By Tim Courtney, Chief Investment Officer
In July, the Federal Reserve (Fed) and market got some good news on the inflation front. CPI inflation came in at 3% over the last year and was actually negative from May to June.1 The market has become hopeful that this will give the Fed enough margin to begin cutting rates soon in an attempt to glide the economy into a position where it remains positive and avoids a recession but slow enough to bring inflation down closer to 2%.
This is difficult to do, even though several market prices seem to indicate that a soft landing is likely. The U.S. economy is huge. It most often changes directions slowly, and there can be long lag times between when a policy lever is pulled and when we might see changes. Interest rates are a lever the Fed can pull, and rates have certainly influenced the direction of the economy and market from the 0% rates of 2020 to the 5%+ rates today.2
But there is another lever the Fed is responsible for managing, and that is the money supply. From 2022 through the early part of 2023, the money supply contracted.3 This is typically seen as a sign of an approaching recession. Over the last year, however, the money supply has grown again, and this, too, could be seen as a sign that an economic soft landing is possible.4
While these numbers are relatively good news, it is important for us to go back and look at the effect the money supply has had on the economy since 2020. Even including the decline in 2022-2023, the U.S. money supply has grown from $15.9 trillion at the start of the shutdowns to $21 trillion today, an increase of 32%.3 Classical economists would predict a similar increase in inflation, and as it turns out, CPI inflation has been 20-25% higher over the same time frame while home prices are 50% higher.4
I recently took a trip to see the Roman ruins in Bath, England. Alongside the unearthed Roman bath are examples of what archeologists have found buried in and around the baths. Hordes of Roman coins have been discovered, and interestingly the newer minted coins were more deteriorated than older ones. This is because the emperors had begun debasing the currency. Using less precious metals and more common metals to create new coins allowed them to mint and spend many more of them. As the mass of new coins made their way through the economy, inflation took hold.
History guides noted that while the market typically determined prices across the empire, during times of high inflation, the emperor's often instituted price controls. Now, some of our leaders are suggesting that price controls are the way to manage inflation brought on by an increase in the money supply.5 The more things change…
While the focus of most of the headlines has been on interest rates, our money supply has played and will play an important role in determining economic growth and prices. A growing economy requires some growth in our money supply, but the recent increase was higher than what the economy could absorb. We will continue to watch this measure and hope the Fed and our leaders will as well. If you have any questions, please contact your Exencial advisor.
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