Money Supply Inflation =/= Price Inflation?
I am currently taking a course on trading and general economics with a rather intelligent prof. I raised a concern over the inflation of the money supply eventually causing hyperinflation (at which time gold is most valuable). He answered me by saying that the former does not necessarily lead to the latter, due to factors such as the velocity of money and market clearing prices. He states that the current velocity of money is very low (3-4ish) compared to the norm (10-12ish) and that fact alone can keep the "high" money off the street for some time. If it doesnt change enough hands, it doesnt get down to the consumer level fast enough to cause hyperinflation. Then theres the market clearing price – such that markets tend to move towards prices which balance the quantity supplied and the quantity demanded, such that the market will eventually be cleared of all surpluses and shortages.
Being a humble worker, my two greatest fears for the future are high inflation and shortage of work. I, like many of us, could be out on the street in no time should things turn for the worst. There are MANY other factors at work here, but im keeping the scope of this thread to the inflation topic.
Any feedback on these points is very welcome!
With regard to the velocity of money exchange, I think there is an important point. An increase in the velocity of money exchange is associated with price inflation. But I am not at all sure that it is a cause of price inflation. In fact, it may be caused by price inflation.
When prices are rising, people are motivated to exchange their money for goods as soon as possible, while their dollars have maximum purchasing power. Thus, you see an increase in the rate at which money is "turned over." One would expect to see money velocity increasing as prices rise; I am not sure your professor is correct in looking at money velocity as a precursor to price inflation.
[quote=WhatNext]I am currently taking a course on trading and general economics with a rather intelligent prof. I raised a concern over the inflation of the money supply eventually causing hyperinflation (at which time gold is most valuable). He answered me by saying that the former does not necessarily lead to the latter, due to factors such as the velocity of money and market clearing prices.[/quote]
What he is essentially saying is that increasing the supply of money doesn’t necessarily reduce its value if the demand for money is also high. Which it is. People, banks and companies are hoarding cash. That’s a deflationary force.
The fear is, when the demand for money goes back down, ie. banks start lending and companies start borrowing, will the Fed reduce supply? Or, will they end up pumping in too many dollars for too long, like some contend they did at the end of the tech bubble bust.
That’s my understanding. I’m just a layman myself so take it for what it’s worth.
Thanx for the replies, they make good points.
Lemony : my prof did imply that a low velocity of money (3 or 4ish) would mean price inflation wouldnt be immediately imminent upon massive $$$ transfers to the bankers. While i do agree with the point that once price inflation catches on, there is further velocity for the reasons you state. What i believe he was specifying is this : if the money goes to the big bankers, but it doesnt move too quickly from them down to the consumer level, price inflation isnt too much of a worry, cause we wont have the money to spend on consumer goods. Im not sure if there are any real holes in this theory though… which is why im inviting opinions and input! Thanx again, and dont hesitate to add your opinion!
Malaci : you also make some good points
Another factor to consider: the Fed zero rate policy makes the T bonds & bills yields almost nothing (yields even went negative for some days). Investors will look for other securities with higher yields: foreing currency bonds, gold… This put much pressure on the dollar. As the dollar is now weakening this put yet more pressure on the dollar.
Just compare US T-bonds with Madoff ponzi scheme. So far US T-bonds still seems to attract investors, which amaze me! But if/when they realize they loose too much money, they will get out as fast as they can. The question is: where will they invest? The US$ will then plunge even faster and a signal for hyperinflation. Big loosers of US T-bonds ponzi scheme? : Chinese, Japanese…
Since the US$ is still the currency of most WW reserves and trade, this may not go as fast as Iceland, Zimbabwe… But some day this could append.
[quote=fujisan]So far US T-bonds still seems to attract investors, which amaze me![/quote]
There’s really nothing amazing about it. At this point in time, people aren’t concerned about profits, they’re worried about losses. People are in effect hiring the U.S. government as an armed guard to protect their money.
A significant proportion of these ‘people’ is the credit default swaps ‘industry’. Everybody has in effect been hit with margin calls. They’ve been required by their counter-parties to put up collateral to show they can cover their side of the deal. One of the only assets which is being accepted as collateral right now is U.S. treasuries.