30 April, 2012

Where has that inflation gone?

Something of a puzzle to many commentators is that Obama's vast money printing binge has not produced rapid inflation. A greenback buys less than it used to -- particularly overseas -- but not spectacularly less.

Jerry Bowyer wisely remarks that it often takes a long time for an influence to work its way through the system and he is undoubtedly right so that is clearly part of the story.

But I think the major factor is a straightforward example of what economists call the "velocity of circulation" effect. Price inflation is a product of the amount of money on issue multiplied by its velocity of circulation and the velocity of circulation has fallen precipitously just as the money supply has increased -- the one influence largely cancelling out the other.

My apologies for introuducing a bit of economic jargon into a general political blog but I have been puzzled that none of the discussions of the matter that I have seen have mentioned the role of the velocity of circulation. Perhaps it is just that other writers have better manners than I do.

To make amends, let me put up a somewhat oversimplified version of my suggestion: Most of the money Obama has issued is just sitting still in the reserves of banks, other financial institutions and major companies. It is not being spent or lent out. Its velocity of circulation is nil. It might as well not exist as far as the economy as a whole is concerned.

And because of general nervousness that is not going to change soon. But if and when it does change the party will really be on -- a party for everyone except people who have savings.

Let me suggest a scenario. Suppose Romney is elected and fires all the Obama cronies running the EPA and other business-obstructing agencies. That suddenly gives everybody more confidence in doing business. So the banks start lending again and businesses with reserves start using their reserves to expand. The money starts flowing again. The velocity of circulation rises. There is now a greater demand for resources: both labour and capital goods. People might even start building new houses again. For a little while that greater demand for resources will be met from presently idled resources: Unemployed people will get employed and shuttered mines and manufacturing facilities will reopen. So everyone will be having a party.

But parties like that tend to feed on themselves and breed yet more optimism -- and so the demand for resources will soon go beyond what can be met by reactivating idled resources. With the money now flowing again, prices will be bid up as everybody wants a piece of the action. And an expanded volume of money chasing a relatively fixed resource base can only lead in one direction -- to price rises. Inflation will be underway. How far it will go is anybody's guess but with everybody now using the extra money that Obama has created, it could be a whopper of an inflationary process. What a greenback will buy could easily drop to (say) half of what it will buy today.

So Romney will inherit Obama's inflation and will probably be blamed for it. And savers will rightly feel utterly betrayed by the political system that has cut the value of their savings in half. "Spend it while you can" will become the new wisdom. My personal hint: Put most of your savings into blue-chip company shares NOW. I did so long ago.

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