year there will probably be enough stock
market weakness and enough signs of economic deterioration to prompt the Fed
to step away from its "tapering" plan."
And in the 14th April Weekly Update, we wrote:
"The Fed began to reduce the rate at which it creates new dollars a
few months ago and plans to turn off its 'money pump' before the end of this
year. We think that by July-August of this year the Fed will be sufficiently
worried about how the stock market and the economy are faring to prematurely
end its "QE tapering", but in the meantime there will be a further
scaling-down of the Fed's so-called "monetary accommodation"."
The US economy has been sluggish during the first half of this year; however,
the senior US stock indices have continued to grind upward. The S&P500
Index is only up by around 6% since the beginning of the year, but it just
made a new high. Its upward trend is therefore intact. Although a significant
(10%+) decline is likely within the next two months, the fact that it is
taking longer than expected for the stock market to top-out suggests that
equities won't get weak enough soon enough to jolt the Fed from its
"tapering" path.
As an aside, the inability of the economy to 'gain traction' is an inevitable
consequence of the Fed-engineered monetary deluge of the past several years.
This is because the flood of new money prevented markets from clearing,
discouraged saving (the necessary initial step in the growth process), and
caused resources to be wasted on projects, businesses and other investments
that would not have been viewed as economically viable if not for the
central-bank suppression of interest rates.
The stock market's resilience is undoubtedly due in part to an increase in
the pace of commercial bank credit creation. The current 3.8% year-over-year
(YOY) rate of growth in commercial bank credit is low by historical
standards, but it is up from only 1.2% at the beginning of this year (note
the up-tick on the chart displayed below). Importantly, in the process of
expanding their balance sheets at a faster pace the commercial banks have, to
date, created enough new money to more than offset the Fed's reduced pace of
money pumping. This has pushed the YOY rate of growth in US True Money Supply
(TMS) up from 7.0% at the end of December-2013 to 8.2% at the end of
May-2014. It is therefore fair to say that monetary conditions in the US are
easier today than when the Fed commenced its QE "tapering".
So, getting back to the question of whether the Fed will scale down the
current QE program to zero as originally planned, our answer is now: yes, it
probably will. Thanks to the up-tick in commercial-bank credit growth and the
extension of the stock market's upward trend, the Fed probably won't be
pressured by its unwavering devotion to bad economic theories to provide
additional monetary 'support' until after this year's QE "tapering"
has run its planned course.
This is an excerpts
from commentaries posted at www.speculative-investor.com over the past week.
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