People often confuse Deflation and Depression perhaps because in the 1930s the U.S. experienced a lot of both of them at the same time. This combined with the similarity in the sound of the words tends to compound the confusion. But they are not synonymous, it is quite possible to have an inflationary depression as the Hyperinflation in Weimar Germany from 1919-1923 shows.

Just as inflation is more than just rising prices, deflation is more than just “falling prices”. In both cases, the terms “inflation” and “deflation” actually refer to the macro “cause” while the change in prices is simply the “effect”. Unfortunately, lazy speech tends to confuse the “cause” with the “effect”. So when referring to more than just falling prices, for clarity it can be referred to as “debt deflation” as debt i.e. Corporate Bonds feels the effects the most because they must be repaid by ever more valuable money, while during an inflation debt is repaid with “cheaper dollars”.

Although most people won’t object to falling prices, runaway deflation can be as devastating as hyperinflation to an economy. In the following article, the editors of Elliott Wave International look at the 5 countries most at risk for runaway deflation today. ~Tim McMahon, editor

Severe Debt Deflation: Why These 5 Nations Are Most at Risk

“The private sector feels the urge to deflate its debt more acutely than the public sector”

By Elliott Wave International

Debt deflation is devastating. It’s also rare.

The world experienced a brush with it when the subprime housing market imploded about 12 years ago.

Before that, the last all-out deflation was in the early 1930s — commonly known as the “Great Depression.”

Before delving into the nations most at risk for a severe debt deflation today, let’s do away with the common misconception that says deflation is just falling prices.

The actual definition is that deflation is a contraction in the volume of money and credit relative to available goods. Falling prices do occur during deflation, but they are simply an effect.

In other words, as Robert Prechter’s 2020 edition of Conquer the Crash, notes:
When the volume of money and credit falls relative to the volume of goods available, the relative value of each unit of money rises, making prices of goods generally fall. Though many people find it difficult to do, the proper way to conceive of these changes is that the value of units of money are rising and falling, not the values of goods.

Deflation requires a precondition: a major societal buildup in the extension of credit and the simultaneous assumption of debt.
Here in 2020, this precondition has been mostly met.

Also, keep in mind, it’s private-sector debt that we need to focus on most in a debt-deflation because the private sector cannot print money to service the debt, as Murray Gunn, EWI’s Head of Global Research, recently noted.

With that in mind, Elliott Wave International’s June Global Market Perspective, a monthly publication which covers 40-plus worldwide markets, showed this chart and said:

The private sector feels the urge to deflate its debt more acutely than the public sector, not to mention that lower credit quality in the private sector deflates debt via defaults.

If we strip out government debt and just look at the private sector, the chart shows [that] Hong Kong, the Netherlands, Switzerland, Sweden, and Ireland are the five countries most at risk of a severe debt deflation.

If this calculation included the financial sector, the U.S. would be further up the “at-risk” scale.

And, of course, those who live in the countries “least at risk” should also prepare for a severe global debt deflation.

One way to prepare is to make sure you have plenty of cash on hand.

Returning to the June Global Market Perspective:
For corporations and for individuals alike, the ultimate shelter in a storm is cash. Cash is liquid, and in deflation, its value goes up as other asset and good values go down.

*****

This is an ideal time to tap into more of EWI’s global analysis, and you can do so free via the valuable resource, 5 Global Insights You Need to Watch.

EWI’s top global experts share their latest forecasts for cryptocurrencies, crude oil, interest rates, deflation, and the future of the European Union.

The result is a short, 5-video series (plus, two quick reads). In just 13 minutes, you get insights into markets and factors that can have a major impact on your investments.

These 5 videos and 2 excerpts are from EWI’s Global Market Perspective. It’s premium, subscriber-level data.

And — you can get it free with a quick Club EWI signup. Club EWI is the world’s largest Elliott wave educational community and membership is also free.

Follow this link: 5 Global Insights You Need to Watch — free, subscriber-level content.

• The Great Depression and the Deflationary 1930′s– 1930-1939
• What is Deflation?
• What is Hyperinflation?
• What is Stagflation?
• What Is Fiat Currency?

Read more on InflationData.com.

The Bureau of Labor Statistics Released the Inflation Data for the 12 months ending in May on June 10^th.

Inflation is virtually ZERO at 0.12%.

 Annual Inflation Retreats

• Annual Inflation fell again to 0.12% in May from 0.33% in April.
• CPI Index rose marginally from  256.389 in April to 256.394 (virtually identical).
• Monthly Inflation for May was 0.002%, April was -0.67%, March was -0.22%, February was 0.27%… typically January through May are highly inflationary so this is VERY unusual.
• The FED continues to crank up the “printing presses” using “Quantitative Easing” in an effort to stimulate the economy in the wake of COVID-19.
• FED Funds Rate remains near Zero.
• Next release July 14^th

Annual inflation for the 12 months ending in May was 0.12%, April was 0.33%, March was 1.54% down sharply from February’s 2.33% and January’s 2.49%. 

The CPI index itself was up very marginally to 256.394 from 256.389 in April down from 258.115 in March. Resulting in a monthly inflation rate so small we had to go to 3 digits to measure it. 0.002% i.e. virtually zero. The annual inflation rate got closer to zero as well going from 0.33% in April to 0.12% in May. 

Prices falling on a monthly basis but rising on an annual basis is called disinflation.

The Moore Inflation Predictor is showing the possibility of actual Deflation late in 2020. But there is also the possibility that the massive FED money creation will result in much higher inflation and some people fear actual hyperinflation.

Monthly Inflation:

According to the BLS commissioner’s report, “The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.1 percent in May on a seasonally adjusted basis after falling 0.8 percent in April, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 0.1 percent before seasonal adjustment.
Declines in the indexes for motor vehicle insurance, energy, and apparel more than offset increases in food and shelter indexes to result in the monthly decrease in the seasonally adjusted all items index. The gasoline index declined 3.5 percent in May, leading to a 1.8-percent decline in the energy index. The food index, in contrast, increased 0.7 percent in May as the index for food at home rose 1.0 percent. “

Seasonally Adjusted Inflation Table

The key words from the Commissioner’s report are “Seasonally Adjusted” and “Monthly” we can see the -0.8% that he’s talking about at the top of the April column. The 12 month unadjusted column shows 0.1% which we calculate to two decimal places at 0.12%.

From the May 2020 column in the table above we can see that on a MONTHLY seasonally adjusted basis, Energy was down -1.8%. On a Non-adjusted annual basis, however,  Energy was down -18.9%, over the entire year.

On a monthly basis, in May, Gasoline was down -3.5% and fuel oil was down -6.3%, Food was up 0.7%,  Apparel was down -2.3%, Transportation Services were down -3.6%, and Medical care services were up 0.6%.

Current Inflation Situation

Annual inflation for the 12 months ending in May was an astonishingly low 0.12% down sharply in spite of the massive money creation by the FED… primarily due to lower oil prices and the Coronavirus shutdown. It was 0.33% in April,  1.54% in March,  2.33% in February and 2.49% in January.

For more information See Annual Inflation.

