Transcript 2009 Budget Deficit originally estimated to be $407 billion

The Case for Inflation
Daryl Montgomery
June 4, 2009
Copyright 2009, All Rights Reserved
The Underpinnings for Major Inflation
• U.S. is creating new money at a faster rate than
economic growth to finance its budget deficits and
trade deficit (Credit Crisis has made this problem
much bigger).
• Excess money availability is the one thing in
common that all major inflations have throughout
history (it’s not going to be different this time).
• Money supply is expanding rapidly and potential
credit availability is exploding.
• At the same time, there is a commodity inflation
cycle taking place between 2000 and 2020.
• The correct definition of inflation is a currency
losing its purchasing power (not credit creation).
• The U.S. government understates inflation.
Long Term Commodity Cycle
Actual U.S. CPI Inflation Versus Reported
1980 to 2008
MZM – Zero Money, Seasonally Adj.
Adjusted Monetary Base 1959 to 2009
Currency Plus Bank Reserves (future inflation)
Total Reserves – 1959 to 2009
Sum of Deposits that count for Reserve Requirements
Excess Reserves:
Total Reserves minus Required Reserves
Historical Backdrop for Inflation
• When the U.S. left the gold standard in 1971, the
dollar became a fiat currency – backed by
nothing.
• The restraints that prevented the creation of
unlimited amounts of currency and credit were
removed (and trouble followed).
• This allowed the U.S. to run budget deficits from
1970 (except for 1997 to 2001) and Trade Deficits
from 1976, which we can’t pay for with taxation,
so borrowing from other countries and printing
new money became necessary.
U.S. Budget Deficit 1961 to 2008
National Debt 1940 to 2008 (1/2)
Trade Deficit 1960 to 2007
The Current Situation
• The Credit Crisis has caused the U.S.Budget Deficit
($1.85 trillion for 2009) and National Debt (now around
$12 trillion) to explode.
• Despite economic weakness, the Trade Deficit has only
slightly improved. It only got better because of lower
oil prices (and cheap oil is running out).
• The Fed has expanded potential bank credit availability
astronomically. Recovery will cause this money to flood
into the economy.
• The U.S. government can now only fund its twin
deficits by ‘printing’ new money (foreign borrowing
can no longer cover them).
• It only gets worse in the next decade because of rising
Social Security and Medicare payments.
Projected Budget Deficits Next 10 Years
2009 Budget Deficit originally estimated to be $407 billion
Problem with Deflation Arguments
• Excess money creation has always led to
inflation in the past (with a lagged effect).
• Deflation claims fail to take into account money
printing and that it can alter price behavior.
• Price needs to be considered as a percentage of
money supply, not as a fixed number as all
deflation arguments assume.
• Deflation claims rely on analysis that is twodimensional instead of multi-dimensional.
A Simple Example
• There is an economy which has $100 of currency and
produces 100 widgets. Supply and demand are in
balance and each widget sells for $1 (or 1% of the
money supply).
• A recession causes supply/demand equilibrium for
widgets to fall to 80. If the money supply stays the
same, each widget now costs 80 cents (0.8% of the
money supply) and there is 20% deflation.
• However, the government doubles the money supply to
$200, so 0.8% of money supply is now $1.60 and there
is 60% inflation in widget prices.
Classic Supply Demand Chart