economics

Post-COVID, A Large Increase in Inflation May Be Coming

Economist, Political Analyst
Economist, University of Buckingham
Genesis
Response
Penultimate
Finale

Tim Congdon

Economist, University of Buckingham

May 24th, 2020
Non-economists may chuckle about economists' bickerings, particularly when they relate to something apparently so esoteric as the best money aggregate to use in macroeconomic analysis. But I insist that in the USA M3, not M2, is that aggregate. M2 excludes bank deposits if their holder owns more than $100,000 in a particular account, which has the effect of not counting money held by big business and large financial institutions. That is crazy in my view. Of course, their money holdings affect decisions by big business and large financial institutions, and these decisions affect output, employment, the price level...(Yes, I know that the Federal Reserve stopped publishing M3 numbers in 2006. That is another demonstration of its incompetence and folly.)
I am pleased that Professor Schettino agrees that recent US money growth patterns signal a future rise in inflation. They have indeed been extraordinary. As I pointed out in my first response, Federal Reserve data show that in the last three months bank deposits—the main constituent of money on the broad definitions—have been expanding at annualised rates of 75% or so. The annual increase in the M3 quantity of money—now just above 20%—is likely to rise further. In fact, 2020 will be the highest money growth in modern American peacetime history. (The previous peak was in 1919, at 19%, in exceptional circumstances just after the First World War.)
Most observers would say that the money growth splurge is attributable to—and largely excused by—the lockdown. Of course, that is true to some extent. But who can overlook that a Presidential election is due to be held on 3 November, a mere five months away? The Federal deficit is widely expected to exceed $3,000 billion in the current fiscal year, a monster figure that amounts to 15% of national output. But Democrats in the House of Representatives are urging another so-called "fiscal boost" of $3,000 billion, to take the deficit towards $6,000 billion or an incredible 30% of national output. If that is financed heavily from the banking system, with the USA following the catastrophic example of Venezuela and other Latin American countries, money growth will accelerate further. Higher inflation will follow.
To keep inflation down, either the budget deficit must be reduced or the Federal Reserve must ensure that it is financed in non-inflationary ways from long-term, non-bank investors, including those in foreign countries. An ominous trend is that foreign investors are turning away from US Treasuries. In 2014 they owned over 45% of the USA's government debt; today the comparable figure is under 35%. Foreign holdings actually fell between February and March, hardly a vote of confidence in American economic management and the administration's response to the pandemic. The less that foreigners invest in US government debt, the more the budget deficit will be financed by money creation and the higher will be inflation.
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