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Transcript
The Case for Inflation Daryl Montgomery June 4, 2009 Copyright 2009, All Rights Reserved The Underpinnings for Major Inflation • U.S. is creating new money at a faster rate than economic growth to finance its budget deficits and trade deficit (Credit Crisis has made this problem much bigger). • Excess money availability is the one thing in common that all major inflations have throughout history (it’s not going to be different this time). • Money supply is expanding rapidly and potential credit availability is exploding. • At the same time, there is a commodity inflation cycle taking place between 2000 and 2020. • The correct definition of inflation is a currency losing its purchasing power (not credit creation). • The U.S. government understates inflation. Long Term Commodity Cycle Actual U.S. CPI Inflation Versus Reported 1980 to 2008 MZM – Zero Money, Seasonally Adj. Adjusted Monetary Base 1959 to 2009 Currency Plus Bank Reserves (future inflation) Total Reserves – 1959 to 2009 Sum of Deposits that count for Reserve Requirements Excess Reserves: Total Reserves minus Required Reserves Historical Backdrop for Inflation • When the U.S. left the gold standard in 1971, the dollar became a fiat currency – backed by nothing. • The restraints that prevented the creation of unlimited amounts of currency and credit were removed (and trouble followed). • This allowed the U.S. to run budget deficits from 1970 (except for 1997 to 2001) and Trade Deficits from 1976, which we can’t pay for with taxation, so borrowing from other countries and printing new money became necessary. U.S. Budget Deficit 1961 to 2008 National Debt 1940 to 2008 (1/2) Trade Deficit 1960 to 2007 The Current Situation • The Credit Crisis has caused the U.S.Budget Deficit ($1.85 trillion for 2009) and National Debt (now around $12 trillion) to explode. • Despite economic weakness, the Trade Deficit has only slightly improved. It only got better because of lower oil prices (and cheap oil is running out). • The Fed has expanded potential bank credit availability astronomically. Recovery will cause this money to flood into the economy. • The U.S. government can now only fund its twin deficits by ‘printing’ new money (foreign borrowing can no longer cover them). • It only gets worse in the next decade because of rising Social Security and Medicare payments. Projected Budget Deficits Next 10 Years 2009 Budget Deficit originally estimated to be $407 billion Problem with Deflation Arguments • Excess money creation has always led to inflation in the past (with a lagged effect). • Deflation claims fail to take into account money printing and that it can alter price behavior. • Price needs to be considered as a percentage of money supply, not as a fixed number as all deflation arguments assume. • Deflation claims rely on analysis that is twodimensional instead of multi-dimensional. A Simple Example • There is an economy which has $100 of currency and produces 100 widgets. Supply and demand are in balance and each widget sells for $1 (or 1% of the money supply). • A recession causes supply/demand equilibrium for widgets to fall to 80. If the money supply stays the same, each widget now costs 80 cents (0.8% of the money supply) and there is 20% deflation. • However, the government doubles the money supply to $200, so 0.8% of money supply is now $1.60 and there is 60% inflation in widget prices. Classic Supply Demand Chart