How Price Inflation Works, and Why it May Finally Work Now!

Plane made of burning dollar bills symbolizes price inflation and the Fed moving to digital currency

I’ve said this before, but there is a strong reason why it has been clear we would NOT have price inflation during all the Federal Reserve’s money creation after the Great Recession and why we very well could have it now.

I think this deserves a quick summary because even financial writers don’t get it.

Here’s an example:

Hedge funds and speculators… and economists… expected inflation to rise in 2010 and 2011 as the Federal Reserve pumped a lot of money into the economy through three rounds of quantitative easing. For other reasons, as I have documented in many posts over the past ten years, inflation did not arise but the stock market hit many new highs…. As I have written recently, I don’t believe that inflation is going to be the problem and, consequently, I don’t believe that this is the reason for the fall in the value of the dollar. The major reason for this view is that inflation has not been a problem, and will likely not be a problem in the near future.

Seeking Alpha

The last line is the giveaway: the only basis given for the overall statement is that inflation has not been a problem in the past with Fed money creation; therefore, it is not likely to become one in the near future.

That’s a fallacy that a lot of people are choosing to believe right now. They think the Federal Reserve can keep on doing what it is now doing because it didn’t run into inflation in the past.

Inflation has not been a problem for years, and I’ve said for years it would not be a problem. Now, I am saying to watch out for it because the risk has become real. I never joined the many with gold to sell who said every year inflation would be a problem.

However, everything is different this time in ways that do finally create price-inflation risk.

There are many kinds of inflation

It is important to be clear on our definition of “inflation” because many who write about it keep changing the goal posts. One minute they are saying expanded dollar supply is inflation; the next sentence they are talking about increased prices.

So, let’s be clear: There is inflation of money supply or “dollar inflation.” There is “price inflation.” There is “asset inflation.” And there are all kinds of other things that can inflate, but those three are our concerns.

Inflation of money supply (expanding the number of dollars) does not necessarily create price inflation, which is what many of the inflation hounds have been saying would happen for years — prices would soar because of the Fed’s expansion of money supply. We would see hyperinflation through the roof! The value of gold in dollars would soar to $5,000/ounce because the value of dollars would shrink because so many were being created.

Poppycock! They have been wrong! For years they have been wrong, and I have not joined their chorus.

This time is different.

Inflation is more complicated than that but not much

The principle is so incredibly easy to understand. It’s just a little more complex than more dollars equal price inflation or gold inflation.

Because price inflation is actually quite easy to understand, the inflation hounds are without excuse, too, just as the stock guru above is for saying inflation won’t become a problem now because it hasn’t been so far. He just wants more of that free Fed money that takes stocks to the moon.

Key point: Inflated money supply ONLY creates price inflation where money flows. For years, all of the Fed’s free and almost-free money was fed into bonds and stocks. Because the money endlessly recirculated in stocks and bonds, it only created inflation in stocks and bonds — asset inflation.

NOW we have helicopter money. That means much of the Fed’s money printing is going to buy government bonds that are being used to supply money directly into the hands of the people through the Payroll Protection Program, enhanced unemployment benefits, and $1,200 stimulus checks.

Inflation of money supply creates inflation where the money flows. Increase the dollar supply but lock all the new money inside of bank vaults so no one who is buying goods and services has access to any of it, and you can create an infinite amount of new money and create no price inflation in goods and services at all! That’s because the money is being kept out of the general economy. It’s just making banker’s richer, and there are not enough of them buying underwear to have a big impact on the price of underwear even if they are too big for the britches.

Lock the money up in financial speculation, and it only creates inflation of financial asset prices, which you’ll experience as a good thing if you own those things. If the financial money moves to gold as an asset, then it will create inflation in the price of gold, which is priced globally in dollars. Gold remained out of style with many for the past decade, so that particular asset did’t inflate much. The asset ala mode was stocks.

Point Two: Where you get price inflation is when you put additional money supply into the hands of people AND you have a shortage of goods and services.

