Too Much Money Portends High Inflation

July 24, 2021

June’s inflation index jumped 5.4% from a year ago, the highest reading since August 2008. The experts were surprised. Clearly, Federal Reserve watchers never bothered to consult Milton Friedman. Lost is a core Friedman dictum: “Inflation is always and everywhere a monetary phenomenon.” To appreciate this loss, just consider Fed Chairman Jerome Powell's Feb. 23 Congressional testimony, when he said that the growth in the money supply, specifically M2, “doesn’t really have important implications.”

To get a handle on what the recent money supply explosion implies for inflation, we must use a monetarist model of national income determination. That famous model was displayed on Milton Friedman’s California license plates. It’s compact: MV=Py, where M is the money supply, V is the velocity of money, P is the price level, and y is real GDP.

When we plug in numbers and solve for M, we find that M2 growth since March 2020 is nearly four times the "ideal" rate that would allow the Fed to hit its inflation target of 2% per year. Inflation is baked in the cake, and it’s likely to persist. By the end of the year, the year-over-year inflation rate will be at least 6% and possibly as high as 9%. And, as velocity picks up and greases the monetary wheels, inflation might hit the high end of our forecast range.

Mr. Powell and his colleagues should start paying attention to the money supply. Money matters. Indeed, it dominates.

Record Inflation Levels Are Coming

In a recent interview with David Lin of Kitco News, I discuss June's Consumer Price Index (CPI) headline inflation number of 5.4% and the Hanke-Cofnas Gold Sentiment Index.

June's inflation increase of 5.4% from a year ago was very predictable. And, it's here to stay. That's because money matters. Since March 2020, the money supply (M2) has been growing almost four times the rate that would allow the Fed to hit its inflation target of 2% per year. So, inflation of 6%-9% by the end of the year is baked in the cake.

Since my previous appearance on Kitco News, gold sentiment, measured by the Hanke-Cofnas Gold Sentiment Index, had become more bullish. As I had pointed out in that previous interview, the gold sentiment price chart had a "double bottom" pattern, meaning that gold sentiment was likely to rebound. This did, in fact, occur, and gold sentiment has reached slightly bullish territory. And, as has been the case since the beginning of my gold sentiment measurement "pilot program," the price of gold has closely followed the Hanke-Cofnas Gold Sentiment Index.


Steve H. Hanke is Professor of Applied Economics at the Johns Hopkins University in Baltimore, MD. He is also a Senior Fellow and Director of the Troubled Currencies Project at the Cato Institute in Washington, D.C. You can follow him on Twitter: @Steve_Hanke

The California Gold Rush began on January 24, 1848 when gold was found by James W. Marshall at Sutter's Mill in Coloma.
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