MacroView: 2021 – A Disappointment Of Growth And Disinflation

As we head into 2021, there is a large consensus that the massive monetary interventions in 2020 will lead to an explosion of economic growth, inflation, and higher interest rates. We suspect that the outcome of more debt-driven spending will lead to a disappointment in growth and disinflation instead.

Milton Friedman once said:

“Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.” 

There is little argument currently that the Federal Reserve is “printing money” without any reservation. The chart below is the “supply of money” as represented by M2.

Disappointment Of Growth Disinflation, #MacroView: 2021 – A Disappointment Of Growth And Disinflation

That massive spike in M2 is from the Government’s gigantic monetary rescue to combat the pandemic-related economic shutdown.

“In our analysis, the ‘end game’ for the Fed’s twin asset bubbles in stocks and bonds is inflation.” – Crescat Capital

Of course, if the massive monetary infusions create an economic boom, then a surge in inflation and interest rates should follow. As noted recently by GaveKal:

“In summary, my indicators tell me that US growth will be strong and we are on the right side of the four quadrants framework. As prices seem set to accelerate, we are moving into the upper half, which means that 2021 should see an inflationary boom in the US.”

There are several reasons why expectations may fall short of reality.

Why Printing Money Won’t Create Inflation

For the last 12-years, the annual refrain from economists has been “this year is the year of economic growth and inflation.” Each year has been a disappointment of those expectations.

The chart below compares the money supply to GDP growth and our composite economic indicator. The composite includes inflation, wages, and interest rates, which directly correlate to economic activity.

Disappointment Of Growth Disinflation, #MacroView: 2021 – A Disappointment Of Growth And Disinflation

While in theory, “printing money” should lead to an increase in economic activity and inflation, such has not been the case.

A better way to look at this is through the “veil of money” theory. If money is a commodity, more of it should lead to less purchasing power, resulting in inflation. However, this theory began to fail as Governments attempted to adjust interest rates rather than maintain a gold standard.

As shown, beginning in 2000, the “money supply” as a percentage of GDP has exploded higher without a resulting rise in inflation or economic growth. As shown by the attendant trendlines, it has been quite the opposite.

Disappointment Of Growth Disinflation, #MacroView: 2021 – A Disappointment Of Growth And Disinflation

However, this is where monetary velocity becomes essential.

Monetary Velocity

The Federal Reserve has failed to grasp that monetary policy is “deflationary” when “debt” is required to fund it.

How do we know this? Monetary velocity tells the story.

What is “monetary velocity?” 

“The velocity of money is important for measuring the rate at which money in circulation is used for purchasing goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

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Norman Mogil 4 weeks ago Contributor's comment

The Friedman equation MV=PT always assumes that the velocity is constant. He never envisioned a collapse in velocity as we are experiencing now. That's why the equation breaks down as a forecasting tool for inflation