Is Money Supply Inflationary? You Bet Your Madoff!

The Federal Reserve reported their Money Stock Measures yesterday and November showed a y-o-y increase of M2 money supply of 7.6%, which is the highest y-o-y growth rate in the last 12 months and, as seen on the chart below, is on an accelerating trajectory. Undoubtedly, money supply only accelerated in December as the Federal Reserve became even more focused on deflationary pressures and the need to stimulate growth.

We would expect money supply to continue to grow, especially since there no longer exists the “policy lever” option to adjust interest rates now that the current target rate for federal funds stands at 0 - 0.25%, or effectively zero. As Fed Chairman Bernanke outlined in a 2004 speech:

“Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”

Bernanke’s remarks lead us to believe that the next policy step is to “print” money. More money ultimately results in the declining value of money, which is always inflationary.

We have been a bit of a lone voice beating the “re-flation” drum in the past few weeks, but this report from the Fed seems to suggest, especially if the money supply continues to accelerate, that “reflation” is not a matter of if, but when.

Stock markets are certainly “re-flating” today.

Daryl G. Jones
Managing Director