Supply And Demand For Money – The End Of Inflation?

August 5, 2020
Analyst, Author, and Owner of Kelsey's Gold Facts

A current headline says “fears of currency debasement drive gold price higher”. Seems reasonable; and it is.

Historically, governments have been “debasing” their currencies for centuries. The debasement leads to a loss of purchasing power in the currency in use.

Since gold is original money and has proven itself to be a true store of value, then it should not be unexpected that gold’s higher price over time reflects that currency debasement.

The debasement leads to a loss of purchasing power in the currency in use.

All currencies are substitutes for ‘real money’, i.e., gold; and all governments inflate and destroy their own currencies. 

UNDERSTANDING INFLATION

Governments debase their currencies by inflating (LITERALLY) the supply of money and credit. Too often, incorrectly, people refer to rising prices as inflation. Even, more specifically, also inaccurately, they might call the rising prices “price inflation”.

The rising prices are an effect of inflation. The inflation has already happened.

The primary definition of inflation in the dictionary is “the action of inflating something or the condition of being inflated – the inflation of a balloon“.

Now then; when have you ever heard the ‘popping of a balloon’ referred to as inflation? The popping of the balloon is the result of stress induced by the previous act of inflating the balloon with too much air.

When we talk about inflation, and if we want to understand it to any reasonable degree, it is imperative to recognize the difference between inflation and its effects. It is critically important because the effects of inflation are unpredictable.

Sure, you can say that the balloon will eventually pop; but when? Can you describe how and why; and calculate any potential collateral damage?

SUPPLY AND DEMAND FOR MONEY

The supply of money referred to here is the supply of US dollars that we use as a medium of exchange. That supply is created and manipulated by government and the Federal Reserve.

Since that supply of money is virtually unlimited, and since the manipulation is designed to bring about the intentions of those in power, it is not difficult to see how – and why – things have gotten so bad.

The Federal Reserve has been “creating and manipulating” for more than one hundred years. Their traffic record is abominable. But still, some look to them to fix the problems that they, themselves, have created. A better way to describe the Fed’s efforts is that they are now mostly geared to managing and mopping up the ill effects of their own poor decisions and misdeeds.

The demand for money is the actual desire to hold cash (currency or demand deposit accounts) and cash-substitutes (money market funds, etc.)

It is true that the supply of money is a principal factor in the degree to which the effects of inflation are experienced and felt. But the effects of inflation, the increase in the general level of prices for most goods and services, is also influenced by the demand side.

Twelve years ago, when the Federal Reserve unleashed their trillion dollar answer to the credit crisis and the economic collapse that appeared almost certain, almost no one was thinking about the demand side of the equation – the desire of people in general to hold and save money.

Focus was almost exclusively on the supply side: liberal extensions of credit, targeted relief measures which involved the creation of new money, etc. There was a renewal of interest in and attention paid to the “inflation trade” – and on a scale that seemed to dwarf anything seen previously, or scarcely imagined possible.

Most expected much higher prices for all goods and services, and the possibility of “runaway inflation”. The price of gold surged and the US dollar fell sharply in foreign exchange trading.

But, we didn’t get the “runaway inflation” or anything close to it. As badly as the dollar was bullied on foreign markets, the hugely higher prices that were expected here in the US failed to materialize.

Why? Nearly everyone forgot demand-side of the equation. The desire for holding cash increased. Individuals and companies chose to pay down debts and hold money instead of borrowing and spending. The available credit wasn’t put to use in any measurable way that would encourage an increase in economic activity that might normally have occurred.

For ten years, we heard about the Fed’s concern re: hitting their 2% inflation target. The response from their generous efforts did not yield the expected results. In essence, Fed actions was reduced in scope to the point of fighting its own demons. (see The Fed’s 2% Inflation Target Is Pointless)

Even with the obvious inflation that is currently being created in the effort to stem the tide of economic collapse, focus on the supply side by gold bulls is short-sighted. It is anticipated by some that recent Fed money creation will lead to renewed “dollar bashing” and a big loss in its purchasing power.

It might. And it might not. And to what degree? Will there be a complete repudiation of the US dollar? That is possible.

On the other hand, the current vacuum in economic activity and the high unemployment rate is indicative of a situation that is more representative of the Great Depression.

If people decide they need to hold cash, then inflationary pressures will be lessened; not increased. And, there isn’t much the Fed can do about it.

THE END OF INFLATION

Which brings us to our final point. The expectation of continued inflation won’t keep it going indefinitely.

The large scale of weak economic conditions is indicative of a society that has, as a result of chronic inflation, become cash poor. Most people simply don’t have enough money. The demand for money is accelerating.

As the demand for cash increases, people begin to sell things; anything and everything. It will require a deflationary collapse to heal completely and to recover from the ill effects of the past eighty years.

Otherwise, it is a matter of postponing the inevitable; in which case the cure will be much worse when it finally happens.

Historically speaking, periods of entrenched inflation always end in economic collapse. There are many examples of ridiculously high inflation rates which ended up at dramatically lower levels after a collapse. And the economic collapse can happen either with, or without, experiencing runaway inflation.

*********

Kelsey Williams has more than forty years experience in the financial services industry, including fourteen years as a full-service financial planner. His website, Kelsey's Gold Facts, contains self-authored articles written for the purpose of educating and informing others about gold within a historical context. In addition to gold, he writes about inflation and the Federal Reserve.

Kelsey is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED! 

Kelsey Williams is available for private consultations, public speaking, and interviews at kwilliams@kelseywilliamsgold.com

Gold weighs 19.3 times as much as an equal volume of water.

Gold Eagle twitter                Like Gold Eagle on Facebook