Federal Reserve Actions

In response to the recent Coronavirus stock market crash, the FED has implemented QE4 equal in speed to QE1 and greater in magnitude than QE1 through QE3 combined. Many believe that this will create massive inflation in the days to come. We’ve highlighted the May increase in Red.  See Inflation Expectations and the Massive Fed Stimulus and Will the $2 Trillion Covid-19 Stimulus Cause Inflation? for more information.

FED Funds Rate

In this chart, we can see that the FED reduced the FED Funds Rate beginning in August 2019 through November 2019. From there through February 2020 they have were relatively flat. But  in March in an effort to fight a coming market crash due to falling oil prices and coronavirus fears the FED dropped rates to 0.65% with hints that they might go as low as 0% or possibly even negative. In April they reduced rates to virtually zero (i.e. 0.05%) and held it at that level in May.

For more info See NYSE ROC and MIP.

Not Seasonally Adjusted Monthly Inflation Rates

See: Monthly Inflation Rate for more information and a complete table of Unadjusted Monthly Rates.

Misery Index

In  April the Misery Index shot up to 15.03% based on 14.7% unemployment and 0.33% inflation.  In May it fell back slightly due to a decrease in the Unemployment rate as some people began returning to work. The highest peak for 2019 was at 5.79% in December and the Low was in September at 5.21%. Previous peaks were 6.87% in July 2018 and 7.44% in February 2017. 

[Read More…]

NYSE Rate of Change (ROC)^©

Hold Signal

NYSE levels are almost back to year-ago levels generating a “Traders Buy” signal and a Conservative Investors Hold Signal.

See the NYSE ROC for more info.

NASDAQ Rate of Change (ROC)^©

Buy Signal!

Unlike the NYSE the NASDAQ ROC did not fall below zero and has rebounded quicker. Last month the NASDAQ ROC crossed sharply back above its moving average reinstating the buy signal. This month it has tacked on another 8% gain resulting in an almost 28%annual gain.

See NASDAQ ROC for more.

Regional Inflation Information

The U.S. Bureau of Labor Statistics also produces regional data. So if you are interested in more localized inflation information you can find it here.

You Might Also Like:

From InflationData.com

• Why Inflation Affects Various Individuals Differently
• April Inflation Near Zero
• What Causes Inflation? Rising Prices Explained
• The 2008 Financial Crisis
• What are Central Banks?
• Inflation Expectations and the Massive Fed Stimulus
• What is the Federal Funds Rate?
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?
• Does the FED Control Mortgage Rates?

Read more on UnemploymentData.com.

• Tips for Starting a Business While Unemployed
• Unemployment Rate Falls Contrary to Economist’s Projections
• Unemployment Rate by State April 2020
• Why Woodworking and Manual Trades Are Still in Demand in 2020
• Coronavirus Shutdown Causes 20 Million Job Losses

From Financial Trend Forecaster

• Oil Goes from Zero to $35 in a Month, But is it Enough?
• Top 5 Reasons Why 5G Will Change the Finance Industry 
• How Can Oil Be Worth Less than Nothing?
• Saudi Arabia’s Oil Price War Is Backfiring
• Electricity Rates by State

From Elliott Wave University

• Emerging Markets and Epidemics
• Deflationary Psychology Versus the Fed: Here’s the Likely Winner
• Crude Oil’s 2020 Crash: See What Helped (Some) Traders Pivot Just in Time
• Stocks: Is the Worst Over or is there Worse Yet to Come?
• Junk Bonds: 2 “Golden” Junctures

From OptioMoney.com

• Learning to Trade from Video Tutorials
• How Saxo Bank Democratizes Trading and Investment
• Five Business Tips to Help Your Company Thrive
• Have Minimal Car Insurance? What to Do in Case of an Accident
• How to Choose a Residential Roofing Contractor

From Your Family Finances

• Budget-Friendly House Flipping
• Beware Of Foreign Exchange Fluctuations When Buying A U.S. Home
• Cut Household Expenses for Your Big Family Move
• Which is Better: New Construction or a Pre-Owned Home?
• Navigating Estate Planning and Probate Law

Read more on InflationData.com.

The cause and effect are both commonly called “inflation” which can cause some confusion. Typically, “Inflation” is defined as “an increase in the cost of a basket of goods over time”. Technically this should be called “Price Inflation” which is often the result of “Monetary Inflation”. As we have discussed in “What is Inflation“, monetary inflation can also be referred to simply as “inflation.”

Inflation is a common phenomenon that affects millions of households every year. Let’s look at how it affects various types of individuals.

Inflation and Income

A fixed income combined with rising prices decreases the ability of people to purchase the same number of goods. As inflation increases, many people face difficulties due to their reduced ability to buy the same number of goods as they were able to purchase before. In other words, with rampant inflation, real (i.e. inflation-adjusted) income falls, reducing purchasing power, and causing increased misery.  The “Misery Index” attempts to measure this by combining both inflation and unemployment rates into a single simple well-being indicator.

Inflation causes Employees to expect an increase in their paycheck every year.

Generally, most businesses give their employees some sort of Cost of Living Adjustment (COLA)  This tends to lead people to believe that they are entitled to more money every year. This is logical if overall prices have inflated because the company will also have raised the prices of their product or service along with the general inflation rate.

However, what if prices have not risen? If the worker is still putting the exact same widget onto the same thing-a-ma-jig as they did last year, why are they entitled to more money? Of course, if they can do it faster or their increased experience and knowledge makes them a more valuable employee, then they do deserve a performance-based raise in addition to the COLA.  But this performance-based raise is earned, not automatic, and not related to inflation.

One disadvantage of the COLA is that it is not retroactive. That is, you don’t get the increase until the next year. So you have already experienced a year of increased prices before you get the raise. This is not too noticeable at low inflation rates but can be very serious at higher rates.  Assuming a 12% inflation rate equally spread over a year, we can see its effects. At the end of January, prices will have increased by 1% and at the end of February they will have increased by 2%, and so on. At the end of December, you get a 12% raise but throughout the year you paid an average of 6% more for everything you purchased. So you start the next year behind by 6%.

Fixed Income Problems

Those on fixed incomes suffer more damage caused by inflation since the costs they pay increase every year but their income does not, so each year they can afford to buy less and less. This is why Social Security includes a COLA as well. Unfortunately, the Social Security COLA in the U.S. is indexed to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) using a complex formula rather than the experimental CPI-E which is more closely related to the actual expenditures of the elderly who tend to spend more on healthcare and less on mortgages, etc.

Lenders vs. Borrowers

Inflation has different effects on lenders versus borrowers and the longer the term of the loan the greater the effect. Inflation is actually a borrower’s friend, in that it allows a borrower to pay off the loan with “cheaper dollars”. Lenders, on the other hand, are getting less and less value as the term of the loan continues.

So for example, if the inflation rate averages 5% and a person borrows money for a 30-year mortgage… based on the Rule of 72 inflation will have doubled in roughly 14.4 years. This means that it only costs half as much in “real” purchasing power to make your mortgage payment and by the end of the mortgage it will only be costing you a quarter as much in “real” purchasing power. This makes lenders less likely to want to make loans unless they charge much higher interest rates in order to offset the loss of purchasing power over the life of the loan.

