If anyone doubts we are moving to more monetary accommodation, take a look at the excerpt below from last night's U.S. Financial Data release from the St. Louis Fed. The lower right hand corner reflects the most recent trends.
In June, we posted an article indicating a seeming correlation between the trend in direction and magnitude of U.S. M2 growth and U.S. economic activity. The decline in the M2 growth rate has now turned, and is headed up again, as you can see below, but the turn is not as dramatic as the growth in the Monetary Base.
We've previously stated our concern that the U.S. could be heading into a period of rapidly increasing inflation, similar to that experienced in the early 1970s that led to many years of stagflation, only ending with Mr. Volcker's monetary castor oil. We've got all the ingredients, including this summer's rapid runup in commodity prices. The past twelve month the GDP price deflator has dropped from 2.4% to 1.9% on an annual basis, averaging a bit above the Fed's 2% target. 2-3% is in the range where the 1970's inflation began to take off. Yet, we're in a period where many, if not most, observers have been talking recession and increased likelihood of deflation. Real inflation will come as a black swan for many, with significant implications for both fixed income and equity markets.
Could the current round of easing be the spark that finally ignites the inflationary flame? There are lots of reasons to suspect that's possible. Calculated Risk just supported a growing belief that housing may finally be bottoming. Declining home prices have been a primary force that's kept inflation in check for the past few years. Add to that a renewed commodity spiral, annual wage inflation in China hitting 13-15% and evidence that the banking industry may be finally loosening the credit spigot, and you've got the potential for lighting a bonfire.