Update on Monetary Inflation and the US Rise and Bust

Cullen Roche profile picture

diego tomazini

Editor’s note: Originally published on tsi-blog.com on November 3, 2022

[This blog post is an excerpt from a commentary published at TSI last week]

Monetary inflation is the engine of the boom-bust business cycle, and booms are set in motion by rapid monetary inflation and ongoing crashes after the rate of new money creation falls below a critical level and/or projects become impossible to complete due to resource scarcity. The chart below shows that the US monetary inflation rate (the year-over-year growth rate of the US real money supply) extended its decline in September 2022 and is now below 4%, below from a high of almost 40% at the beginning of last year.

US TMS YoY Percent Change

Due to the economic damage caused over multiple cycles by central bank manipulations, the current US economic crisis began with a higher rate of monetary inflation than previous crises. Furthermore, most of the things related to the current transition from boom to bust have happened within a short time frame.

In previous cycles over the last three decades, a fall in the monetary inflation rate below 6% initiated a 1-2 year sequence that included a yield curve inversion, a substantial widening of credit spreads (the start of The spread widening trend combined with the start of an uptrend in the gold/commodities ratio marks the start of the downside phase) and a yield curve reversal from flattening/inversion to steepening – previous at the beginning of an economic recession. This time, however, all of the above except a steepening of the yield curve occurred within 7 months of a drop in the monetary inflation rate below 8%.

There has yet to be a reversal in the yield curve from flattening/inverting to steepening, but that’s because this time around the Fed continues to aggressively tighten monetary conditions amid an economic downturn. This is similar to what happened in 1973-1974.

To further explain the above comment, the monetary inflation rate (the blue line in the monthly chart below) drives the yield curve (the red line in the chart). Of particular relevance to this discussion, a yield curve inversion (the red line falling below zero) is a effect of a large drop in the monetary inflation rate and, in general, a trend reversal in the yield curve from a flattening/inversion to a slope requires an upward trend reversal in the monetary inflation rate.

Given that the downward trend in the US monetary inflation rate is unlikely to end before the first quarter of next year, a turnaround in the yield curve is likely to be several months away. performance (towards a pronunciation). In the meantime, it is reasonable to expect the curve to move further into inverted territory.

US TMS YOY vs. 10Y-2Y Spread

As mentioned in the weekly update on October 3, if the Federal Reserve sticks to its current balance sheet reduction plan for a few more months, then by February of next year, the annual growth rate of money supply US will likely turn negative. , that is, the US will be experiencing monetary deflation. If this happens, the prices of most assets will be much lower than they are today.

As also mentioned above, economic and stock market weakness will eventually put irresistible pressure on the Fed to start a new monetary easing campaign, but there is nothing to be gained by trying to guess when that will be. This is because initial attempts to ‘stimulate’ will almost certainly not be enough to start a new boom, and because the stock market generally does not bottom out until long after the trend in monetary inflation has reversed to the upside. . At the moment we are a long way from such a reversal.

Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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