A Practical Look At "Flation"
It depends on your definition of inflation; if it's a growth in money supply, then, yes, this is already extremely inflationary. But so far, this hasn't translated into higher price levels or even higher long-term inflation expectations as measured by the spread of 10 year TIPS versus 10 year Treasury bonds; TIPS are inflation protected Treasuries that provide compensation for increases in the consumer price index (CPI); it is this spread that the Fed is most concerned about when gauging the market's inflation expectations.
Why has it not (yet) been inflationary? Well, the Fed can provide all the money it wants, but it cannot force institutions to lend. Below is a chart of the "excess reserves" in the banking system; these are the reserves banks hold in excess of what they are required to maintain.
Until September, excess reserved hovered at or below about US $2 billion, but have ballooned to over $600 billion as of November 19, 2008. Read in conjunction with our discussion above on the Fed "printing money", the Fed has thrown money at the banking system, but the banks are hoarding the cash, they do not lend. For banks to lend money, two basic conditions must be bet: they must feel strong enough to provide credit; and they must feel their customers - be they consumers or businesses - are creditworthy enough.
That for me is the key issue. And the reason why it has not affected the prices of goods, services, asset prices, or even inflation expectations as measured by TIPs is that banks are not extending credit.
Here is a table of conditions and whether or not one would expect to see those conditions in inflation, deflation, stagflation, hyperinflation, and disinflation. Some expectations are debatable so I left those bank.
*** Current Conditions
** Base Money Supply spiked during Great Depression as one of the previous charts shows
* The Purchasing power of gold is in relation to other commodities
Those using practical definitions have an easy time explaining things. Those lost souls screaming hyperinflation missed the boat completely. Hyperinflationists have had trouble for years explaining falling home prices, and falling treasury yields.
Those screaming stagflation no longer have a case with falling commodity prices, a rising dollar, and falling treasury yields.
Disinflation makes no sense with stock prices down 40% and corporate bond yields soaring. Stocks do best in disinflation. Corporate bond yields drop in disinflation. This is not disinflation by any stretch of the imagination.
Routine inflation makes no sense in light of corporate bond yields priced for bankruptcy, collapsing stocks, plunging commodity prices and a negative CPI.
Those who think inflation is about prices alone were busy shorting treasuries, and looking the wrong direction for over a year. Only after the stock market fell 50% and gasoline prices crashed did the media start picking up on "deflation". Only those who knew what a destruction in credit would do to jobs, to lending, to retail sales, to the stock market, to corporate bond yields and to treasury yields got it right.
What It's Not
It's Not Disinflation
It's Not Stagflation
It's Not Inflation
It's Not Hyperinflation
What's left looks like a duck, walks like a duck, flies like a duck, and squawks like a duck. And that duck is deflation no matter what others suggest.
Those who stick to a monetary definition of inflation pointing at base money supply are selecting a definition that makes absolutely no practical sense. Worse yet they do it screaming about bond-bubbles at yields of 5% or higher, all because they refuse to see or admit the destruction of credit is happening far faster than the Fed is printing.
And it is that destruction of credit, coupled with the fact that what the Fed is printing is not even being lent that matters, not some Humpty-Dumptyish academic definition that has no real world practical application!
Phooey. I prefer a practical definition of deflation that matches and even predicts what the credit markets and stock markets are going to do, not some definition that is useless for anything but academic debate.
The trick now is to figure out how long deflation will last, not whether we are in it.
