I was a kid in the 80’s. I don’t remember the last time America had an inflation rate much higher than a savings rate. Unfortunately, inflation is now running at 7.9%, and short term treasuries are paying 0.63%. Holding treasuries pays a real rate of -7.27% right now. At this pace, in five years you’ll have 68.5% as much purchasing power as you have today. Instead of being able to buy 10 hamburgers, you’ll only be able to buy 7 in five years, even though you are invested in treasuries!
Let this sink in. At this rate your wealth will be cut by half in ten years. If you saved just enough for retirement, you will be 50% short.
The big question is “What is driving inflation?”. For a while the narrative is the supply/demand shocks we are going through post-pandemic. We have millions of people changing jobs. We have ports that have gotten clogged. Russia is disrupting oil supplies with its war on the Ukraine. We have companies stocking up on parts. We have fewer people wanting to do our hardest jobs. All of these seem like real possibilities. Perhaps all are true. However, I have a simpler approach. Take a peek at USD M3 Money Supply, which I like to think of as American’s supply of money and credit. When you go buy a car or a house or a Starbucks, this is the pool of money competing against you to buy it.
I think the chart above fits my mental narrative for what is happening in the US. Let’s start with 2008-2010. Where is the big spike? Didn’t the government have some big bailouts for the banks and print a lot of money?? Yeah, go read about TARP. So where is the spike in 2008? It never came. The money was used to recapitalize the banks, it wasn’t used to send out checks to households. Neither you nor you neighbor ever got the money.
However, in 2020, you can see what happens when you start mailing checks to citizens. They deposit them. If Americans spend the checks they got, someone else eventually ended up with money. It didn’t disappear. As a result, Americans now have 42% more cash in their bank accounts than they did in February 2020. To be clear, we have no idea how this is distributed, which does matter. If all 42% are in one single person’s bank account, it shouldn’t push up the price of hamburgers. But the more distributed the printed money, the more I imagine demand is heating up for houses, cars, contractors and hamburgers.
If we look at the line from 2011 to 2019, that seems fairly constant, the slope of the curve is about 5.7% a year. Over that time the US averaged inflation of 1.6%. So, over that stretch there wasn’t one to one comparison of M3 and inflation. GDP growth was 2.1%/yr during that stretch. Inflation + GDP growth was 3.8%? Still not the same, but in the ballpark.
Let’s ignore the big jump in March 2020. Even after the big jump we can see M3 is expanding faster than the 5.7% it was from 2011 to 2019. The new trend line is 12.5% per year. If my simple theory of what is happening is even directionally right, expanding M3 at twice the pace as before COVID should imply inflation rates twice what they were before COVID.
Do I know what a 42% jump in M3 over two years is going to mean long term? Can I forecast the inflation we are going to see? No. I really have no idea. However, I think directionally we can expect to see inflation run hot. If congress raises taxes, they could lower M3 by literally pulling it out of your bank account. That doesn’t seem likely. The other option is the Fed could raise rates high enough that Americans start taking the money out of their accounts and buy bonds. However, bond rates at 8% would certainly cause a recession. My guess? Buckle up and watch the M3 curve. Until it bends, prepare for inflation to continue eating away at your wealth.