Tuesday, March 01, 2011

M2 Growth Below 4% + Velocity at 25-Year Lows + 4% Real GDP Growth This Year = No Inflation

Here's an updated chart of annual M2 growth, with data through the second week of February.  For the week ending on February 11, annual M2 growth was only 3.9%, more than two percentage points below the 6.05% average since 2000.  If that kind of M2 growth continues this year, and if we have 4% growth in real output this year, there's very little chance of inflationary pressure building in the U.S. economy.  Moreover, M2 velocity as of the last quarter of 2010 was close to a 25-year low (data here), so it just doesn't appear that we have any of the right ingredients for rising inflation. 

21 Comments:

At 3/01/2011 2:55 PM, Blogger Gale L. Pooley said...

What prevents velocity from taking off?

 
At 3/01/2011 3:03 PM, Blogger morganovich said...

this is circular reasoning.

real GDP growth is a function of inflation.

thus, if we under-report inflation, we over report real GDP and mistake inflation for real growth.

thus, a prediction of low inflation leads to a prediction of low inflation.

if we assume higher inflation that the estimated GDP deflator, the 4% m2 growth is already and will continue to be inflationary.

this argument hinges entirely upon current inflation statistics and estimates being correct.

deflate GDP at at CPI as opposed to the much lower GDP deflator (especially in q4) or something like the BPP figures, and this argument falls apart.

 
At 3/01/2011 4:08 PM, Blogger PeakTrader said...

Good Deflation and Bad Deflation:

Good Deflation
A. Gary Shilling, 02.18.02

The bad deflation of insufficient demand, as in the 1930s and in Japan today. They note that in deflation buyers wait for lower prices, with the result that excess capacity and inventories force prices lower. This confirms buyer suspicions, leading to more purchase postponements and a downward price spiral.

The good deflation of excess supply driven by new tech. This was true in the late 1800s, when the Industrial Revolution and railroads created tremendous productivity and excess capacity. The economy grew an extraordinary 4% per year in real terms between 1870 and 1896, as wholesale prices fell 50%. Similarly, the Roaring Twenties were deflationary, as electricity and autos spread.

 
At 3/01/2011 4:10 PM, Blogger Benjamin said...

The Fed needs to get a lot more aggressive.

Japan has shown the way to what tight money can do to a nation.

 
At 3/01/2011 4:42 PM, Blogger PeakTrader said...

The recession was a combination of "bad deflation" and "good deflation" of "insufficient demand" and "excess supply," and according to Warren Buffett, we're still in recession.

 
At 3/01/2011 4:51 PM, Blogger PeakTrader said...

I stated before, a $5,000 tax cut for each worker in late '08 or early '09 (or $750 billion for the 150 million workers at the time) would've created a V-shaped recovery and strengthened the banking system.

Significant tax cuts worked under Kennedy in '61, Reagan in '81, and Bush in '01.

 
At 3/01/2011 5:09 PM, Blogger morganovich said...

b-

"The Fed needs to get a lot more aggressive.

Japan has shown the way to what tight money can do to a nation."

i notice you had no comment about the mathematical proof i showed you that money supply in japan has had no causal effect on growth since 1990 (whereas it did in prior decades).

this is all on the last japan thread, so i won't repeat it here.

every time you lose this argument you just run off and then make the same unsubstantiated claims again and again.

japan's issue is not monetary, it's based on zombie firms sucking up resources and a demographic disaster.

go read the study and work the eigenvalues and colinearity yourself. the math is not difficult.

you will very rapidly see that the causal or even coincident relationship you posit has not existed in japan for 20 years.

money supply growth is just pushing on a string when it all goes to nonproductive uses and is offset by a huge drop in demand from an aging (and now shrinking) population.

 
At 3/01/2011 6:47 PM, Blogger Benjamin said...

The BoJ not too tight, Morgan?

Explain why the Yen has appreciated so much in the last 20 years.

Waiting....

 
At 3/01/2011 7:20 PM, Blogger morganovich said...

benji-

that's a foolish statement about the yen. it's comments like that that makes me so skeptical of your economics education.

once more, you have chosen a proxy that does not stand for what you are trying to demonstrate.

there are so many moving parts in it that it is not an indicator of anything like what you claim.

is the yen up or the dollar down?

the yen is right where it was vs the euro 10 years ago.

flat to down against the CHF as well.

the yen depreciated 83% vs the dollar from 1995 to 1998. did not help the japanese economy one jot. growth slowed over that period and fell into recession.

then as the yen rose again from 1998-2005, the economy recovered.

so much for you yen indicator.

you have the relationship completely backwards.

because you are such a relentlessly supply side thinker, you completely fail to understand why the causality goes the other way. chart japanese gdp vs the yen. you'll see that the strongest growth over the last decades coincides with the strongest yen.

if you look more closely, you'll see that the causality is not yen driving gdp but gdp driving yen. it's a trade balance issue, not one of monetary policy.

you seem to think that if you just shovel enough yen out there the demand will materialize. this has not been the case. you read that study on jm2 and gdp yet?

it appears that there is no price increase violent enough for you to call it inflation nor any monetary policy profligate enough for you to call it loose.

