10 times more money than output - that's why

Image: Karolina Grabowska

A reminder of what’s still fuelling demand

We talk a lot about the main factors causing supply side inflation.

But not a lot of time is spent looking at what’s beneath the increase in demand side inflation since the planet started to wake up last year.

So here’s a chart that does just that.

Money supply is represented by the blue line, with Real GDP shown by the orange line.

It’s easy to see what’s happened since the Powell Pivot on 30 January 2019.

Ex-Chair Yellen’s balance sheet run-off was taken off auto-pilot (huge mistake) and rates were eventually cut to zero - money supply mooned while economic productivity cratered.

In fact, between Q1 2019 and now money supply increased by 50% while Real output, or GDP only increased by 5%.

Essentially, GDP increased by $700 billion (after tanking a lot lower during COVID) while $7 trillion in ‘money’ was deployed.

Sliced and diced however, what it means is that consumer liquidity (potential to spend money writ large) increased 10 times faster than real output.

How did we get here? It’s been cooking since the GFC.

It came about through a combination of:

  1. helicopter money drops straight down ma and pa chimneys in the form of stimmys (following digital money creation by the Fed which bypassed the bond market - a bit like the UK government bypassed the gilt market and asked the Bank of England to increase its ‘ways and means’ account - aka, money printing); and

  2. money creation in the banking system fuelled by banks taking reserves created during quantitative easing (QE) and lending it out, but noting only half of QE money creation was lent out, with the rest parked with the Fed and earning interest).

Chimney money is inflationary! And when combined with a populist, non-independent and uber-accommodative central bank pursuing QE, it’s hyperinflationary.

That’s what lit demand. That’s why. Simple.

Not only has money lost its value, but it’s not as productive as it once was.

Part of the reason is that stimmys gave millions of American households more than what they were earning prior to the lockdown.

Disposable household income mooned.

During lockdown it was spent on consumer goods, renovations, some new homes and billions in risk assets which were readily available on Robinhood while sports betting and gambling went pandemic-dark.

Once lockdowns were over, remains from stimmy cheques, Robinhood gains and savings were catapulted into post-lockdown experiences. Many were getting ready to cruise again.

Then there was Ukraine which happened at the same time Powell’s populist Fed was signalling interest rate hikes in response to inflation that was no longer transitory (ahem….) and inflation is now the new Saddam Hussein.

And the world followed except for Japan and China, which are now stimulating their faltering economies with big hopes for China in the second half of this year.

Finally, households continue to watch their risk assets lose value and most of the world continues to liquidate the risky end of the curve.

Unsated demand and supply constraints turns into inflationary slingshot

Pair that double fiscal/monetary whammy with supply side inflation from underinvestment in capacity, COVID affected supply chains and geo-political removal of capacity following Ukraine - and you have a triple stranded super jelly rubber inflationary slingshot!

The reality is that by increasing interest rates and removing liquidity from the banking system and markets, central banks are seeking to destroy enough demand so that less money is bidding for a relatively fixed amount of goods, for the time being.

Formulaically it probably looks like this:

  1. Money supply > economic output for extended period = inflation (already happened)

  2. Demand > supply = inflation (already happened)

  3. 1 + 2 + increasing interest rates = lower risk asset prices (now)

  4. 3 + liquidity removal = destruction of aggregate demand (it’s coming)

Liquidity removal is where the Fed decreases its $8.9 trillion balance sheet by reinvesting in lower and lower amounts of maturing securities than it’s currently holding.

That means less money available for banks to lend out. Lower liquidity is already being seen in widening credit spreads.

And this bit is really important - no central bank knows how much each dollar in liquidity removal is going to destroy demand. It’s not as simple as saying that each $50 billion less of liquidity is equal to an interest rate hike of x%. No one knows.

I’ll say it again. No one knows.

That’s why I have been saying that there is a grave risk that the Fed (and ECB), having been at least 5 years late in calling time on the free and easy money party, will overtighten conditions - too much, too little, too late, just like their predecessors did before.

We’ll have to wait and see.

Mike

Image: Dids

Next Level Corporate Advisory is a leading M&A and capital markets advisor with a 20 year track record of delivering the highest quality of independent financial advice as well as strategic transactions to help companies of all sizes level-up, in and out of Australia.

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Michael Ganon#markets, #equities, #stonks, #finance, #economics, #ethereum, #inflation, #deflation, #nft, #bonds, #gold, #globalmarkets, #globaleconomy, #qe, #qeinfinity, #economy, #interestrates, #business, #trade, #transformation, #strategy, #ceos, #directors, #founders, #cfos, #currencies, #construction, #mining, #renewables, #technology, #leadership, #india, #china, #australia, #perthbusiness, #education, #research, #uk, #gdpgrowth, #retail, #businessowners, #future, #brexit, #nextlevelcorporate, #mikeganon, #community, #tradewar, #America, #covid-19, #bitcoin, # perthbusiness, #populism, #crypto, #bitocin, #luna, #ripple, #solana