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Near Term Inflationary Headwinds

A common argument today is whether inflation will be a near or long term threat. With all the recent government efforts to stimulate the economy by increasing the money supply, it is very natural to anticipate an onslaught of inflation. When trying to determine how & when the increased supply of money will have a inflationary impact on the economic system there are several key metrics that one should be aware of.

Velocity of money: the average frequency with which a unit of money is spent in a specific period of time.
 
Though the velocity of money can explain a relative rate at which money is flowing through the economy, it cannot explain why money flow is being slowed down or sped up through the system. The exhibit below shows Commercial Bank Deposits vs. Commercial Bank Loans & Leases. As the exhibit points out, over the past year banks have continued to lend less even as their depositary base has grown. Though this behavior can be explained by many reasons (ex. increased reserve requirements, increasing assets to shore up balance sheets to offset potential write downs), it is important to note that the increased money supply is not fully flowing through the economic system and into the hands of the consumer to then be spent and re-circulated.
 

Source: Federal Reserve

The velocity of money is being slowed down at the bank level which does not allow inflation (or the effects of increased money supply) to fully set in. This action by the banks is giving the Federal Reserve a “window of opportunity” to reverse their actions and pull money out of the system before the next full phase of credit expansion begins. How this will eventually play out will remain to be seen, but in the near term (18m) banks will most likely not be expediting their lending efforts, consumers will not be racing to over leverage themselves, and the velocity of money will continue to remain relatively slow.
 


Disclosure: No Position

Disclosure: No Position