In 1963 monetary economist Milton Friedman said, “Inflation is always and everywhere a monetary phenomenon. Fast forward nearly 60 years and we are still testing his hypothesis.
Let us take a look at what the M1 money supply looks like today. As you can see there has been an explosion in the Central Banks balance sheet from $1 trillion in 1981 to a fraction below $15 trillion today. The Central Banks kept saying that they will contract their balance sheet as soon as the economy stabilises. However, they have always been slow in taking the “sugar” away from the kids and each time before they were able to contract the money supply a new market contraction “crisis” (see blue S&P500 line) entered the equation. With each contraction we have seen even greater Central Bank stimulation as the impact of the sugar high became less powerful (we can see this from the collapse in money velocity). The latest response to the Covid-19 selloff has been the most bold yet. In fact I think this is the closest we have ever been to Ben Bernanke’s dropping money from a helicopter.
So the natural question with all the market intervention is surely this is inflationary, isn’t that what Friedman assured us? Well not so fast look how inflation has been coming down since 1981 following the oil supply shocks of the 1970’s; well that was until now.
Everywhere you turn today there is talk about inflation, most notably in China. Throughout the world but more so in China we are experiencing energy and production supply-chain shocks coupled with a major political drive towards net zero carbon emissions thus combining to drive oil and coal prices to nose bleed levels.
The Central Banks have in effect snookered themselves, raising interest rates to curb inflation is likely to tip the economy into recession, and whisper whisper, they kind of like the idea of inflation watering down the mountain of debt they have created.
If you look at the chart below you can see an analysis of the annual inflation rate and the subsequent 12 month returns for the S&P 500. The rate of 5 – 6% has seen a negative return over the next year, this is where we are right now, so will the markets behave the way they have in the past?
Coming back to the original quote of Milton Friedman and inflation always being a monetary phenomenon. We may have had to wait a long time for this hypothesis to be fully tested but I think the chickens are finally coming home to roost and inflation is everywhere.
The Central Bankers would like us to believe that it is transitory and will soon peak. Unfortunately with the wave of money being pumped into the system from a quantitative easing (money printing) and from a fiscal government spending point of view we are likely to see an insipid response from the powers that be.
How it all plays out I don’t know. I was a deflationist for the last 20yrs I saw the whole pile of debt imploding on itself. Well I was wrong and a slow learner. Didn’t John Maynard Keynes say that when the facts change so does his actions. Well that is exactly what I have done. I have come to believe the modern day Central Banker who is really a puppet of the state is unlikely to ever make the hard decisions. Therefore inflation is probably the way forward. The question is what does it look like 5yrs from now – Zimbabwe anyone?