Income and Wealth

Obviously, income and wealth are integral components of the economic wellbeing of an individual but they aren’t the same thing. An individual can have a high income but not be “wealthy”.

Income generally refers to the flow of funds such as earning from production and selling of goods. In this case, income refers to wages or salary. However, wealth refers to your “Net Worth” which includes tangible assets, such as real estate, gold, and vehicles, etc. Wealth also includes personal funds, such as cash, checking and savings accounts, brokerage accounts, and retirement accounts. This means a person could easily have substantial income but very little wealth.  If they spend every penny and save very little. Surprisingly, this is more common than you might expect as high-income individuals want to present an image of “success” and thus buy a bigger house than they can afford, a fancy car, and spend on credit thus incurring large interest payments. A person could also be “wealthy” but have little income such as a farmer who owns millions of dollars in real estate but only earns a small income from the farm. Or a retiree who has a million dollars in the bank but is only earning 0.5% interest on that money i.e. $5,000/yr.

Income-Based Individuals

So, how does inflation affect such individuals? As we mentioned previously, individuals with large amounts of debt do get a bit of a reprieve by being able to pay off the debt with “cheaper money” but if the debt is of a short term nature i.e. Credit cards, Payday Loans, etc. the boost from inflation is very minimal and the interest is often exorbitant.  Even if you are a high-income person your purchasing power will still be falling behind inflation since you don’t get your raise until the following year.

Asset-Based Individuals

High net worth individuals will fare somewhat better if their assets are properly deployed. Certain tangible assets, such as real estate and gold, tend to hold their value during periods of high inflation. While stocks and inflation-indexed bonds tend to do well during times of moderate inflation. Dividend-paying stocks, Corporate Bonds, and fixed income assets like Savings Accounts, Certificates of Deposit (CDs), and Money Market Funds do well when other markets are falling. So, wise investors create a balanced portfolio of some of each type of asset so that no matter the inflation environment, their portfolio will grow and provide them with enough income to live on comfortably.

You might also like:

• What Causes Inflation? Rising Prices Explained
• Inflation Expectations and the Massive Fed Stimulus
• What is the Federal Funds Rate?
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?
• Does the FED Control Mortgage Rates?
• The 2008 Financial Crisis
• What are Central Banks?

Read more on InflationData.com.

The U.S. Bureau of Labor Statistics (BLS) released its April Inflation report on May 12^th, 2020, for the 12 months through the end of April 2020.

 Annual Inflation Down Sharply… Again!

• Inflation fell sharply to 0.33% in April from 1.54% in March, 2.33% in February and 2.49% in January.
• CPI Index in 258.115 in March fell to 256.389 in April.
• Monthly Inflation for April was -0.67%, March was -0.22%, February was 0.27% typically January through May are highly inflationary so this is VERY unusual.
• The FED has massively cranked up the “printing presses” using “Quantitative Easing” in an effort to stimulate the economy in the wake of COVID-19.
• FED Funds Rate down to near Zero.
• Next release June 10^th

Annual inflation for the 12 months ending in April was 0.33% a full 2% below February’s 2.33%.

March was 1.54%, and January was 2.49%.

The CPI index itself fell to 256.389 down from 258.115 in March from 258.678 in February creating MONTHLY deflation although there was still slight ANNUAL inflation.

Prices falling on a monthly basis but rising on an annual basis is called disinflation.

Currently, the inflation rate is well below the FED’s target 2% rate and very near zero. 

Monthly Inflation:

According to the BLS commissioner’s report, “The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.8 percent in April on a seasonally adjusted basis, the largest monthly decline since December 2008, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 0.3 percent before seasonal adjustment. A 20.6-percent decline in the gasoline index was the largest contributor to the monthly decrease in the seasonally adjusted all items index, but the indexes for apparel, motor vehicle insurance, airline fares, and lodging away from home all fell sharply as well. In contrast, food indexes rose in April, with the index for food at home posting its largest monthly increase since February 1974. The energy index declined mostly due to the decrease in the gasoline index, though some energy component indexes rose.”

Seasonally Adjusted Inflation Table

The key words from the Commissioner’s report are “Seasonally Adjusted” and “Monthly” we can see the -0.8% that he’s talking about at the top of the April column.

Also from the April 2020 column in the table above we can see that on a MONTHLY seasonally adjusted basis, Energy was down -10.1%. On a Non-adjusted annual basis, however,  energy was down -17.7%, over the entire year. In April alone, Gasoline was down -20.6% and fuel oil was down -15.6%. On a monthly basis, Food was up 1.5%,  shelter was unchanged, Apparel was down -4.7% and Medical care services were up 0.5%.

Current Inflation Situation

Annual inflation for the 12 months ending in April was an astonishingly low 0.33% down sharply primarily due to lower oil prices and the Coronavirus shutdown. That puts the inflation rate well below the FED’s target 2% rate, the FED is also currently concerned with a market meltdown due to falling Oil prices and the Coronavirus. Thus it has been pumping up the money supply via a massive Quantitative Easing program i.e. QE4.

For more information See Annual Inflation.

Federal Reserve Actions

In response to the recent Coronavirus stock market crash, the FED has implemented QE4 equal in speed to QE1 and greater in magnitude than QE1 and QE3 combined. Many believe that this will create massive inflation in the days to come.  See Inflation Expectations and the Massive Fed Stimulus and Will the $2 Trillion Covid-19 Stimulus Cause Inflation? for more information.

FED Funds Rate

In early 2019, with inflation falling to around 1.5%, the FED stopped raising FED Funds rate at around 2.4%. By July, inflation was back up to 1.81% (i.e. still below the 2% target) so the FED lowered the FED Funds rate significantly falling from 2.40% in July to 1.55% in November (at that point inflation was back up to 2.05%). The FED halted the easing by holding the FED Funds rate steady at 1.55% from November through January 2020 by which time inflation had climbed to 2.49%. So the FED raised interest rates slightly in February to 1.58% and inflation fell to 2.33%.

And then the Oil Price War between Russia and Saudi Arabia began, combined with the Coronavirus shutdown and inflation rates tumbled, so effective March 3rd the FED set its FED’s Funds target range at 1%- 1.25% but actually lowered it even further to 0.65% by the end of March. Big Banks were speculating that the FED would end up lowering rates to zero by year-end. But it came much sooner than that, as rates were at virtually zero (0.05%) by the end of April.

For more info See NYSE ROC and MIP.

Inflation Forecast

The monthly inflation rate for February was a typical 0.27% but lower energy prices drove March’s monthly inflation rate down to -0.22%. and April’s monthly inflation down to -0.67%. Typically January through May are the most inflationary months of the year, so replacing two of those months with negative numbers eliminates most of the inflation for the year, making this very rare. The last time we had negative monthly inflation in a March month was in 1982 and 1986. Prior to that, we have to go all the way back to 1948 to find one. April had negative monthly inflation in 2013, 2003, 1986, 1954, and 1939.

