Covid has broken and distorted a great number of things – businesses, industries, supply chains, hopes, dreams, and even many people’s capacity for reason.
Large businesses and the people who work for them have thrived (e.g. Amazon, Microsoft, Facebook.) Small businesses (and the people who work for them) have struggled and many have failed (restaurants, small retailers, etc…)
Now many demand higher wages to offset the risk (and hassles) of working with the public. Shipping backlogs are causing unprecedented delays and reduced supply. People flush with cash and booming investment portfolios are willing to pay more for everything from used cars to housing.
Increased production costs. Reduced supply. Excess cash. And behind it all – governments printing literally trillions of dollars.
It’s like the perfect storm for inflation.
It’s a good story anyway.
If you are an online person at all, you have probably seen inflation in the number of people concerned about inflation in recent months. In particular, great concern about the amount of money that the Fed is printing.
“Hyperinflation is coming! This is not normal! The US is going the way of Zimbabwe!!!!”
Cue, the meme: Money Printer Go Brrrr
Behind a lot of these not-unreasonable totally normal people trying to get you to buy Bitcoin raise inflation awareness is one chart, M1 Money Stock
If I had a dollar for every time I’ve seen this chart since the nearly infinite increase in the supply of US dollars (* etc) in May 2020, I would have about 85 Zimbabwe cents .
But since I don’t want to be The Boy Who Cried Hyperinflation, I figured it would be worth taking 5 minutes to understand if the Fed really did print 13 trillion dollars in just a few months. Like, half of all GDP?
And wouldn’t you know it, no, no they didn’t.
What actually happened?
A change in accounting rules.
M1 is mostly liquid currency – bills, coins, and checking accounts. Banks are required to keep reserves on hand for all of this.
M2 is another measure of money in the economy which includes money market accounts and savings account. The main difference between a checking and savings account is that the latter has a limit of 6 monthly withdrawals. Banks are NOT required to keep reserves for these funds because you are “saving” not “spending.” (And they even get to lend against these.)
Then last year when things were dark and the future uncertain, placing roadblocks in the way of people spending their savings seemed problematic so the Fed changed the rules. The monthly withdrawal restrictions on savings account were suspended, making them function like a checking account. They were now fully liquid and thus included in the M1 measurement.
The interim final rule allows depository institutions immediately to suspend enforcement of the six transfer limit and to allow their customers to make an unlimited number of convenient transfers and withdrawals from their savings deposits at a time when financial events associated with the coronavirus pandemic have made such access more urgent.
What would we expect to happen with this change? Don’t ask me, ask the Fed:
Recognizing savings deposits as a transaction account as of May 2020 will cause a series break in the M1 monetary aggregate. Beginning with the May 2020 observation, M1 will increase by the size of the industry total of savings deposits, which amounted to approximately $11.2 trillion. M2 will remain unchanged.
So anyway, the Fed (actually the Treasury) isn’t printing as much money as people think.
Inflation
But what about inflation from other sources – supply side, demand side, etc…
Here is what the CBO projects – modest inflation for the next 10 years with wage growth exceeding price growth.
Much of the inflation that is moving through the system now should be transitory.
Covid -> lockdowns / demand drops -> production drops / supply decreases -> Vaccines & return towards normalcy -> increased demand -> prices rise due to lack of supply -> production increases -> Prices drop
See lumber as an example.
There will be exceptions, of course – rents are currently down in big cities, but housing prices in vacation areas (etc) are through the roof. The ability of many people to work from home long-term combined with a fundamental shift in how people value their non-work time (combined with inability to build to meet demand) probably mean higher prices in these areas are here to stay.
The best way to invest to grow assets faster than inflation? Index funds
(Or Go Curry Cracker Coin.)
Summary
The Fed isn’t printing as much money as many think. Inflation should be mild and transitory. Your mileage may vary.
I hear even if inflation is less than mild – assets like certain index funds and certain rental real estate investments should help better than cash ….. and bond index fund? … and one could always move somewhere cheaper etc …. Beijing :) … of course there can always surprises ,,,,,, like the BIG ONE on the west coast ,,,, computer ransom viruses etc :)
index funds are a great inflation hedge
During bouts of rapid inflation, stocks do not always keep up with inflation. The only way to use stocks to beat inflation is to buy and hold them for the long-term. If you only buy stocks when inflation starts, they will not protect your assets as the market tends to underperform during these periods. Another great reason to buy and hold, only selling when you need to generate cash!
I have a very similar take.
My guess is that things will settle out over the next 6 months.
just getting shipping back to normal will do wonders
Great article – I call this classic GCC! I very much enjoy the insight.
Nice. Thanks!
So, you are saying that basically savings accounts were included in the “available” money for lending in banks. That’s what caused the spike in this graph.
Do you have the “actual new money printed” graph?
M2 is a good proxy for all available cash and cash equivalents.
