Do you think the Fed is behind the curve?
— Michael Zigmont, CFA, Partner, Harvest Volatility Management, LLC
Not yet, but the big test is just around the corner.
The Fed has printed mountains of money, but the banks aren’t lending much (except to the Federal government), so most of the money is still sitting in bank reserves. As a result, the growth of the money supply (M2) has actually been surprisingly modest. This and the weak economy have kept a lid on inflation.
These charts from Northern Trust show what is happening.
First, the monetary base (bank reserves) has grown tremendously over the past year, but it has been flat for the past nine months:
Meanwhile, bank lending has fallen precipitously, which has prevented most of these dollars from entering the money supply.
Combine deleveraging with a crappy economy and the growth of the actual money supply (M2) has been contained (red bars are year over year growth, blue line is 26-week growth):
Thus, so far, core inflation has remained low:
That said, as the chart above also shows, inflation has started to tick up. If and when the banks start lending aggressively, inflation is poised to take off.
At that point, the Fed will have to be very aggressive about raising rates–and they’ll likely have to do it when the unemployment rate is still horrifically high. This will lead to outrage in both Congress (you’re killing the economy!) AND on Wall Street (you’re killing our profits and stopping us from lending!). It also will require Ben Bernanke to have a backbone that he has not yet displayed (it’s easy to give money away).
To be clear: The Fed WANTS inflation to be uncomfortably high for the next few years, as this will help the country inflate away its huge debt mountain (we’ll be paying back our creditors with dollars that are worth less). Thus, the perfect inflation rate per the Fed will be considerably higher than anyone who actually possesses dollars will want. This will lead to lots of folks yelling that the Fed is “behind the curve” when the Fed is exactly where it wants to be. The Fed will respond by talking tough and intentionally remaining behind the curve.
So, no, the Fed is not behind the curve YET. But it will be soon.
Have a question you want to ask Henry? Send an email to [email protected] with “ASK HENRY” in the subject line. (Goofy, yes, but easy to find in a crowded inbox.) Henry will answer as many of the interesting questions as he can.
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