[ FINANCE ]
Is Inflation Finally on the Horizon?
BY IVAN ILLAN
After more than a decade of a below-average (some may say, nonexistent) U.S. inflation rate, there’s a basic question
that begs answering… is inflation on its way? This same question was asked quite a bit coming out of the Great
Recession (2008-09), and there was much fear that higher inflation would ravage the U.S. economy. That fear wasn’t
misguided, as the historical relationship between inflation rates and money supply have been highly correlated from established
research, in decades past.
Is this time different? Often regarded
as the four most dangerous words in
the English language, trying to determine
whether this time truly is different,
particularly when it comes to inflation
expectations, could prove once again an
exercise in futility. Regardless, we should
enter with eyes wide open into this next
phase of economic recovery (or malaise).
Doing so is highly recommended, given
the monetary stimulus that had been so
quickly injected into the U.S. (and global)
economy to help stabilize several challenged
aspects of pandemic crisis management
– unemployment benefits, small
business survival, municipal and corporate
lending facilities, and Federal Reserve
Open-Market Committee activities.
In its simplest form, I’ve always
looked at money through the lens of
being just like any other product in a
marketplace. As such, it’s subject to the
laws of supply and demand. Here’s a
little Economics 101 review… When a
product becomes scarce and demand
for it remains stable, then its price naturally
rises in the marketplace. Likewise,
when demand falls and supply remains
unchanged, its price gets lower. Stock
markets, bond markets, and banana
markets all succumb to this same marketplace
dynamic. So, what happens
when supply increases with falling
demand? Though it’s hard to imagine
this scenario for goods or services – a
company increasing their supply into
a marketplace with less demand – the
endgame is the same. Market dynamics
would force the price to a much lower
market price equilibrium.
This last example is what we can
apply to the money “market.” Flooding
the marketplace with money (e.g.,
Federal Reserve monetary stimulus)
results in increased money supply.
Assuming stable demand for money,
the effect of increased supply would
drive the value of the money down,
along with the interest rates associated
with that money (or currency).
However, let’s say that the demand for
money doesn’t remain stable, but drops
and stays lower for longer (e.g., GDP
growth). In the accompanying chart,
from August 2017 to July 2020, we can
see an annualized U.S. money supply
growth rate of more than 10.3%, while
U.S. Real GDP has delivered a negative
annualized rate of –2.30%.
The dynamics of greater money
supply versus lower goods/services
production has the net effect of more
money chasing fewer goods/services.
This manifests with price inflation of
those goods/services, until such time
that either money supply is mopped
up through FOMC activities or (more
likely) higher output (driven by consumption)
within the economy occurs.
How long does all this take? Will this
time be different? Undoubtedly difficult
predictions to make with high
confidence, but their implications are
worth noting for anyone living off fixed
income or planning for retirement
income over the next decade or two.
18 BAY WINDOW