FEB 27, 2018
U.S. money supply growth is shrinking, and history shows that when that happens, money velocity turns higher, which has inflationary implications. The slowing growth of the money supply has profound — albeit counterintuitive — implications for inflation and the value of the U.S. dollar.
These relationships shed some insight into the idea that tighter monetary policy — reflected in the slowing growth rate of M2 and the onset of the Fed’s balance-sheet reduction — is likely to be inflationary in practice.
The year-over-year growth rate in the velocity of the M2 money stock, which has been negative since early 2011, is heading toward positive territory, after rising from -4.1% in 3Q2016 to -0.3% in 4Q2017, as shown by the red line in the following chart.
Importantly, this is occurring at the same time that the growth rate of the M2 money stock has fallen from nearly 8% in October 2016 to 4.2% recently (blue line).
When money supply growth slows and the demand for funds increases — such as with the $1 trillion-plus fiscal deficits we wrote about last week — the conditions are ripe for an inflationary surge and a falling dollar. One could also argue that this will be good for real assets (which were hurt by QE during 2010 to 2016) but bad for financial assets (which benefited from QE).
ORIGINAL SOURCE: Will Quantitative Tightening (QT), which is deflationary in theory, be inflationary in practice? at 13D Research on 2/15/18