QE Begins: Fed Prints Record $2.4 Trillion in 8 Weeks to Prevent Deflation

During the depths of the 2008-2009 Great Recession, the Fed began a 6 year money creation scheme expanding bank balance sheets by $3.5 Trillion dollars without a post recovery inflation as many feared. This digital explosion of our money supply is now being surpassed during the age of Corona with another $2.4 Trillion in just 8 weeks. Central Banks have relied upon imagineering of currency out of thin air at ever increasing rates during Recessions ever since the US left the Gold Standard in the 1970’s. When we closed the Gold Window at Fort Knox in 1971 and moved to a floating fiat currency system there was an inflationary adjustment decade to reprice our currency relative to our trading partners. After Fed Chair Volker tamed inflation in the 1980’s, our Central Bank has increasingly focused its tools upon countering disinflation. These tools relied primarily upon a term Japan coined in 2001 called Quantitative Easing (QE). The now ubiquitous QE process was essentially a Government arrangement with their quasi independent Central banks to buy Government bonds (debt), expanding free bank reserves for economic stimulation. With no perceived negative consequences, this QE era of printing unlimited Trillions has grown to include pretend money purchases of both public and private debt and even publicly traded stock, in the case of Japan. The Fed and Central Banks around the world tried their best to create inflation over the past 11 years, yet no matter how much debt and currency was created to stimulate the animal spirits, the underlying price impulse toward deflation continued. In response to the current Coronavirus pandemic and Government induced mini-Depression, the Fed has brought interest rates close to zero and announced an unlimited supply of money (QE infinity) to buy troubled assets and prevent the private sector from acting prudently by derisking. The $2.4 Trillion that the Fed has thrown into the banking system over the past 2 months should continue to grow at close to $200 Billion per week pace until there are signs the economy has reversed its contraction of jobs and income. Unfortunately, no amount of helicopter money from our fiscal and monetary overlords can move the economy towards its historic growth trajectory until Government mandated fear from the COVID-19 pandemic is quelled.

With Fed assets at $6.6 Trillion, heading to $8 or $9 Trillion this year and several Trillion in Fiscal stimulus in the pipeline, will there be inflation concerns when the economy recovers? Doubtful! After a record 11 straight years of economic (GDP) expansion that included three rounds of QE and a $10 Trillion jump in the money supply (MZM), we never had a hint of inflation heating up. Expansionary fiscal and monetary policy in the US and around the Globe have been no match for the secular deflationary wave of aging demographics, entitlement burdens and excess capacity. The ever massive amount of debt we create each Recession borrows inflation from our future to spend in the present. The demographic overhang of a shrinking ratio of workers to seniors in 1st and 2nd world countries began in 1980 and has accelerated this past decade as Boomers retire more rapidly. 

Perhaps the father of modern monetary theory, Milton Friedman, would agree that it’s not just the money supply or the relative amount of dollars in circulation that matters, but the velocity of money that is critical. Currently money supply velocity multiplier, the number of times a unit of currency is used during a specific period, is contracting almost as fast as the stock of money is being added.

A more simple measure of inflationary pressure can be assessed by major trends in the US Dollar. The Dollar logically moves inversely to inflation since most global commodities are priced in Dollars. Should the Dollar fall sharply (>50%) we suspect US consumer inflation would rise sharply for the first time since the early 1980’s. However, in times of trouble (pandemic) capital flows to the US and supports our Dollar. Despite the efforts of China and Russia, the US remains the bastion of safety or at least the cleanest shirt in the global laundry of fiat money.

The Feds preferred metric for gauging inflation is the core personal consumption expenditures index or PCE (left scale, red line below). While PCE inflation has failed to hold the Fed’s 2%+ target, it’s almost impossible for inflation to rise as long as the Dollar remains stronger relative to other currencies. With the major currency pairs of Japan and Europe in worse shape than the US and the Dollar denomination of most commodities globally, there are few factors on the horizon that would push the Dollar significantly lower. 

