A Central Banker Speaks About the Economy and Inflation

April 2, 2014

I recently listened to an interview with Mr. William White. He is a central banker who has worked for various world and central banks throughout his career. He says that the continuous money-printing has done a good job of pumped up the financial side of the economy, but has left the “real” side of the economy sorely lacking.

He says the financial markets don’t have any relationship to the market economy. Just because the stock markets keep climbing, doesn’t mean that companies are doing well. All it means is that the money that’s been pumped into the system is going into the stock market. If companies were growing, they would be building more buildings. They’re not; they are using any excess liquidity to buy back shares of their stock and pay out dividends. They don’t feel comfortable enough to sink money into new structures.

Mr. White said that what’s been happening relative to the asset and equity prices is similar to what happened in 2007, just before the recession hit. I don’t know about you, but this makes me pretty nervous.

If your portfolio has recovered a lot since 2008/2009, then congratulations. That is one area where Bernanke’s monetary policy has succeeded. However, if that doesn’t leave you feeling wealthy and spending more money, then Bernanke’s plan has fallen short. With your portfolio value up, you were supposed to start spending more money, which, in turn, would cause some wealth to trickle down to everyone else.

I have had the, possibly mistaken, belief that the massive money-printing would cause inflation. It just seemed to me that with all that extra money being put into the system, it would drive up the prices of goods and services. As it turns out, this hasn’t happened because people aren’t spending. In economic terms, the velocity of money is at a 40 year low. That means the increase in people’s wealth has not caused them to go out and spend. Inflation occurs when there is too much money chasing too few goods and services.

Mr. White pointed out that inflation could become a problem when the economy actually does start to improve. If we have real growth, people and businesses may start to spend more money, thereby rapidly increasing the velocity of money. To put this in layman’s terms, if all the money that’s been printed starts being spent into the economy, then we could see massive inflation come on very rapidly. He has seen this happen in several Latin American countries.

If everyone starts to believe that the economy is doing well and feels wealthy because their portfolio is up or their job feels more secure or they got a raise, they might very well start loosening the purse strings. Something known as pent-up spending can kick in (I’ve experienced it myself). When you’ve been denying yourself things for a period of time and then your situation improves, you start buying all the things you denied yourself. There is a concentration of spending all at once instead of spreading out the purchases.

When people start spending, money flows to others who may not have been receiving much income over the previous several years. Now they have more wealth and their pent-up spending kicks in. With everyone starting to spend, there’s more money flowing through the system. That’s what is referred to as an increase in the velocity of money. That’s what will cause inflation to kick in.

Yours in prosperity,

Sophia


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