Inflation Is About More Than Printing Money

In November 2021, I wrote an article about how printing money alone does not necessarily create inflation. Inflation

The point in that one was printing money doesn’t cause inflation unless people spend it. In 2020 and 2021, much money was created, but inflation failed to show up. The reason was another factor – the velocity of money. That is about how fast money turns over. It is usually around two times a year, but it had dropped to about 1.4 times a year by the end of 2020. People mostly held on to money or used it to pay down debt because they feared for worse to come. Paying down debt or holding the money has no effect on prices.

On the 16th of June 2022, I did another article about inflation and pointed out that inflation is an intersection metric. It is caused by at least two things. The supply of unearned money and the supply of goods and services to spend it on. A policy could be aimed at either side. Interest, to reduce the people’s ability to buy, for example.

Connecting the pieces. 

Have you noticed that if you dispose of some dust-collecting book, file, or tool, not more than two days after the recycling or garbage has been collected, a need for it will appear? Writing articles is like that too. You should expect to find another sound point as soon as it is done. About 12 hours after I finished the article for the 16th, The Wall Street Journal published the missing link. “We Need To Know What Reagan Knew About Economics”

Ronald Reagan, when he took office in 1981, faced high interest rates and high inflation. Did he use policies that reduced the money supply or raised rates further? No! He advanced an approach based on supply-side economics, known as Reaganomics. He wanted the extra money invested in new supply and improved productivity.

Reaganomics compared.

If you don’t spend the extra printed money, it does not affect the price level. In 2020, people reduced debt or held cash against the risk of future shocks. By mid-2021, the fear began to shrink, and some of the money appeared to buy things people had postponed. By mid-summer, You would have been hard-pressed to find a boat to buy. That rush to spend while the supply of goods has not increased induces inflation.

Reaganomics involved two things.

  1. Cut taxes, so the people had more “earned” cash to spend. Spending money that is earned does not raise prices because goods and services are produced simultaneously. While the government had to borrow money to meet its needs, it was not new spending that could lead to inflation. It just supplied existing government services.
  2. Reagan changed the expectations. Reagan inspired people to expect the future to improve, so they saved and invested. The current administration is not inspiring confidence in the future. Quite the opposite.

When people are confident in the future

Reagan and/or his advisors knew that inflation goes away when the supply of money matches the supply of goods and services. The trick is using the earlier printed money to improve supply. When people are optimistic about the future and the behaviour of governments, they don’t spend their money on a new boat, car, house, or vacation. They invest.

As investment money came available, newly optimistic businesses invest in production capability, research and training.

Investing money has the same effect on prices as does reducing debt, so inflation tends to go away.

Expectations matter as much as what you can measure and calculate with a spreadsheet.

The bits to take away

If people today had confidence in the future, inflation would be much lower despite the massive money creation problem.

Inflation has many factors behind it. Printed money is just one.

Look to the other factors like scarcity of goods and the reasons for that situation.

Most of all, people spend rather than invest because they don’t trust the future. That mistrust is a political problem.

 


I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.

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