Category Archives: Money Supply

Persistent Inflation and Loss of Purchasing Power

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U.S. Consumer Price Index (CPI) data was hotter than expected.

March 2024 U.S.CPI annual inflation rose 3.5%, above expectations of 3.4%.

Core CPI inflation increased 3.8% year-over-year (Y/Y), compared to forecasts for a gain of 3.7%.

The March 2024 Consumer Price Index for All Urban Consumers (CPI-U) report marked a third consecutive 0.4% month-over-month (MoM) increase. On a year-over-year (YoY) basis, inflation rose by a stronger-than-expected 3.5% in March

  • The slightly stronger March Consumer Price Index (CPI) report was driven by rises in shelter and energy prices.
  • March’s stronger year-over-year (YoY) rise in the headline CPI suggests the path to the Fed’s 2% target could take longer than expected.

Persistent Inflation occurs when the U.S. money supply grows more rapidly (to pay for huge fiscal deficits) than the country’s economic output.

Money Supply and Inflation:

When the Federal Reserve (the Fed) increases the money supply, it leads to inflation.

Imagine an economy with $100 and 100 bananas. If the government increases the money supply by 10% to $110, but the banana output only grows by 5% to 105 bananas, we have more money chasing fewer goods. As a result, the average price per banana increases from $1 to roughly $1.05. Thus, the purchasing power of the currency is reduced.

The quantity theory of money (QTM) suggests that the value of money is determined by supply and demand. When the money supply grows faster than economic output, inflation occurs.

Monetarist View:

Monetarists believe that inflation results from too many dollars chasing too few goods. As the money supply grows, the value of money decreases due to supply and demand dynamics.

In summary, managing the money supply is imperative for the Fed. Too much growth can lead to persistent inflation, affecting the purchasing power of the dollar.

U.S. Money Supply Drives Inflation

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“Inflation is always and everywhere a monetary phenomenon.” – Milton Friedman

Economist Steve Hanke view has been that the volatile and non-transitory inflation of recent years is chiefly due to changes (a significant increase) in the US money supply, not other factors such as supply-chain disruptions and swings in energy and metal prices.

Hanke, a former economic advisor to Ronald Reagan, served as the president of Toronto Trust Argentina when it was the world’s best-performing market mutual fund in 1995.

“As Milton Friedman taught us long ago, inflation is always and everywhere a monetary phenomenon,” Hanke said. “That’s why our forecast, based off the quantity theory of money, has been so accurate.”

“Inflation is taxation without representation.” ~ Milton Friedman

The veteran economist Hanke and a colleague, John Greenwood, predicted in July 2021 that the headline Consumer Price Index would rise as quickly as 9% on an annualized basis; it peaked at 9.1% a year later. They later forecast the inflation measure would fall to between 2% and 5% by December last year, and it ended the year at 3.4%.

“Money [supply] is the economy’s fuel,” Hanke and Greenwood warned the US economy was “running on fumes” and “on schedule to tank” given its money supply had contracted since March 2022, after growing by a historic 27% in part due to fiscal stimulus measures during the COVID-19 pandemic.

References:

  1. https://markets.businessinsider.com/news/stocks/steve-hanke-stocks-economy-outlook-recession-inflation-forecast-fed-money-2024-1