By Mohammad Zulfiqar
One of the questions being asked by investors these days is “where’s the inflation?” After the financial crisis and the fall of Lehman Brothers, the Federal Reserve and the U.S. government stepped in to help the financial system. As a result, they promised to print money, and thus quantitative easing was born. Banks received billions of dollars in bailout money.
With this, there was a significant amount of speculation that the increased money supply in the U.S. economy would lead to a period of out-of-control inflation, or hyperinflation.
Fast-forwarding to now, it’s been more than five years since the collapse of Lehman Brothers, but out-of-control inflation has yet to occur. Were those who said there will be hyperinflation wrong? What’s the inflation situation right now?
In August, the Bureau of Labor Statistics reported that the prices in the U.S. economy increased by 0.1%. From January to August, prices increased in the U.S. economy by only one percent. (Source: “Consumer Price Index – All Urban Consumers,” Bureau of Labor Statistics web site, last accessed October 29, 2013.)
Other indicators of inflation ahead signal it’s going to remain dismal as well. For example, I look at the producer price index (PPI) as one of the key indicators of inflation.
In September, the PPI showed that producers in the U.S. economy experienced a deflation of 0.1%. Since the beginning of the year, the inflation in producer prices has only increased by 1.1%. (Source: “Producer Price Index-Commodities,” Bureau of Labor Statistics web site, last accessed October 29, 2013.)
With all this in mind, I stand little different from those who say there will be hyperinflation in the U.S. economy. My take: I say we will experience high inflation in the U.S. economy, but before that we may experience a period of deflation.
Why will there be deflation?
Inflation occurs where there’s an increased amount of money supply; which the current U.S. economy possesses. The Federal Reserve is printing $85.0 billion a month, with many rounds of quantitative easing having already occurred; the balance sheet of the Federal Reserve is nearing the $4.0-trillion mark.
There’s just one thing missing: the money has to be used. Currently, it seems that it is just sitting in vaults.
Take the velocity of money—the frequency at which one dollar is used. As it stands, the velocity of M2 money stock in the U.S. economy—this is the money in circulation, plus various savings and checking accounts—stands at 1.577. This number stands at the lowest level ever recorded. (Source: “Velocity of M2 Money Stock (M2V),” Federal Reserve Bank of St. Louis web site, last accessed October 29, 2013.)
Once the velocity of the money starts to pick up, then the inflation will march ahead.
When this will occur, only time will tell. If all the pieces of the puzzle come together, then it’s clear that bonds will not be the greatest investments; they will provide investors with losses, because inflation is a bond’s worst enemy. Investors who are heavy on bonds in their portfolio need to consider this phenomenon and act accordingly.
This article was originally published at Daily Gains Letter