It’s not me saying it, it’s the Fed. (the opposite though – savings included in liquid accounts for spending.)
Are you concerned about deflation?
I’m not, no
This is the 1st time I’ve seen someone explain this clearly and dispassionately. Thank you!
my pleasure, James
Text exchange on 18 March:
Friend: Do you trade any crypto currencies?
Me: No
Friend: I just bought my first fraction of a Bitcoin today. I believe it’s going to be a good hedge against inflation. I think that all the developed countries in the world have printed sh*tloads of paper money in order to deal with COVID and pay people stimulus, etc. Inflation is inevitable. Bitcoin is the only thing up in my portfolio today.
Bitcoin’s gone from ~58k to ~35k since then.
Yeah this kind of thing makes me sad.
I mean it is certainly possible that a bunch of belligerent dudes with no social skills have discovered a solution to all of the modern world’s financial challenges despite repeatedly demonstrating that they don’t understand basic economic principles, but even then putting 100% of your portfolio into just one thing is ill-advised.
I think the takeaway here is that there is entirely too much cash sitting in very low yielding savings and money market accounts. And even if inflation was at 2% (likely higher) then the cash on the sidelines is never going to stop shrinking.
How much sitting cash is the right amount?
There is no right amount, as it depends on many factors, like how much income you have coming in and how many streams of said income. The more your income is diversified the less emergency fund you need. But if you only have 1 source of income and that’s cutoff you’re stuck. Hold some VTAX or another low cost index fund that’s easy to liquidate to raise funds if needed. If you’re smart you raise your cost basis by harvesting gains so taxes will be minimal if you ever do need to liquidate to fund living expenses.
People who have their entire wad just sitting in cash are losing value to inflation. All the major banks pay a paltry 0.05% in interest. It’s laughable. It’s possible to find some higher yielding banks with balance caps to stash the emergency fund or other temp funds, so at least it’s matching the usual 2% inflation if you absolutely must have an emergency fund.
And then there’s the people who keep all of their cash sitting in non interest paying accounts and use their debit cards and cash to pay for everything. Avoiding credit cards leaves A LOT on the table. Maximize maximize maximize.
Of course, what’s right for me or you is not what’s right for someone in a different situation.
I’m with you on all of that, I was thinking as a nation since we were looking at M1/M2. If standard advice is to keep funds you need in the next 3-5 years in cash, 10+ trillion in cash doesn’t seem like too much.
Agreed. The savings rate in America is super low in general. Earn and burn is the name of the game.
Feels like we have 5% inflation for a year (YoY anyway) and then maybe we get back to business as usual 2-3% CPI?
Let’s hope anyway.
My personal CPI seems to be going up at least 5% this summer but I’m not a representative sample as a FIREd dude. Mostly spending on lodging in USA vacation hotspots, dining out, groceries, and gas. All seem to be pretty pricey at least by YoY basis.
I can’t complain too much because my portfolio also inflated by almost a million bucks YoY :) As it turns out, owning 10,000 companies through my index funds = all those companies that raise prices also make more profit and go up in value too.
I agree with your general point (that we aren’t looking at hyper-inflation levels of money printing), but the dollars in circulation are going up at an accelerating rate.
I can’t think of the last time M1 came up since, like you point out, savings accounts aren’t included and, despite the 6 withdrawal limitations, are still pretty “liquid”.
M2, on the other hand, does still show a pretty steep increase:
https://fred.stlouisfed.org/series/M2SL
M2 on Jan-2008: $7.5T
M2 on Jan-2020: $15.4T
M2 on May-2021: $20.3T
I’m not too worried about what this natural experiment means for CPI-type inflation in the short term, but the flip side is that truly scarce asset (Hamptons beach houses, professional sports franchises, rare artwork) prices are going up much faster than official inflation numbers. I’m not sure what the price inflation curve looks like for purchases falling between a Starbucks coffee and the Dallas Cowboys, but it will be interesting to see if real estate prices start to fall again, or we’ve just set a new floor.
Inflation is occurring because of supply is less than demand. I do not think it is due to too much money being printed at this time. As supply catches up inflation should taper.
Yes, my thoughts also
What about the huge increase in equity values? People who hold Apple, Amazon, Facebook… (in top 10 holdings of S&P 500) really are richer. It seems like this could increase demand for everything (eating out, travel, stuff in general). Additionally, if you unlock a lot of money with people buying houses outside of expensive cities and spending tens of thousands to fix them up, it seems that this could be keep things sizzling (inflationary).
The wealth effect is real – people do spend more when their portfolio values are up.
The majority of people don’t own stocks so that is a factor. Or if they do it is in a retirement account so they don’t have immediate access to it. And the uber rich probably don’t spend more on dining just cuz they have an extra billion.
Great article Go Curry Cracker! I really like how you broke things down and included a lot of graphs. That’s what I really like about a lot of your articles!
“Inflation should be mild and transitory”.
This hasn’t aged well.
Correct