 
At 3/01/2011 7:23 PM, Blogger morganovich said...

also note:

dollar yen hit 79 and change in 1995.

it's 81.83 now.

 
At 3/01/2011 7:39 PM, Blogger PeakTrader said...

Wikipedia:

"In April 1995, the yen hit a peak of under 80 yen per dollar, temporarily making Japan's economy nearly the size of the US. (based on PPP)."

We know that's not really true (e.g. Japan real per capita GDP twice the size of U.S.).

 
At 3/01/2011 8:48 PM, OpenID Sprewell said...

Interesting that you make that point, Gale, as I was going to make the converse: what could ever prevent velocity from going up or down? Other than secondary effects like Obama's overregulation chilling the business climate, it strikes me that money supply growth is way overrated in an economy like the US. Obviously if there's rampant money supply growth, like in Zimbabwe, that's going to have an effect, but I wonder if velocity isn't a much bigger factor in countries like the US, where money supply growth always stays within a stable range. In fact, the whole argument that the Fed or the money supply are so important is somewhat fatuous, as it requires that the limiting factor in total transactions is the overall supply of cash, which is probably almost never the case.

I bet a lot of monetarists and the Fed-obsessed are confusing correlation with causation, ie the Fed raises or lowers the money supply in response to overheating or chilling velocity and prices correct, but they would have anyway, even without the Fed changing a thing, as prices revert to trend. Hummel and Henderson have pointed out that Greenspan essentially froze the monetary base and it was a rise in velocity, particularly with a big jump starting in the '90s, that caused most of the inflation we've seen since. The truth is that Friedman's famous dictum that inflation is always and everywhere a monetary phenomenon, at least as it can be interpreted as putting money supply growth paramount, has been found in the ensuing decades to be empirically suspect. A recent EconTalk about inflation touches on the subject of velocity perhaps being more important. In sum, while it is perhaps useful for some investors to try and tease out to what extent prices don't reflect fundamentals, I bet a lot of the time spent obsessing over the money supply is wasted.

 
At 3/01/2011 9:15 PM, Blogger VangelV said...

I stated before, a $5,000 tax cut for each worker in late '08 or early '09 (or $750 billion for the 150 million workers at the time) would've created a V-shaped recovery and strengthened the banking system.

Significant tax cuts worked under Kennedy in '61, Reagan in '81, and Bush in '01.


You forgot the other side of the equation; cutting government spending. Cut the federal government by 75%, get rid of most of the agencies that get in the way of honest people trying to get ahead and you will have a real and sustainable recovery. Cutting taxes without addressing the serious problem of a government that is too big will not do the trick.

 
At 3/01/2011 9:17 PM, Blogger VangelV said...

The Fed needs to get a lot more aggressive.

Japan has shown the way to what tight money can do to a nation.


Japan borrowed money and now has the greatest Debt to GDP ratio of all developed nations. It did not pursue a tight money policy and intervened with the best of them. The only thing that saved Japan (so far) is the fact that its debt was held internally.

 
At 3/01/2011 9:38 PM, Blogger PeakTrader said...

The cause of the recession was the combination of restrictive monetary policy and contractionary fiscal policy.

The chart shows the money supply was too low from 2003 until the recession (or below 6% nominal growth), while budget deficits shrunk to $162 billion in 2007.

Also, I may add, in the equation MV = PT, if M and P are constant, then V = T, i.e. V, the velocity of money, or the number of times money is exchanged, equals T, the number of transactions, or the quantity of goods exchanged. T can be represented by real GDP.

The goal of monetary policy should be to keep actual GDP close to potential GDP, which smooths-out the business cycle creating optimal growth (since there's neither strain nor slack in the economy).

The fact that there are monetary tightening and easing cycles, to close output gaps, are attempts to smooth-out T in the short-run. V and T fluctuate in the short-run, which require adjustments in M to stabilize P and smooth-out T.

For example, if people decide to hoard money, then V and T will fall (in the short-run). So, M needs to rise (higher than a constant growth rate).

 
At 3/01/2011 10:33 PM, Blogger PeakTrader said...

A problem of monetary policy are the lags in the adjustment process. So, the Fed has to work in the future economy.

