The late and great Milton Friedman told us that inflation is always and everywhere a monetary phenomenon. But there is an asterisk to his equation that we need to examine, namely, the velocity of money. Sometimes a fast-growing money supply is not as inflationary as you might think. Then we will take quick looks at why the banking sector is in for more and larger rounds of write-offs, as well as note that the housing industry is in a hole but is gamely digging itself deeper. This week’s letter will require you to put your thinking cap on as we travel to a mythical island to get an understanding of how the economy really works. There are a lot of charts, so the letter may again print long, but the word length is normal. And with no “but first,” we jump right in.
When most of us think of the velocity of money, we think of how fast it goes through our hands. I know at the Mauldin household, with seven kids, it seems like something is always coming up. And with my oldest daughter Tiffani getting married this summer (forget gas, you haven’t seen inflation until you start buying floral arrangements), more kids in school, “Dad, I need a car,” high energy costs, etc., the velocity, at least in terms of how fast money seems to go out the door, seems faster than normal. And what about my business? Travel costs are way, way up, and as aggressive as we are on the budget, expenses seem to rise. About the only way to deal with it is, as my old partner from the 1970’s Don Moore used to say, is to make it up with “excess profits,” whatever those are.
Is the Money Supply Growing or Not?
But we are not talking about our personal budgetary woes, gentle reader. Today we tackle an economic concept called the velocity of money and how it affects the growth of the economy. But let’s start with a few charts showing the recent and high growth in the money supply that many are alarmed about. The money supply is growing very slowly, alarmingly fast or just about right, depending upon which monetary measure you use.
First, let’s look at the adjusted monetary base, or plain old cash plus bank reserves held at the Federal Reserve. That is the only part of the money supply the Fed has any real direct control of. And it is not growing that much (less than 2%!), and a lot of the cash goes overseas, never to come back to the US. Also note that the growth in the monetary base has been trending down until recently…