See our Moore Inflation Predictor to see our current projections.

Not Seasonally Adjusted Monthly Inflation Rates

See: Monthly Inflation Rate for more information and a complete table of Unadjusted Monthly Rates.

Misery Index

In March, the Misery Index was at 5.94% based on 4.4% unemployment and 1.54% inflation. But due to the COVID related jump in Unemployment, the Misery Index for April shot up to 15.03% based on 14.7% unemployment and 0.33% inflation.  The highest peak for 2019 was at 5.79% in December and the Low was in September at 5.21%. Previous peaks were 6.87% in July 2018 and 7.44% in February 2017. 

[Read More…]

NYSE Rate of Change (ROC)^©

Sell Signal

After passing a milestone of doubling since the September 2011 low (up 108.8%) the market was panicked into a massive “correction” by a combination of the CoronaVirus (COVID-19) and falling oil prices. Back on April 10^th the NYSE rebounded to 11,136.61 so it was “only” down 13.59% from year-ago levels. This month it has gained another 1.3% bringing the annual rate of return to -11.78%.

See the NYSE ROC for more info.

NASDAQ Rate of Change (ROC)^©

Buy Signal!

Unlike the NYSE the NASDAQ ROC did not fall as low and has rebounded quicker. It did not cross below the zero-line. Last month we said, “However, in the last week, it has rebounded from an open on Monday of 7,660 to 8,153 as of the close on Thursday.” This month the NASDAQ ROC has crossed sharply back above its moving average reinstating the buy signal.

See NASDAQ ROC for more.

Regional Inflation Information

The U.S. Bureau of Labor Statistics also produces regional data. So if you are interested in more localized inflation information you can find it here.

You Might Also Like:

From InflationData.com

• What Causes Inflation? Rising Prices Explained
• The 2008 Financial Crisis
• What are Central Banks?
• March Inflation Crashes
• Inflation Expectations and the Massive Fed Stimulus
• What is the Federal Funds Rate?
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?
• Does the FED Control Mortgage Rates?

Read more on UnemploymentData.com.

• 4 Industries That Are Urgently Hiring Essential Workers
• 7 Reasons to Consider a Career in Data Analytics
• How to Be a High Productivity Individual at Work
• Essential Jobs That Are in High Demand During Emergencies
• Dealing With Temporary Disability After a Workplace Injury
• 8 Reasons Why You Should Pursue Higher Education (Now!)
• 5 Jobs Every Company Needs and How You Can Get One

From Financial Trend Forecaster

• Top 5 Reasons Why 5G Will Change the Finance Industry 
• How Can Oil Be Worth Less than Nothing?
• Saudi Arabia’s Oil Price War Is Backfiring
• Electricity Rates by State
• Oil Is Now More Volatile Than Bitcoin

From Elliott Wave University

• Deflationary Psychology Versus the Fed: Here’s the Likely Winner
• Crude Oil’s 2020 Crash: See What Helped (Some) Traders Pivot Just in Time
• Stocks: Is the Worst Over or is there Worse Yet to Come?
• Junk Bonds: 2 “Golden” Junctures
• Is the Buying Opportunity Here Yet?
• Did the Oil Crash Wreck the Stock Market?

From OptioMoney.com

• Learning to Trade from Video Tutorials
• How Saxo Bank Democratizes Trading and Investment
• Five Business Tips to Help Your Company Thrive
• Have Minimal Car Insurance? What to Do in Case of an Accident
• How to Choose a Residential Roofing Contractor

From Your Family Finances

• Are We Switching From a Sellers to a Buyers Real Estate Market?
• Essential Investment Considerations for Seniors
• What to Do If Your House is Sagging?
• 4 Signs You’re Financially Ready to Buy a Home
• Things You Should Know When Investing During Your Retirement Years

Read more on InflationData.com.

Economists say that there are 3 major causes of inflation. They are:

1. Cost-Push Inflation
2. Demand-Pull Inflation
3. An increase in the Money Supply

What is Cost-Push inflation?

As the cost of raw materials or wages increases it causes producers to be forced to increase the cost of their products in order to be able to cover their costs of production and a reasonable profit. This results in a “snowball effect” as these new products raise the prices of other products.

But that leads us to the “chicken or the egg” question. What caused the cost of raw materials or wages to rise in the first place? It is possible for foodstuffs to be in short supply due to weather considerations thus causing a shortage and temporarily driving up prices. Other possible causes include natural disasters like a hurricane, flood, or earthquake damaging or destroying production facilities thus reducing supply and in view of constant demand thus causing a rise in prices.

The interesting thing about all of these factors that can start the process of cost-push inflation is that they are all temporary. Floodwaters will recede, factories will be rebuilt, weather conditions will improve, and crops will regrow, etc.

On the other hand, there is a different class of causes that are not so temporary, and they result from government actions. Wars can cause shortages of labor and raw materials. Other government policies such as minimum wage laws can drive up wages, environmental regulations can raise compliance costs, and trade regulations can limit markets. Thus, governments can cause systemic problems that can wreak havoc over decades or longer.

What is Demand-Pull Inflation?

We have all heard that prices are a result of the balance between supply and demand. If demand falls, sellers must lower their prices in order to induce customers to buy their products. According to Keynesian Economic theory the opposite is also true and is the cause of Demand-Pull Inflation. In other words, when people suddenly all decide they want to buy something at once it will drive up the price of an item and cause inflation.

Once again, the major problem with this theory is that it is only temporary and not a cause of systemic inflation. As demand rises, the producer ramps up production in order to capitalize on the increase in demand and although this may take time, it will happen, causing prices to begin to fall again. Also, competitors will enter the market with cheaper competing products, and this will also drive prices down. The only way to ensure ever-higher prices is through a government-imposed monopoly, where supply can be permanently restricted.

The real underlying cause of all systemic (i.e. long-term) inflation is an increase in the money supply. When gold was the primary currency, the money supply was relatively fixed with only a few examples of massive discoveries causing a sudden increase in supply. However, a major discovery of readily available gold could cause a temporary inflationary boom because as the new gold entered the economy, people spent it, increasing demand (similar to what happens in demand-pull inflation).

How an Increase in Money Supply Causes Inflation

When boiled down to the lowest common denominator, long-term systemic inflation is caused by an increase in the money supply.  A simple example is that of an island with ten people on it and each person has $1. and one item for sale. Simple mathematics tells you the average price for each item would be $1.

Now suppose you wanted to make everyone richer, so you gave each one another dollar. There are still only 10 items for sale but now there is $20 to spend so the average price would now be $2.  This means the price doubled, so no one is any richer because they can still only buy one item with their $2.

In this case, no one was better off because the increased money supply was distributed evenly. But in real life that is not how it works. In real life, the government gets all the new money and spends it at its original (higher) value. As it filters through the economy, people begin to realize that it is worth less and prices are driven up. Thus, hurting the people whose income is still fixed at the old lower rate the most.

You might also like:

• What are Central Banks?
• The 2008 Financial Crisis
• 5 Reasons to Invest In Gold
• What is the Federal Funds Rate?
• Does the FED Control Mortgage Rates?
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?

