Market Overview

This Chart Shows Why Inflation Fears Are Overdone

This Chart Shows Why Inflation Fears Are Overdone
Related BROAD
FOMC Statement From July 29 to July 30
Euro Hangs In The Balance As Fed Meeting Gets Underway
Related SPY
Vice Index: Where The US Economy Stands Going Into 2018
Central Bank Vigil: FX Steady And Going Nowhere via OANDA
Wall Street Breakfast: Fed Decision, Outlook On Watch (Seeking Alpha)

Everyday, economists vent their opinions on the Federal Reserve's easing policies and each one touts the need for easing. However, more focus has been given to the risks of expansionary monetary policy lately, mainly those of inflation.

Well, here is one chart that clearly, substantially, and quantitatively cancels out those fears... at least for now.

Economists have argued, and somewhat proved, that in the last thirty years, do to the increased use of and reliance on monetary policy to stimulate economies, inflation has become a monetary phenomenon.

Austrian economics, a third school of economic thought that differs from Keynesian and Monetarist schools of thought, argues that growth (and thus inflation) are simply dependent on the growth of credit-money.

This is one of the key tenets that differentiates Austrians from other economists and one that was verified by the Great Recession. As bank lending collapsed due to the massive over-inflation of the housing market, inflation slowed and so did the economy.

Thus, believers in the theory argue that more conservative banks making smaller and fewer loans argues exactly for the sort of stimulus provided by global central banks, including the Fed.

As the chart at the bottom of the page shows, inflation has slowed over the past ten years as has the velocity of money. A quick glance at the chart shows that inflation has slowed as the velocity of money, or the rate at which money flows through the economy, has slowed.

Thus, the lower rate of the creation of credit-money due to slower bank lending not only calls for central banks to step in and fill the void, but also shows that inflation is no where on the horizon.

So long as the velocity of money stays low and drags inflation lower with it, and so long as bank lending remains conservative as banks focus on cost cutting to boost profitability, expect inflation to remain tepid and sub-trend.

This is one of the reasons that the Fed has adopted an unofficial inflation target of 2.5 percent Core PCE inflation over the medium-term, back where it was in the boom times of 2005 and 2006.

So what does this mean for your portfolio? First of all, it means the fears of a sudden and imminent collapse of the bond market are over-done. The Fed has committed itself to purchasing bonds to meet both of its targets, inflation and employment. Thus, as long as the Fed is printing to reflate the economy back to 2.5 percent inflation and ease unemployment to below 6.5 percent, expect the Fed to keep a bid under the bond market.

Also, the fears of inflation eroding away yields on bonds also seem overdone unless inflation, by way of the velocity of money, suddenly picks up.

Bond markets, as measured by the break-even rate of inflation, are pricing in anywhere between 2.2 and 2.5 percent inflation over the next ten years. This rate is extrapolated by subtracting the TIPS yield for a given maturity from the nominal bond yield.

Since TIPS yields are negative all the way out to January 2029, government bonds are expected to return a real yield slightly below inflation through 2029, although only marginally so.


As the above chart clearly shows, and as many know, stocks have increased as the Fed has expanded the size of its balance sheet. Thus, so long as the velocity of money remains low, and as long as the Fed is forced to fill the void in the creation of credit-money left by conservative banks, bond prices should remain well bid and stocks should remain supported as well.

This should last until banks begin growing lending at rates not seen since 2005-2006 and inflation begins to creep higher. Until then, inflation is no where to be found.

Stock chart: 
Stock chart

Posted-In: Long Ideas News Bonds Global Econ #s Economics Markets Trading Ideas Best of Benzinga


Related Articles (GLD + BROAD)

View Comments and Join the Discussion!

Partner Center