Inflation is transitory? Or at least that is what we are being told nowadays by the majority of leadership in the financial markets. However, we are starting to see some sources break from the transitory narrative. For example, this recent WSJ article states, “Americans should brace themselves for several years of higher inflation than they’ve seen in decades, according to economists who expect the robust post-pandemic economic recovery to fuel brisk price increases for a while.” In a prior post, we showed some recent warnings coming from other inflation experts, including Michael Burry, that contradict the idea that inflation in the US dollar will only last a short amount of time.
The fact is that it is very unlikely in my opinion that inflation is transitory and I fear that we will see the dramatic impact of money printing for many years to come. In the previous post, we introduced some of the main concepts of inflation but in this post, we will dig much further.
Essentially, there are 3 main components of inflation:
- Growth in money supply
- Monetary velocity
- Lack of resource slack
Growth in the money supply is the first component and can be measured using MZM (Money Zero Maturity). MZM has become one of the preferred measures of money supply because it better represents money readily available within the economy for spending and consumption. Furthermore, the Federal Reserve stopped tracking M3 in 2006. This measurement derives its name from its mixture of all the liquid and zero maturity money found within the three M’s. MZM includes money in all of the following: Physical currency (coins and banknotes), Checking and savings accounts, and Money market funds. Economists and central bankers use MZM along with the velocity of MZM to better predict inflation and growth, because the more funds readily available, the more money there is to spend, which can be a sign of inflationary pressures. The St. Louis Federal Reserve stopped tracking MZM Money Stock in February 2021. There are supposedly replacement metrics in M1 and M2 money supply which I’ll have to verify in the future.
Monetary velocity is the second component. The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another. It also refers to how much a unit of currency is used in a given period of time. Simply put, it’s the rate at which consumers and businesses in an economy collectively spend money. The velocity of money is usually measured as a ratio of gross domestic product (GDP) to a country’s M1 or M2 money supply. The St. Louis Federal Reserve also stopped tracking MZMV in Q4 2020. Similarly, this was replaced with M1V and M2V, which is the velocity of M1 and M2 Money Stock. Further analysis is required to understand how this differs from the prior measure.
The third and last component is lack of resource slack. This metric is closely tied to unemployment, resource utilization, and manufacturing capacity. This component is also a little harder to explain but it essentially gets at the cycle of wages. At some point a business can’t hire anybody unless they raise wages. Everybody is looking for workers so they are forced to raise wages to get them. As a result, people leave old jobs because the new employer will pay more to get them than the old employer will pay to keep them. Offhand, this doesn’t sound so bad. Keep following the cycle though and at some point, the business is either fully employed as much as possible or is maxed out on capacity. In other words, the business still can only get so much output out of their current resources. Rising expenses lead to a need to also increase prices, or raise income. Lack of resource slack implies that as long as rising wages lead to increased production then it is ok. As soon as the business maxes out production though, there is trouble.
Admittedly, this has all been a somewhat technical description so let’s attempt to simplify this concept with a story. So, let’s travel back to 1981. The average cost of a new home was $78,000, average monthly rent was $315, and a gallon of gas cost $1.25. On that date, I decide to stash $4000 in cash in my mattress because I know that that should be enough to pay for 1 year of rent. Just writing down those numbers just now, I think we can all see the problem as it relates to purchasing power. The $4000 would be our money supply. However, if I was somehow frozen in time and re-awakened in 2021, it would still be $4000 cash in my mattress. Now, it isn’t until I go to spend my $4000 cash that I begin to realize how much less I get for the same amount of money. The spending of money is the monetary velocity. At some point, I also begin to realize that the price of my steak is increasing month over month. Last month, I could buy 3 steaks for $45. This month, it has increased to 3 steaks for $50. The manufacturer has passed on price increases to consumers as they have had to deal with their own increasing expenses, including wages, transportation expenses, increased taxes, etc. Some other people decide to stock up more and buy up extra supply of items before they increase further in price. However, the manufacturer is tapped out in extra capacity so the shelves just go empty. Prices continue to increase as people begin to offer more for necessities. They realize that they need to make more money in order to pay for these higher prices and jump jobs for higher pay. A vicious cycle indeed!
And now that we have a basic understanding of inflation, we can all begin to see why the narrative that inflation is transitory is very suspect.
We’ll discuss our plan of action against inflation in a future post. For now, set up your FREE consultation with us here so we can customize your personal inflation plan.