Where is the Inflation?


9 months ago by LuoZhen

Inflation is an increase in the supply of money and credit. Money is gold, silver, cryptocurrency these days, physical fiat currencies such as paper U.S. dollars. Credit is everything from mortgages to U.S. treasuries and corporate bonds.

The modern monetary system is a credit based monetary system. A couple trillion in physical U.S. dollars exist against $84 trillion in debt. Banks conjure (print) U.S. dollars out of thin air when they create a mortgage. The U.S. government mainly “prints” U.S. dollars by issuing Treasury bonds. In this system, the Federal Reserve’s main purpose is securing the debt. When the system swings into reverse, credit is destroyed and a recession begins. The Federal Reserve creates Federal Reserve Notes and swaps them for treasuries, mortgages and corporate bonds. It monetizes debt by turning them into FRNs, aka U.S. dollars. It doesn’t create the treasuries, mortgages or corporate bonds. The Fed keeps the system from collapsing, it only supports lending and borrowing to the extent that it encourages more borrowing. If and when the borrowing slows for whatever reason, there’s not much the Fed can do about it. See 2008 until today.

Below is loans and leases at all commercial banks. During a brief window from 2014 to 2016, private credit growth exceeded 5 percent. Otherwise, it stayed below 5 percent after the 2008 financial crisis. Prior to 2008, anytime credit growth fell below 5 percent there was a recession coming or one was already underway.
There are several books on the Weimar hyperinflation. A somewhat dry, but thorough financial account is The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany by Costantino Bresciani-Turroni. During the hyperinflation, credit growth soared as companies and individuals borrowed as much as possible. Private borrowing spiked during the pandemic because corporations maxed out their lines of credit as a precauition, a one-time effect that wore off. Right now people are not behaving as if they anticipate inflation. Consumer surveys tell us people worry about it, but they aren’t borrowing. Instead, they’re cutting back on consumption. The perception of inflation far exceeds the actual inflation.

Total credit outstanding did increase a substantial amount in the past year, but the main borrower was USG, the U.S. government. If USG doesn’t pass a new stimulus or infrastructure bill this year credit growth already peaked in Q4 2020. After 2008, total credit growth never exceeded 5 percent, a level associated with the depth of recessions in prior years.
Over the past decade of low inflation, debt mainly flowed into financial assets. Corporations issued bonds and bought their own stock. Banks sold treasuries to the Federal Reserve and used the cash to buy stocks. Prices didn’t soar at the supermarket or gas pump, but they did in the technology sector and cryptocurrency markets.

Everyone saying the inflation is coming misses the inflation of the S&P 500 and BTC. The inflation already happened and is embedded in asset prices. The next step forward is a continuation of the process, where the Federal Reserve keeps lifting asset prices higher and higher as the real economy stagnates because inflation gets “sterilized” by the asset markets. Or something such as disrupted supply chains induces a behavioral and perception change that unleashes inflation into the real economy. Financial assets and those that don’t benefit from higher prices (such as farmland, mines and oil wells) would devalue in real terms. Or asset prices collapse and the inflation gets wiped out by major bear market.

I looked at debt vs equities in Total Debt vs the S&P 500 Index Here is the same chart as that article, but inverted with the S&P 500 Index as the numerator. The resistance line has been broken because the last data point for TCMDO was for Q1.
A continuation of the post-2008 environment, where inflation flows mainly into financial assets, would keep lifting the above ratio. The inflation thesis expounded by most everyone you read in financial media or on social media, would look more like the tags of that line in 1965 or 1999. Asset prices are at their apex and ready for a massive relative collapse versus real assets and commodities.