After a long period of subdued but stable prices, raw commodities have fallen hard this year deflating over 25%. The global pandemic and forced economic contraction elevated US Dollar strength and crushed prices of most commodities and assets. When this economic cycle begins to recover the US Dollar will weaken. Once a strong recovery growth trend is established, we would expect the Dollar to fall (15 to 25%) triggering a temporary phase of moderately higher than normal inflation in consumer prices (PCE). This is the pattern that occurred from early 2009 to early 2011 when our Dollar fell and raw commodities soared. Assuming we adapt to COVID-19 and virtually eliminate much of the fear factor suppressing current activity, then the Euro and metals will rise as the Dollar falls.

 Assuming we exit the current COVID contraction later this year, we will be watching to see if the US Dollar devalues vs other currencies as a sign of accelerating commodity inflation. Based upon the 40 year trend since inflation peaked in 1980, we would not be concerned about consumer prices. Currently, World Governments and their Central banks are the only game in town. However, since all currencies are backed only by the faith in the credit of Government, we should remain wary that unlimited money printing to rescue defaulting debt bubbles could someday trigger a loss of fiat currency confidence and a liquidity trap of hoarding assets. For now, until COVID fears subside, we should expect unlimited QE and fiscal stimulus will continue and interest rates will remain lower for longer.

2 Comments

  • Paul Sawyer says:

    I’m may be naive about all of this but my reaction to what is going on is that all the money printing will have to cause inflation once the economy recovers. Ray Dalio says “Cash is trash”. My guess is that people are worried that their cash will be trash and are pouring it in the stock market because they think that the market will be a better store of value than cash. That explains why the market is doing well while the economy is in lockdown.
    I also think that there are different metrics of inflation depending on how rich you are. If your poor the cost of food is most important and there has be deflation in the cost of food. However, if you are middle class the biggest expense you have is the cost of a home. The home prices that I follow (on the east and west coast) have done pretty much nothing but go up for a hundreds years. So for the middle classes there has be continuous high inflation. I don’t know how they calculate PCE but my guess is that they weight things like the price of food, clothing, energy and electronics (which have inherent reasons to go down) more than they should.
    Ray Dalio also says that when you come out of a major economic downturn, almost everybody comes out poorer than they thought they were. I suspect that this time it is going to be because of inflation.

    • Kurt Kallaus says:

      Paul, It’s a valid point that near zero interest rates encourages investors to buy stocks vs cash or bonds. That has been the case as interest rates have been in a downtrend since 1980 & never more true than today.
      Ray Dalio has had a storied career. His forecasts have been for a Depression each year since at least 2017 – frequently siting 1937 as an analog.
      We are always wary of potential Depressions whenever there is a a GDP contraction, but we don’t see red flags at this time. A new spike in the Virus back to peak death rates triggering a new lockdown would be a trigger of “major” concern financially, but that is not in our current expectations.
      As for different inflation measures: Yes this is an imperfect tool at best as nobody can truly measure inflation that would apply accurately to everyone. Lower incomes spend high proportion on food, energy & housing while higher incomes spend more on insurance & investments. Yet, “all” inflation indices with food & energy or without have the same trends, just different amplitude. With Food & Energy we would see actual deflation some years. For consistency & forecasting policy changes we focus on the Fed’s model that removes highly volatile food/energy. All broad inflation measures are showing low inflation in recent years, falling hard now. As our report discussed, there will be commodity inflation for a year or two once a strong GDP recovery is underway after this massive contraction ends, but history has shown no worrisome inflationary trends since the 1970’s that would warrant an abnormal uptrend in interest rates to combat prices. Remember that the Fed prints Trillions to combat alarming deflationary collapses and money supply is only inflationary if it has a high multiplier or velocity of money. If people will not borrow and spend more but actually hold onto their cash more which occurs as we age, then the stimulus will require ever greater expansion of the money supply. Nobody knows at what level is required to trigger a major bout of inflation above normal. Central Banks new goal posts have shifted to seeking more inflation these past 11+ years. We’ll see how well they succeed this next up cycle. Should the Fed finally overshoot inflation targets, we suspect it will be short lived and lead back to deflation concerns once again without the one time inflation/stagflation adjustment away from the Gold Standard back in the ’70’s.

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