Read more on InflationData.com.

Approximately every 50 to 80 years the world experiences an economic meltdown of catastrophic proportions. The one most people think of is the “Great Depression” of the 1930s. But the more recent example is the 2008 Financial Crisis. This crisis had the potential to be as bad as the Great Depression but Government action i.e. Unemployment Insurance and massive liquidity pumping was able to mitigate the effects somewhat. However, even with those actions, U-3 unemployment reached 10.6% and U-6 unemployment which is more like the measurement used in the 1930s reached 18%.

What Caused the 2008 Crisis?

The 2008 crisis is the culmination of a series of missteps and failed legislation. Traditionally, lenders would only lend to “qualified buyers” but Congress decided that it would be a good thing to encourage homeownership so they instituted a series of changes to regulations allowing banks to shift some of the risk from the lender to the Federal Government. Specifically, to the three housing agencies Fannie Mae, Freddie Mac, and Ginnie Mae.

• Fannie Mae (FNMA – Federal National Mortgage Association)
• Freddie Mac (FHLMC – Federal Home Loan Mortgage Corporation)
• Ginnie Mae (GNMA – Government National Mortgage Association)

These three agencies allowed banks (and mortgage brokers) to create loans pretty much regardless of the borrower’s ability to repay and then pass off the loan to one of these agencies which then bundled them into various large bundles and sold them to investors, both foreign and domestic.

To make matters worse, risk rating agencies gave these “mortgage-backed securities” high safety ratings i.e. AAA ratings. This was partially because housing prices were going up, so the risk was considered to be minimal because “the house could always be sold for more than the mortgage due to rising prices”. Another reason the risk was considered minimal was because most people were unlikely to default because they were a “good credit risk” and adverse to losing their home. And finally, there were thousands of mortgages in the bundle so even if a few defaulted it was only a small percentage.

Increased Demand for Mortgage-Backed Securities

Since these securities paid better returns the demand for them increased. So, lenders did their best to create more of them. To do so they had to lower their lending standards. They began lending to anyone with a pulse even if there was no way they could actually repay the loans. These were called “subprime mortgages”.  But even then there weren’t enough borrowers so lenders got even more aggressive in their lending, trying rope in the unsuspecting with “predatory lending practices” which included variable rates that started out great but quickly became unaffordable.  The new lax lending requirements and low-interest rates drove housing prices higher, which only made mortgage-backed securities seem like an even better investment.

Collateralized Debt Obligations (CDOs)

In addition to regular mortgage-backed securities investment firms and big banks “sliced and diced” these bundles of mortgages into “derivatives” which created the appearance of even less risk than there actually was. A CDO is a specialized financial product backed by a pool of loans. CDO sales rose almost tenfold from $30 billion in 2003 to $225 billion in 2006. In an effort to further limit and divide risk financial institutions created Credit Default Swaps which is a derivative of the mortgage bundles and CDOs. Basically, it was a form of insurance against default. This transferred the risk of default to someone else.

The Housing Crash

When housing prices began to fall and the whole “house of cards” excuse the pun, began to fall. As prices declined people who had borrowed 100% of their house value realized that their mortgage was now more than their house was worth and their expectation of being bailed out by rising house prices was now a “pipe dream’. So, the less credit-worthy began defaulting and this drove housing prices down further. This snowballed into further price declines and more defaults.

Unfortunately, issuers (like AIG) of Credit Default Swaps underestimated the sheer magnitude of the risk they were taking on and as housing prices crashed and more people defaulted, these insurers ended up unable to cover all of their losses causing them to declare bankruptcy. The problem snowballed to Lehman Brothers and Bear Stearns and threatened to take down the entire banking industry. At that point, the government stepped in to halt the chain reaction.

Economic Slowdown

As the housing crisis snowballed the overall economy began slowing down as well causing people to lose their jobs and more people realized that they could no longer make their mortgage payments, thus causing more defaults, etc. Panic set in, stock markets crashed and people feared that the banking system would collapse.

Government Actions

In an effort to stem the tide of the crash the government stepped in and bailed out the biggest banks. The Federal Reserve offered to make emergency loans to banks shoring up those who were fundamentally sound but simply suffering from the overall panic. They eventually ended up spending $250 billion bailing out banks, AIG and even automakers.

The U.S. Treasury also conducted “stress tests” on the largest banks publishing the results, in an effort to alleviate popular fear about the safety of the banks. Congress also passed a huge stimulus package of over $800 Billion in January 2009, in an effort to pump more liquidity into the economy.

In 2010, Congress passed the Dodd-Frank Law in an effort to increase transparency and regulate how much risk banks can take. It set up a consumer protection bureau to reduce predatory lending practices. It also made the trading of CDOs and derivatives more transparent. It also made it possible for banks to fail in a more controlled predictable manner thus further eliminating uncertainty.

The government failed to properly regulate and supervise the financial system and they created “perverse incentives” that encouraged lending to high-risk individuals with the expectation that everyone could pass the risk on to someone else.

Key Terms:

1) Default – when a debtor is unable to meet the legal obligation of debt repayment.

2). Mortgage back securities are created when large financial institutions bundle mortgages and sell them as securities i.e. bonds.

3) Subprime mortgage – a loan granted to individuals with poor credit history.

4) Credit default swaps- a derivative of mortgage-backed securities intended to “insure” against default.

5) Perverse incentive – when a policy ends up having a negative effect opposite of what is intended.

5) Moral hazard – when one person takes on more risk because someone else bears the burden of that risk.

You might also like:

• Does the FED control Mortgage Rates?
• Imports, Exports, and Exchange Rates
• How the Economy Works
• Inflation: The Hidden Tax
• How the FED Controls the Money Supply

Read more on InflationData.com.

History of Central Banking

Like everyone, kings like to spend money, whether it is to wage war or to build palaces, but they often didn’t have all the money they “needed”,  so they had to borrow it. To facilitate this large scale borrowing,  they created a Central Bank to handle that function. In 1790, “Federalist” Alexander Hamilton advocated for a Central Bank in the United States.

Democratic-Republicans, Thomas Jefferson and James Madison believed that the Constitution did not grant the Federal government the authority to create a bank, based on the 10th amendment i.e. that all powers not endowed to Congress are retained by the States (or the people). But Hamilton argued that although not specifically mentioned, the Constitution’s “necessary and proper” clause implied that such a bank could exist. Jefferson rejected the idea that the Bank was truly necessary or even desirable. Both he and Madison also feared that the Bank would be a tool that urban Northern interests could use to dominate the agrarian South. Jefferson’s tour as ambassador in France in the 1780s, during the waning years of the Bourbon monarchy, helped to form his conviction that powerful, centralized governments are prone to corruption, debt, and ultimately tyranny. And Centralized banks were a key component of that tyranny. Jefferson advocated for decentralized banking under the control of the individual states.

Despite Southern objections, Congress passed the bill granting a 20 year charter to the “First Bank of the United States” which was modeled after the Bank of England and given the monopoly privilege of its notes being the only acceptable form of payment for tax payments to state and federal government, and no other banks were permitted to operate in the country.

