Why Prices are not Rising

There is an article in the July-August number of Foreign Affairs on the magic of easy money. The author, obviously knowledgeable, as writers in the magazine tend to be, discusses the huge expansion of the money supply and expresses perplexity at how it is that prices have not been rising accordingly.  Recently I saw a similar puzzlement expressed in an article found in The Atlantic. Talented financial writers note that we are flooded with money without price inflation. They find it even more remarkable in the absence of increased production of goods and services. You could understand prices not going up if the production was rising just as quickly, but the current case consists of much more money chasing after fewer goods and services. How can that be? We don’t know, they say; it’s a mystery, but it is how it is, and apparently we can print unlimited money without price inflation resulting. 

What they are missing is that the extra money is not chasing goods and services very hard. The velocity of money has slowed way down. People aren’t spending. At least, not quickly. This is a behavior that characterized the Great Depression. The Social Credit Party recognized the congruence between the low velocity of money and depression and tried to use their “funny money” to raise the frequency of economic transactions. The value of their money was programmed to decline by a fixed amount each week. One had to spend it to get rid of it to avoid the erosion.

The drop in the velocity of money is one indicator that we are in a depression. I don’t think that we may be sliding into it; I think we are in the early stages already. It will last for several years, and damage will be high.

I do not want to imply that the velocity of money is an independent phenomenon. It is dependent on individuals making decisions about whether to spend. The question each person has is which do they want more --- the money, or the goods and services? It appears that right now people have become inclined to choose money more readily than they were before the pandemic. I attribute it to their uncertainty about the future.

We might view the velocity of money as nothing more than the velocity of goods as Henry Hazlitt argued --- a function of decreased demand. Decreased demand tends towards economic slowdown: why produce what people don’t want?

My expectation is that once people begin to feel more certain about the future, or at least more certain about the probability of some plausible futures, particularly in regards to a decreased likelihood of outliers they today view with alarm, they will once again be wanting to buy more. And they will be operating with more cash. The M1 money supply has grown with the government having created cash out of credit. The result will be a run-up in prices. The chickens will come home to roost.

My guess is that we are already in a depression (a lengthy and deep slowdown in production) which will tend to be a deflationary depression that will turn into an inflationary depression. People are going to get hurt. And it will last for several years at least.