Printing Money Does NOT Cause Inflation

david-frazierNumerous self-proclaimed financial market “experts” claimed over the past six years that the United States would soon enter a period of hyperinflation due to the Federal Reserve’s massive creation of new money that began during September 2008.

Yet, instead of experiencing large and rapid increases in inflation, the country’s household inflation rate rose at an average annual compounded rate of only 1.3 percent from September 2008 to May of this year. That comes as no surprise to me, as I began telling investors during mid-2009 that inflation rates in the United States would not rise to any problematic levels for at least several years.

In fact, I advised my clients during May 2011 to sell short gold bullion via an inverse-gold exchange-traded fund (“ETF”) because my research indicated at that time that the overall inflation rate in the United States would soon peak and then turn lower. Four months later, during September 2011, the consumer price index did in fact peak, at 3.8 percent, and it trended substantially lower over the past 44 months, falling to a mere 0 percent as of May 31 of this year. During that same period, the inverse-gold ETF that I continued to recommend to my clients appreciated by 31.6 percent.

The reason I was convinced that inflation rates would remain in check, and that gold prices would therefore trend lower, is really quite simple – contrary to the claims made by some financial market pundits, the creation of new money, even massive amounts of new money, does not cause inflation. Instead, inflation rates tend to rise substantially only during periods when a large and growing number of persons increase their spending at a rapid rate and/or their salaries and wages rise sharply, or when energy and food prices trend substantially higher because of supply shocks; (see the chart below).


And, as you can see from the chart above, Americans have increased their spending at a relatively slow pace since mid-2011. Additionally, the average salaries and wages of U.S. households rose at a slow pace over the past six years.

Although energy and food prices rose substantially from 2009 to mid-2014, Americans kept a tight lid on their spending during that period in response to very meager increases in their salaries and wages. And, energy and food prices fell considerably over the past 12 months.

Now, I’m not suggesting that the creation of money can never lead to substantial increases in inflation rates. But, for that to happen, a large portion of any new money that’s created by the Federal Reserve must be borrowed and spent. Yet, that’s not what occurred over the past six years—quite the contrary.

Editor’s Note: Discover how central banks influence interest rates

The vast amount of all new money that’s been created by the Fed since September 2008 has been sitting in the Fed’s vaults (via electronic deposits) instead of being borrowed and spent. That fact is illustrated by the large increase in the monetary base – in commercial bank deposits with the Fed plus currency held by the public – and the much smaller increases in the M1 and M2 money supply from September 2008 to May of this year.

If you’re not familiar with the M1 and M2 money supply, those terms are defined as follows:

  • M1 Money Supply – Currency, coins, and non-bank-owned checking account deposits (M1).
  • M2 Money Supply – M1 money supply plus savings deposits, money market mutual funds and other time deposits.

Although the monetary base has risen by more than four-fold since September 2008, the M1 money supply doubled and the M2 money supply rose by only 52 percent during that period.

Hence, most of the money that’s been created by the Federal Reserve as a result of the Fed purchasing large amounts of U.S. government securities from government bond dealers, and those dealers then depositing the proceeds from those sales into the Fed’s 12 branch banks, has remained in the Fed’s vaults. Otherwise, the M1 and M2 money supply would have risen by much larger percentage.

Meanwhile, the velocity of the M2 money supply – the number of times that M2 money has been spent – has fallen sharply since mid-2008, declining during the first quarter of this year to the lowest level on record.

The factors and developments discussed above suggest that the household inflation rate in the United States will continue to rise at a very modest pace, at worst, until Americans begin to borrow and spend a large portion of the massive amount of new money that’s been created by the Federal Reserve.

With the readings on numerous leading economic indicators suggesting that the U.S. economy will grow at a slow pace over the next 12 months, there appears to be little change of that occurring over the near-term.

Therefore, I encourage you to stop listening to all of the non-sense that’s been promulgated by financial market pundits who claim that the United States will, eventually, enter a period of hyperinflation.

By the way, eventually the Detroit Lions might win the Super Bowl and the Chicago Cubs might win the World Series. And, eventually, we’ll all be dead.

David Frazier is President and Chief Market Strategist of Frazier & Mayer Research, LLC, an independent investment research firm that offers customized research and analytical services to registered investment advisors, hedge funds and high net-worth individual investors.