According to Murray Rothbard History of Money and Banking in the United States The First Bank “pyramiding on top of $2 million in specie” issued millions of dollars in paper money and demand deposits and “promptly fulfilled its inflationary potential.” It invested heavily in the US government, and “The result of the outpouring of credit and paper money by the new Bank of the United States was … an increase [in prices] of 72 percent” from 1791–1796. So,  when the bank’s 20-year charter expired in 1811, Congress refused to renew it by one vote.

The Second National Bank

Five years later, in 1816, Congress tried again. The charter for the Second Bank of the United States was passed by a narrow margin. But by the time Andrew Jackson was elected President in 1828 popular opinion was once again turning against a central bank. So Jackson pursued a policy to end the bank. In 1832, he vetoed a bill calling for the early renewal of the Bank’s charter. And he instituted a policy whereby effective October 1, 1833, federal funds would no longer be deposited in the Second National Bank but instead would be deposited in various State banks.

In an effort to fight back, the President of the Second Bank, Nicholas Biddle, started presenting state banknotes for redemption, calling in loans, and generally contracting credit. He hoped that a financial crisis would demonstrate the need for a national bank. This battle between Jackson and Biddle became known as the Bank War, and became the hot topic among Congress, the Press and the public. In the end, Biddle’s ability to disrupt the economy worked against the central bank in the mind of the public and the Second Bank’s charter expired in 1836.

Free Banking

From 1836 through 1865, banking was handled through State-chartered banks and unchartered “free banks”. During this period banks issued their own notes redeemable in gold or specie. Toward the end of this period the Civil War resulted in massive inflation primarily in the South. Confederate Inflation Rates (1861 – 1865).

During the Civil War, the National Banking Act of 1863 was passed, providing for nationally chartered banks, whose circulating notes had to be backed by U.S. government securities. An amendment to the act required taxation on state bank notes but not national bank notes, effectively creating a uniform currency for the nation. Despite taxation on their notes, state banks continued to flourish due to the growing popularity of demand deposits, which had taken hold during the Free Banking Era.

Stress from the Civil war and uncontrolled fractional banking resulted in a banking panic in 1893. Another round of speculation on Wall Street in 1907 set the stage for “banking reform”. The Aldrich-Vreeland Act of 1908, provided for the emergency issue of currency during a crisis. In late 1910, a group of bankers held a clandestine meeting to plan a bill for the formation of the Federal Reserve at a “Duck Hunting Reserve” on Jekyll Island, GA. Although they were planning a “Central Bank” for political reasons they presented it as “decentralized”. Eventually, this plan became the Federal Reserve Act passed in December 1913. Not so coincidentally the Federal Income Tax was instituted earlier that same year.

The Federal Reserve

In the United States, the Central Bank is called the Federal Reserve or FED. In the U.K. it is the Bank of England (BoE) and in Japan, it is called the Bank of Japan (BoJ).

A central bank, also known as a reserve bank, is an institution designed to serve several various and often conflicting functions. The primary reason that central banks were originally created was to be the bank for the government.

However, over the years other functions have been added to the basic “banker to the government” role. Beginning in 1977 Congress imposed a “Dual Mandate” on the Fed requiring both price stability and full employment. These two mandates are polar opposites however, so the FED has a bit of a balancing act to maintain the best balance possible.

Other functions of the Central Bank include:

• Implement Monetary Policy
• Act as a banker to Banks
• Regulate the Financial System

Act as a Banker to the Government

The FED and other Central Banks still act as the Banker for the Government lending it money to wage wars or create social welfare programs. When the government runs a deficit, it has to get the money somewhere and this is achieved through a complex money shuffle done by the Federal Reserve.

Implement Monetary Policy

“Monetary policy” is the methods in which the Central Bank controls inflation, money supply, economic growth, price stability, and liquidity.

Central banks use a variety of different methods to achieve these goals. Things, like modifying interest rates, regulating foreign exchange rates, and changing the amount of money banks, are required to maintain as reserves. They can also increase or decrease the supply of government bonds by either being a net buyer or seller of the bonds. This can increase or decrease the amount of money in the banking system.

In “Operation Twist” the U.S. FED was neither increasing or decreasing the money supply. Instead they wanted to fight an inverted yield curve. They did this by buying long-term bonds and selling short-term bonds. In an effort to decrease short-term interest rates and increase long-term rates.

Foreign Exchange Rates

Up until 1992, most Central Banks fixed their exchange rate against foreign currencies by law but beginning in 1992 Central Banks abandoned that practice in favor of allowing the rate to be determined by the free market on FOREX exchanges. Some Central Banks like the Central Bank of China, however, still set their Exchange rate by fiat. This “arbitrary” setting can cause adverse forces in the economy.

Act as a Banker to Banks

As the banker to banks, the FED has a variety of functions. It sets interest rates through its FED Funds rate which is the rate that banks can borrow each other’s “excess reserves” that are actually held by the FED itself.

The FED is also the “Lender of Last Resort” which means that if a bank can’t borrow from other banks it can always borrow directly from the FED itself. This borrowing is done at the “discount Rate” which is also set by the FED but is higher than the FED Funds Rate.

Some Central Banks also provide deposit insurance to help maintain confidence in the banking system and prevent “runs” on the banks. Although the U.S. FED doesn’t provide this type of insurance to the U.S. banking system there is another independent federal agency insuring deposits in U.S. banks called the Federal Deposit Insurance Corporation (FDIC).

One disadvantage of policies like Lender of Last Resort and Federal Deposit Insurance is that banks can see this as a license to take more risk and thus create instability in the entire banking system as we saw in 2008. For this reason, the FED also has a regulatory role.

Regulate the Financial System

The FED requires its banks to maintain a certain percentage of their funds in reserve. In other words it must not lend out 100% of its money. And the FED doesn’t just take a bank’s word that they have these reserves. Instead, the banks must keep their required reserves in the FED’s bank. The bank gets no interest on these reserves, so if it has any excess over the required minimum it will loan that to another bank with a shortfall. This lending is done at a rate very close to the FED’s recommended “FED Funds Rate”.

Different countries use different methods to monitor and control their banking sector. The U.S. uses several different agencies. The three main 3 federal agencies are, the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Office of the Comptroller of the Currency plus others on the state and the private level.

For more information:

• Wikipedia: The First Bank of the United States
• Misses.Org: The Corrupt Origins of Central Banking
• Federal Reserve: History

You might also like:

• Inflation: The Hidden Tax
• How the Economy Works
• Does the FED Control Mortgage Rates?
• Imports, Exports, and Exchange Rates
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?
• What Impact Does Interest Rates and Inflation Targets Have on Stocks?

Read more on InflationData.com.

The U.S. Bureau of Labor Statistics (BLS) released its March Inflation report on April 10^th, 2020, for the 12 months through the end of March 2020.

