Why Quantitative Easing Has Not Created Inflation (And Why It Won’t)

Harry S. Dent | Wednesday, August 28, 2013 >>

The only time we’ve had a similar level of Quantitative Easing (QE) and money printing we have in the U.S. today, was during World War II, when the Fed bought its own bonds to keep interest rates low and demand high enough to finance the war effort.

Back then, the Fed’s actions did what you’d expect: They caused a modest level of inflation. But the war effort suppressed consumer demand, so consumer prices didn’t rise as much as they would when flooded with stimulus in normal times.

You’d expect the Fed’s unprecedented actions today to create substantially higher inflation. In fact, with the greatest money printing effort in history, it wouldn’t be unreasonable to fear hyperinflation.

That’s what gold bugs fear most.

Yet inflation is very mild. What gives?


Quite simply, the money the Fed is printing through QE is largely going into financial speculation, not into expanding the money supply through lending and spending. So instead of inflation, we see bubbles inflating in the financial markets… and they’re just like the ones we’ve seen before when tech stocks blew up… then real estate… then emerging markets… then commodities… then gold… junk bonds… Treasury bonds.

Those bubbles did nothing to create a stronger future. Instead, they tempted investors to misallocate resources. Then, when the bubbles inevitably burst (like 2000 – 2002 or 2008 – 2009), the system they’d stretched and warped with debt fell apart.

The new bubbles will end the same way.

So why are gold bugs’ fears of hyperinflation so misplaced? Because they’re ONLY looking at the amount of new money being created and I’ll grant them, current printing is unprecedented.

What they’re not considering is the velocity of money. Is it being lent and spent productively?

It’s because we look at BOTH of those pieces of the puzzle that we lead the cheer squad in the deflationary camp.

Look at this chart. It comes from one of my few favorite U.S. economists, Lacy Hunt at Hoisington Investment Management.

See larger image

Lacy explains this better than anyone so I’m pleased he’ll be speaking at our Irrational Economics Summit this November 6 – 8 in La Jolla, CA. I suggest you reserve your seat now as spaces are filling fast.

Until then, I’ll paraphrase Lacy’s view on this matter (but I do urge you to join us in November to listen to the man speak)…

When money velocity is rising, it means the economy is expanding. Production capacity is increasing. Deposits from rising wages are being lent and invested effectively. Essentially, more money is moving around the economy, in the places it should. Late 1978 into 1997 was such a period.

When money velocity starts to fall (as we saw after 1918 or 1997), it means investment is increasingly speculative. Less money is spent on productivity enhancements or capacity improvements. Workers’ wages stagnate or fall, so they spend less. Basically, the money flow shifts.

Think of it like our circulation. When money velocity is rising, blood is flowing through all our veins and arteries smoothly, feeding our muscles and organs the necessary nutrients and oxygen we need to function optimally. When money velocity is falling, blockages form and the blood pools dangerously. Blood clots and strokes become a constant threat.

When money velocity drops below average levels, as the black line in the chart above shows, then those bubbles and the debt behind them are starting to deleverage, and that causes deflation and negative money velocity.

The last time we saw money velocity drop like a rock was between 1919 and 1929. Back then we had bubbles building into the Roaring ’20s. The first time money velocity went negative was in 1930, and it stayed in that territory until 1933. It was during those three years that bubbles burst left, right and center, and debt deleveraged at breakneck speeds… creating deflation, not inflation, even with record low interest rates and Fed stimulus to fight the great Depression.

Inflation is cyclical. It rises like the temperature during spring and summer. Then it begins to cool and eventually becomes deflation during the winter economic cycle. It’s happened this way every 60 to 80 years for as long as we can track this economic cycle. It never happens any other way.

We started to see deflation in 2008 and 2009, when the economic Winter Season began to take hold, on schedule. But the Fed and other central banks declared war on deflation and debt deleveraging and their weapon is massive and continued QE.

Yet all they’ve achieved is a tepid 1% to 2% inflation.

And they’re running out of steam. The next deflationary period will see years of negative money velocity, beyond the sharp drop into neutral territory since 2008. We’re talking a rerun of the early 1930s between 2014 and 2019… when my most important longer-term cycles all point down together.

The Fed and governrnments around the world can’t continue to fight the massive debt overhang AND worsening demographic trends. They will lose this battle and the result will be deflation.

Are your investments protected from inflation or deflation? Most debt crisis experts have people protected from inflation. The people that followed their recommendations in 2008 got burnrned.

Don’t get burnrned when the next crisis starts, likely by early 2014. Listen to us instead and come to our conference in November where you’ll see George Gilder and Lacy Hunt, along with many other speakers. You’ll walk away with a clearer view in a world turnrned upside down.


P.S. You have until midnight Saturday, August 31 to save $200 on your seat at our Irrational Economic Summit in La Jolla, CA this November. Click here to get your discount.


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