Pep,

As you've indicated many times, the classical definition of deflation is a decrease in the quantity of money (cash + credit).

Personally, I've yet to see a broad measure of money supply that has actually declined. For example, all monetary aggregates you show in this missive, including M3 continued by SGS, indicate positive YOY growth.

Perhaps I'm missing something, but is it really accurate to state as you have here that government attempts to inflate the money supply have been 'unsuccessful' thus far?

Based on a review of the data, it seems that one could just as easily posit that government actions to increase the money supply have successfully staved off the deflationary beast...thus far.

Humbly,

Matty

What we have is rather unprecedented. It may help to look at a four part picture. Inflation is the expansion of money base. Inflation plus time generates higher prices as more money is chasing up the price of goods and services. In simplest terms deflation is the opposite of inflation. ergo a reduction of money base leading to a loss of demand for goods and services leading to lower prices. Wrong annalysis. The inflation part is correct, but the deflation part works in the opposite direction. Deflation begins with Falling prices which can have any number of causes and plus time will cause deflation of the money base eventually. What we have right now is we are stuck in the middle of the time part. In econmomist's and government thinking letting deflation reach the point of having an effect on the money base is unacceptable, and the consensus theory is that the easiest way to fight the deflationary downward spiral is through increasing the supply of money. Hence the cats meow. We have deflation and inflation at the same time. Inflation will rule, as deflation is considered unacceptable.

Reading the Bloomberg article on the conundrum, it seems to me that at some point the Fed may take less of a shotgun approach. Instead of buying US treasuries, they may focus directly on mortgage rates and move toward government guaranteed loans to home buyers to keep mortgage loans at a lower interest rate.

Letting rates rise on mortgages does not seem to be an option if they want to stimulate the economy. And housing is a root problem for the economy.

Matt - Velocity is definitely contracting and the money is not making it into the economy. Simply looking at the broad measure will not paint the full picture of the magnitude of the debt unwind. I agree with you that a strong case can be made that the Federal Reserve has not yet fully lost control of monetary policy and their attempts to stave off the worst of the deflationary debt unwind so far is working. But it's not over yet.

First, thanks for this comment as it made me really stop and think about this article and these charts.

I think what these charts might be hiding is that the increased money supply is not actually available to the people who make the economy go. The Fed is pouring money into the institutions that used to make credit available for Jane and Joe Average.

But for "real" inflation to happen, I think we need to get money to the Averages/ (Tee hee..) In my world, the opposite is happening. I have 1 less credit card as of June 1 (I was an Advanta Business Card holder, which I never used.) My credit card offers have slowed to a trickle. I know from my sister that private student loan funding is very precarious. My aunt just locked in a HELOC for fear she couldn't get one next year.

The Fed is debasing the currency, certainly, but short of large direct loans or deposits, I don't see how the Fed can overcome the loss of private institutions increasing the money supply at will.

What do you (Kevin, Matt) make of the M1 figure? Is that people moving to cash after the last years worth of economic crisis?

Higher M1 fits the pattern of more risk aversion.

Re the money/credit 'not getting' to many people quick enough, this ALWAYS during an inflation. Certain entities get the money/credit first when it has relatively high value. As the money trickles down thru the system, it loses value. By the time it gets to the remainder of the people, it's worth much less. This is one mechanism for inflation as a wealth confiscation/redistribution device.

And yet, we go willingly...

Thanks! Okay, so I was reading M1 that in a similar manner.

As far as inflation goes, I'm not sure we have a choice. Even if we remove the stupidity of the last decade, our Federal debt alone is completely unpayable. Add in state, local obligations, and SS obligations and there are absolutely no choices. We either default or print money or (more probably) print money until we default.

I get how printing money debases the currency and makes those not getting the money first, especially poorer. I guess I tend to think of there being two separate economies: 1 of them, at the Fed, level is about moving millions/billions of dollars. It's about the derviatives market and credit crisis noone on Main Street understood because their credit cards still worked.

The other, the one really 95% of us live, consists of moving around a few thousand dollars, going to Wally world for supplies and hoping we have a job tomorrow. They each affect the other but it's not a straightforward relationship. Will the Fed dumping money into the rarified air of the M3 world mean that I'm broke in 5 years or can't afford to buy food thanks to out of control inflation? Maybe or maybe not. It depends on what those institutions are doing going forward. (I was introduced to the idea of 2 separate economies by the folks at iTulip, but I suspect they wouldn't like my deflationist tendencies. *grin* )

I don't doubt we'll move into inflation at some point in the next decade or two, too, as I mentioned before. I just don't see how we get there in the immediate future without the Fed literally handing the teeming masses thousands of dollars. That's what the masses had before the credit crisis hit and now, not so much. :(

So they're not mailing out credit cards over the new rules or because they know that they are already facing a 25% default rate?

If the populace follows the government and business model of the past year, they'll max out their credit cards and HELOC's. That could be where our three month bounce has come from; Spring, happy days are here again, let's start spending!

The FED is trying to keep the capital at the top, in the banks and insurance and other companies, hoping that it will bolster confidence, borrowing, and a return to the market.

What if the only people coming to the party are the bad debt risk crowd that are spending what credit they have left, or the people who have lots of money and aren't worried about spending it? If the middle class stays at home it won't matter what the FED does to bolster banks or markets.

Kevin, won't inflation eventually rear it's head as yield rates go up and the value of the dollar goes down? If housing prices drop another 15-25% and the commercial real estate bubble pops, and the foreclosures ramp up, how quickly does the debt unwind and do we whipsaw into inflation?

Cheers,
Eric

should begin to pick up, once the Fed refuses to allow them to sit back & invest in treasuries. Given that accounting rules have been altered, so that the banks need not tremble about posting whopper losses, I think all that remains is for Fed to place additional limitations on how they may operate "their" businesses. I don't think it is feasible for the Fed to continue usurping the role of all players in the "free" credit markets. What has come to pass amounts to massive power transfer to the Fed...publicly traded banks will be forced to arrive at the conclusion that consumer lending is required...that is need not be economically profitable lending, since political profitability is all that anyone in power cares about.

That's what could kick inflation into high gear. First the Fed tries everything under the sun to pyramid credit thru the banking system. If this system truly is broken, at some point they'll figure this out. Rather than just give up and tolerate further deflation, central banks might then get out the helicopters and bypass the broken credit system by sending money directly to the masses.

Such a situation would be more in line w/ Weimar.

And that's the tough part: how likely is it that the Fed will hand out thousands of dollars directly into people's bank accounts? It's a possible scenario but it seems improbable currently.

And the implication of an action like that is that the Fed has completely and utterly lost any semblance of it's original mission and/or whatever control it had.

I guess that's why my personal confirmation bias is toward deflation. I understand and feel like I'm living through the mechanisms of those forces, despite the best efforts of the Fed. The near term inflation (next 12-18 months at least) mechanisms have always seemed highly improbable.

The only scenario of inflation I've really liked is the idea of inflation through shortages rather than price increases. However, I haven't seen or heard reports like that yet.