 Annual Inflation Down Sharply

• Inflation fell sharply to 1.54% in March from 2.33% in February and 2.49% in January.
• CPI Index in February was 258.679 and fell to 258.115 in March.
• Monthly Inflation for March was -0.22%, February was 0.27% typically January through May are highly inflationary so this was VERY unusual.
• The FED has massively cranked up the “printing presses” using “Quantitative Easing” in an effort to stimulate the economy in the wake of COVID-19.
• FED Funds Rate down sharply.
• Next release May 12^th

Annual inflation for the 12 months ending in March was 1.54% down sharply from February’s 2.33% and January’s 2.49%.

The CPI index itself fell to 258.115 in March from 258.678 in February creating MONTHLY deflation although there was still ANNUAL inflation.

Prices falling on a monthly basis but rising on an annual basis is called disinflation.

Currently, the inflation rate is below the FED’s target 2% rate. 

Monthly Inflation:

According to the BLS commissioner’s report, “The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.4 percent in March on a seasonally adjusted basis, the largest monthly decline since January 2015, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.5 percent before seasonal adjustment.

A sharp decline in the gasoline index was a major cause of the monthly decrease in the seasonally adjusted all items index, with decreases in the indexes for airline fares, lodging away from home, and apparel also contributing. The energy index fell 5.8 percent as the gasoline index decreased 10.5 percent. The food index rose in March, increasing 0.3 percent as the food at home index rose 0.5 percent.

The index for all items less food and energy fell 0.1 percent in March, its first monthly decline since January 2010. Along with the indexes for airline fares, lodging away from home, and apparel, the index for new vehicles declined in March. The index for shelter was unchanged, with increases in the indexes for rent and for owners’ equivalent rent offsetting the aforementioned decline in the index for lodging away from home. Indexes that increased in March include medical care, used cars and trucks, motor vehicle insurance, and education. “

Seasonally Adjusted Inflation Table

From the March 2020 column in the table above we can see that on a MONTHLY seasonally adjusted basis, Energy was down -5.8%. On a Non-adjusted annual basis, however,  energy was down -5.7%, over the entire year Gasoline was down -10.2% and fuel oil was down a MASSIVE -20.1%. On an annual basis, Food was up 1.9%,  shelter was up 3.0%, Apparel was down -1.6% and Medical care services were up 5.5%.

Current Inflation Chart

As we can see from the chart below, throughout 2019 the inflation rate stayed within a fairly narrow range. It crossed above its 12-month moving average in November at just above 2% in November (at 2.05%) while bottoming at 1.52% in February. After rising to 2.49% in January 2020 it fell back almost to February 2019 levels in one fell swoop. For more information See Current Inflation.

Federal Reserve Actions

Throughout 2018 the FED followed a policy of “Quantitative Tightening” (QT) in addition to raising the FED Funds rate that they charge banks.  This eventually crashed the stock market and the FED reversed course. Then in response to the shut down of the global economy due to the Coronavirus the FED has begun a massive reflating process. The question now is: Will the $2 Trillion COVID-19 Stimulus Cause Inflation?

FED Funds Rate

The FED stopped raising FED Funds rate in early 2019 at around 2.4%. After July, the FED lowered the FED Funds rate significantly falling from 2.40% in July to 1.55% in November. The FED halted the easing by holding the FED Funds rate steady at 1.55% from November through January raising it slightly in February to 1.58%. Effective March 3rd the FED set its target range at 1%- 1.25% but actually lowered it even further to 0.65% by the end of March. Big Banks are speculating that the FED will end up lowering rates to zero by year-end.

For more info See NYSE ROC and MIP.

Inflation Forecast

The monthly inflation rate for February was a typical 0.27% but lower energy prices drove March’s monthly inflation rate down to -0.22%. Typically March is one of the most inflationary months of the year, so this is very rare. The last time we had negative monthly inflation in a March month was in 1982 and 1986. Prior to that, we have to go all the way back to 1948 to find one. 

See our Moore Inflation Predictor to see our current projections.

Not Seasonally Adjusted Monthly Inflation Rates

See: Monthly Inflation Rate for more information and a complete table of Unadjusted Monthly Rates.

Misery Index

Currently, the Misery Index is at 5.94% based on 4.4% unemployment and 1.54% inflation.  This is not significantly different from last month’s 5.83% although Unemployment is much higher and inflation is much lower. This is still below the 6.09% in January, but above the 5.79% in December, 5.55 in November, and 5.36% in October.

[Read More…]

NYSE Rate of Change (ROC)^©

Sell Signal

After passing a milestone of doubling since the September 2011 low (up 108.8%) the market has been panicked into a massive “correction” by a combination of the CoronaVirus (COVID-19) and falling oil prices. On Thursday, April 10^th the S&P 500 gained 2.1 percent by the close bringing the NYSE back up to 11,136.61 “only” down 13.59% from year-ago levels. This resulted in an 8.7% gain for the week so far. The ROC remains in sell territory crossing below its moving average and below the zero line.

See the NYSE ROC for more info.

NASDAQ Rate of Change (ROC)^©

Sell Signal!

The NASDAQ ROC crossed sharply through its moving average generating a sell signal. However, unlike the NYSE ROC it has not crossed below the zero-line. The market was in freefall panic mode because of a combination of falling oil prices and the Corona Virus. However, in the last week, it has rebounded from an open on Monday of 7,660 to 8,153 as of the close on Thursday.

See NASDAQ ROC for more.

Regional Inflation Information

The U.S. Bureau of Labor Statistics also produces regional data. So if you are interested in more localized inflation information you can find it here.

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Inflation is loosely described as a general economic state of rising prices. In February 2020, the US inflation rate dipped from a high of 2.5% in January, to 2.3%. Assuming the standard of steadily increasing prices, driven largely by food, fuel, and living expenses, one can expect the inflation rate to tick higher.

Forecasts for April 2020 are at 1.7%. Given that the major drivers of inflation are excess demand (demand-pull inflation), or cost-push inflation, current conditions based on Coronavirus quarantines have created a murky demand climate.

Oil Prices and Inflationary Expectations

All major US indices, including the Dow Jones Index, have plunged precipitously. Stock portfolios on the Dow Jones have lost upwards of 30% of their value, if not more as the global slide into financial oblivion continues unabated. Nothing was spared on the Dow, as a veritable tidal wave of bad data sank the Dow from almost 30,000 to under 20,000 within weeks. The unprecedented collapse mirrored the worst of what markets have endured including 1929, 1987, and 2008. As global economic activity grinds to a halt due to the coronavirus pandemic wreaking havoc on enterprises across-the-board, while an oil price war combined with sinking oil demand has driven oil prices to multi-decade lows.

On April 1, 2020, the price of WTI (West Texas Intermediate) crude oil plunged below the critical $20 support level, while Brent crude oil was hovering around the $25 per barrel level. Crude oil is widely regarded as one of the primary drivers of global economic activity, and as a barometer of such activity. Now that demand has cratered, oil prices have likewise dropped.

It is important to bear in mind that if oil prices are decreasing, and global demand is decreasing, the same is true of demand for most products and services. Although energy and oil specifically are major components of Inflation, oil is not the only component of inflation but a falling oil price will tend to drag the inflation rate down.