If the Fed began the easing cycle several months earlier, that would've made a significant difference, e.g. between a mild recession and a moderate recession.

However, the Bush tax cut in early '08 gave the Fed time to catch-up. The country was on a path to a mild recession, until Lehman failed in Sep '08.

 
At 3/02/2011 8:19 AM, Blogger PeakTrader said...

It's more accurate to say in the mid-2000s, monetary policy was accommodative, became neutral, and then restrictive rather than the money supply was too low.

Also, up to $800 billion a year trade deficits drained money out of the private sector, because dollars were shifted to export-led economies, and then flowed into the government, i.e. U.S. Treasury bonds.

 
At 3/02/2011 1:20 PM, Blogger Benjamin said...

Morgan-

What the hell charts are u using?

The yen was at 145 in 1990 and about 81 now. It gets stronger and stronger the dollar rather steadily.

Vange-

I do not agree with Japan's deficit spending, especially as it was not accommodated by monetary expansionism.

I think the facts are irrefutable that Japan is choking itself. China and S. Korea are passing them by.

The new Thailand-Japan bund (sorry to mix terms) is interesting, and may offer an avenue for Japanese comppanies to step outside the airless room created by the BoJ.

10-15 years from now you may buy products marked "made in Thailand" nearly as often as you buy "Made in China".

 
At 3/03/2011 1:46 PM, Blogger morganovich said...

benji

that's a cheap dodge.

the yen hit 79.78 in 1995. go look it up.

you are just cherry picking a start date.

it then depreciated for 4 years while japan slid into recession.

it then remained in a stable range vs the dollar for a decade.

run the r squared yourself - strong yen has coincided with stronger japanese gdp growth and a wek one with weak growth.

i think it was growth driving yen as opposed to the other way around, but whichever is true, your claims are demonstrably invalid.

 
At 3/03/2011 2:02 PM, Blogger morganovich said...

"The yen was at 145 in 1990 and about 81 now. It gets stronger and stronger the dollar rather steadily. "

you are just making stuff up. what chart are YOU using?

yen was 79 in 1995, hit 147 in 1998, 101 in 2000, 135 in 2002, 101 in 2005, then 124 in 2007.

it's been appreciating since vs the dollar, but that has to do with our policy, not theirs.

it's down vs the euro this year and has basically gone nowhere vs the CHF since mid 2009 and is at a chf/jpy exchange rate of 88.44, essentially right where it was in late 1992 and a great deal weaker than the 58.80 it hit in 2000.

dollar debasement is not the same as tight money in japan.

 
At 3/04/2011 9:43 PM, Blogger VangelV said...

The cause of the recession was the combination of restrictive monetary policy and contractionary fiscal policy.

Hell no. The cause was a massive injection of liquidity that had to end some time. Fiscal policy has never been contractionary because the government has failed to live within its means or to shrink to its appropriate size. This is why the dollar is on the brink as are most, if not all, fiat currencies.

The chart shows the money supply was too low from 2003 until the recession (or below 6% nominal growth), while budget deficits shrunk to $162 billion in 2007.

No, the chart shows that money supply was growing by more than 2%. It does not show and cannot make a judgement about the money supply being too high or too low.

Also, I may add, in the equation MV = PT, if M and P are constant, then V = T, i.e. V, the velocity of money, or the number of times money is exchanged, equals T, the number of transactions, or the quantity of goods exchanged. T can be represented by real GDP.

The Fisher equation is total nonsense because you can't calculate 'P', which is supposed to be the 'average price level' of commodities and services. The variable 'T' is the quantity of goods and services against which payments are made and the money is exchanged. The velocity, 'V", is not an independent variable and also can't be measured.

So what we have is an equation that is only true because it says that what is paid is equal to what is received. In essence, had the money side balance the goods side.

But Fisher was full or crap because statistical studies showed that his treatment of 'V' was wrong. In his book, The Purchasing Power of Money, Fisher treats V as a relative constant which makes the price level directly proportional to M.

But the statistical studies have shown that is not the case. Individuals are not automatons who follow certain predetermined mathematical rules and they react to things other than just the money supply, particularly over the short term. Early in the game you may be able to expand the money supply rapidly without seeing the same level of increase in the price level. But as time passes the price levels catch up and finally surpass the change in the money supply later in the game. This is exactly why you get a blow off spike in prices late in hyperinflationary episodes that looked contained earlier on.

It is this reliance on stupid formulas that do not reflect reality that causes many of our modern economic problems. As economists abandoned the sound theories that they knew so well and moved towards abstract 'empirical' and 'mathematical' modelling studies that were far removed from reality the economy became less and less stable. Believe in the voodoo if you wish but a prudent man would bet with reality.

 

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