Covidcrisis creates the perfect storm for price hyperinflation

Right now, we have a serious risk of a shortage of goods and services because of the Covidcrisis. People are not producing anywhere near as much in goods and services all over the world. On top of that, we have major trade barriers we’ve erected in the US that also reduce the flow of goods and services and of the parts/supplies used to produce those goods and services domestically.

First, the shutdown hugely shut off production. Now social-distancing and a partial reopening creates business inefficiencies that slow down production and services; yet, many people actually have more money now than the did before the Covidcrisis because the government is putting money directly into their hands.


People have things they want and need, and they face shortages of those things but have plenty to spend, so they start bidding up the price. If, by way of familiar example from the Covidcrisis, they need toilet paper or want it badly, and there is not enough, they’ll either stand in line for an hour or pay double the price to someone who doesn’t make them stand in line.

Òila! Price inflation.

Expansion of money supply can only create inflation where the money is allowed to flow and in the right environment. We have both now, so the possibility of price inflation just became real. Next, we need to look at what will make that possibility a reality or prevent it from happening.

In a deep recession or depression, people usually have a shortage of money due to high unemployment and depleted unemployment benefits. So, even though there is a shortage of goods and services due to unemployment in a recession or depression, there is also a shortage of income, leaving a shortage of money to chase those diminished goods and services. Thus, you can have price deflation, even in the face of shortages.

What is happening is the money supply in the hands of consumers is becoming even lower than the supply of goods and services. In fact, people may become so anxious to gain a little money, that they will sell things cheaper or provide their services cheaper just to make any money at all.

This time is different because the government is making up the cash shortfall.

So long as the government doesn’t go overboard and merely keeps the additional money supply in line with the available goods and services, it will avoid creating inflation and merely stabilize prices. That has its problems:

  1. Can we trust the politicians to limit their money creation based on inflation when their constituents are screaming for the money?
  2. If they do limit it, that can seriously hurt the unemployed who don’t get benefits or whose benefits are reduced because the unemployed NEED the natural price deflation that happens in a deep recession in order to survive with less income.

So, this is now a tightrope to be walked by politicians because the Fed will fund whatever the government demands in order to keep government interest on its massive debt under control, or else the Fed will anger the politicians who have the power to change the Fed or even end its congressional charter that gives it a monopoly on the global dollar.

You cannot automatically bank on there being either inflation or deflation at present because it depends on how far the government goes with this and how serious the shortages of goods and services are (if they even happen). So, remain vigilant. If you see prices starting to rise and see the government doesn’t get it and keeps creating more helicopter money, bank on serous price inflation.

If you see other ways that the Fed’s free money is moving into the general economy — and I’ll certainly be watching for those — that could also create inflation risk.

So, there is no certainty of price inflation, depending on how carefully the additional megamoney supply is handled, but there is a great possibility of it now that the money is going into the general economy and now that we have some likelihood of future shortages of goods and/or services.

For deeper understanding of what gives money its value, you can read the following article: “The Moron’s Guide to Money: What gives money its value? And what is the gold standard?

The following is a good counterargument as to why we are more likely to see deflation in the year ahead. Its points about money supply are valid and worth considering. In essence, banks are not multiplying the Fed’s base money at nearly the ratio they used to because they no longer care much about making loans or are constrained by reserve requirements or simply because the new money the Fed is creating far exceeds what banks are able to leverage with new loans (conceivably because there isn’t any greater demand for traditional loans even at lower rates). Therefore, total money supply is not expanding with anywhere near as much leverage over and above the Fed’s base supply. The argument, however, does not deal with the fact of helicopter money going straight to the public now, which it did not do before this year, or of shortages of goods pushing prices up — too many dollars chasing too few goods — or the fact that government is now controlling how much money goes into the system, not the Fed. Still, the article presents countervailing forces to inflation worth considering:

3 Reasons Treasury Rates Can Still Hit 0%

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