Quantitative Easing (QE) and the US Economy

Quantitative easing is the process by which the Federal Reserve Bank injects a massive stimulus into the economy, in an effort to drive up the velocity flow of money, thereby increasing spending and demand. The theory behind this monetary policy mechanism is that excess money flow makes it cheaper to access capital for financing purposes. Interest rates are inversely related to the money supply. When the money supply is high, interest rates are low, and vice versa. Now, the Federal Reserve Bank has instituted sweeping policy changes such as slashing the interest rate to ZERO and buying up $700 billion worth of Treasuries and mortgage-backed securities. It does this by buying up financial securities from big banks and corporations. By buying those assets from banks this is supposed to increase the money supply available to banks. The rationale behind this is: if commercial banks have more funds available, they will be more likely to lend to consumers and corporations. This credit-driven expansion at near-zero interest rates is seen as a stimulus measure that increases the total amount of currency in the economy.

But the effect of cutting interest rates to near-zero levels means that the Fed has no wiggle room to implement traditional monetary policy mechanisms any further. As a result, it has to adopt unconventional practices to stimulate economic activity. Including quantitative easing or negative interest rates. As an extreme measure, the Federal Reserve Bank has it within its purview to deliver money directly to consumers a.k.a. “helicopter money” which is exactly what the current “CARES ACT” is. The Fed is scrambling to make the US economy more liquid and it is doing it by sending each person a check and increasing unemployment benefits by $600 a week.

The extra $600 a week, however, might have the unintended consequences of incentivizing staying unemployed for many people on the lower levels of the pay scale. For instance, if you previously earned the average wage in the hospitality industry of $410.65 and you collect $250 in State Unemployment and an additional $600 from the Federal Government you would actually be making more than twice as much being unemployed as you made while working. So it would be logical to stay unemployed as long as they could. The same logic would apply to retail workers who earn an average of $626.03 a week so if their state unemployment check was $400 combined with an extra $600 Federal check they would be getting $1000 being unemployed. Even Transportation and Warehousing workers who average $964.22 a week might get $600 in unemployment and another $600 from the Federal Government so it still pays for them to remain unemployed as long as possible.

Can Access to Cheap Money Help the US Economy?

The expectation is that ready access to funds will significantly boost aggregate demand, thereby driving up economic activity. Increasing aggregate demand invariably raises inflation expectations over time. This is precisely what happened after the Financial Crisis of 2008 when the Federal Reserve Bank aggressively rolled out a massive Quantitative Easing program to reignite the US economy after one of the worst meltdowns in the history of the country. But as you can see in the chart below the FED has recently increased assets very similarly to QE1 in an effort to head off a recession before it even starts.

The actions of the Fed can have an impact on inflation. For the most part, inflation was stable and consistent through 2019. With consumer prices hovering around 2% in January 2019, allowing the Fed to hold off on interest-rate hikes. From January 2019 through January 2020, the interest rate rose steadily, before contracting in February 2020. The Fed has consistently targeted an inflation rate of 2%, and deemed that essential to healthy economic growth.

Unfortunately, the global pandemic has upended any notion of economic stability, causing massive and unprecedented disruption to the everyday functioning of businesses and entire industries. A severe economic crisis is now on our doorstep, and the Fed’s actions are an attempt to stave off an unprecedented economic recession. Fortunately, deflation fears appear to be at bay, given that demand and supply declines are simultaneously taking root. This is significantly different from the Great Depression in the 1920s and 1930s, or the economic collapse of 2008, but we’re only in the infancy stages of this crisis.

Read More:

• How the Economy Works
• Inflation: The Hidden Tax
• 5 Reasons to Invest In Gold
• How the FED Controls the Money Supply
• Does the FED Control Mortgage Rates?
• Imports, Exports, and Exchange Rates
• Will the $2 Trillion Covid-19 Stimulus Cause Inflation?

Read more on InflationData.com.

By law banks are required to maintain a certain percentage of their assets in reserves at any given time. This money is held at the Federal Reserve bank and is called the “Reserve Requirement”. Generally, this money does not earn any interest. But, any money over and above this minimum can be loaned to other banks to who might not have enough reserves.

The rate that banks can charge each other is called the “Federal Funds rate” or “Fed Funds Rate”. The monetary policy-making body of the Federal Reserve System, is called the “Federal Open Market Committee” or “FOMC”. The FOMC meets eight times a year to discuss the economy and decide on any changes to monetary policy. One of the major policy factors that they discuss is where they will set the Fed Funds Rate.

Because the stock market hangs on every word that comes out of FOMC they carefully craft the wording of the report of their actions. They use the Fed Funds rate to tweak the economy. If they believe the economy is getting too sluggish they might lower the Fed Funds rate in an effort to stimulate borrowing which they hope will increase buying and therefore create more jobs and snowball into a healthier economy.

On the other hand, if the FOMC believes that the economy is getting “overheated” they might raise interest rates in an effort to dampen borrowing and buying, and thus reduce inflationary pressures.

Recently, Fed Funds rates began rising around January 2016 as the FED felt the economy was recovering and was able to sustain higher rates. They continued rising until January 2019 at which point the stock market was faltering so the FED halted any further raises. At their July 2019 meeting they announced that they would begin lowering the FED Funds rate which they did until November 2019 when they began holding steady at 1.55%.

Why Raising Interest Rates Might Dampen Inflation

When people expect things to cost more tomorrow than they do today (i.e. inflation) they tend to spend money faster rather than hold it or save it. After all, why hold onto something that will be worth less tomorrow than it is today. They may actually even borrow money they otherwise wouldn’t assuming that they can repay it with “cheaper dollars”. The speed that people want to spend their money is called “Velocity of Money”.

Raising interest rates makes that practice less profitable. It also raises the cost of buying a house, or borrowing to buy a car. Thus, fewer people can afford to buy things and this slows the economy down. Inflation and Velocity of money go hand in hand. The higher the inflation rate the faster people want to spend their money. But the faster they want to spend it the less likely they are to be “shopping around” looking for the best deal so venders can charge more which raises the inflation rate. By slowing the demand it also slows the velocity of money as well.

How the FED “Enforces” the FED Funds Rate

Technically, the Federal Reserve can’t enforce the FED Funds Rate. It is instead negotiated between the two banks, so the FED Funds Rate is simply a “target” range set by the FED. However, the FED also controls the “Discount Rate” which is the rate at which it will loan out money to individual banks. So, in effect it can set a cap on how much a bank has to pay.

Therefore, if the FED sets the FED Funds rate at 2% it might set the discount rate at 2.25%. That way no bank is going to pay another bank more than 2.25% if it can borrow directly from the FED for the discount rate.

The FED can also increase or decrease the money supply which will affect the reserves of both banks.  Thus increasing the money supply will add reserves to both banks. This will decrease the first banks need to borrow and increase the 2^nd banks desire to lend. Based on supply and demand factors this will have the effect of lowering the interest rate both banks are willing to trade at.

See Also:

• Does the FED control Mortgage Rates?
• Imports, Exports, and Exchange Rates
• How the Economy Works
• Inflation: The Hidden Tax
• How the FED Controls the Money Supply

Read more on InflationData.com.