Written by Klaraos
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11 December 2009
Inflationary Times and What History Teaches Us
In 1023, the Song Dynasty of China became the first civilization to issue true paper money. The concept behind these notes was that they were backed by the government and were transferable for gold, silver or silk. Every three years, these notes were to be exchanged for new ones, with a minimal charge to the money holder. Theoretically, three years would pass, new notes would be printed and the old ones would be replaced with new ones. Not so surprisingly, the system failed when people refused to give up the old notes in exchange for new ones. This created an economy with too many notes in existence; creating the world’s first bout of inflation.
Fast forward nearly a millennium, and our monetary base still struggles with inflation. Our current concern is with re-inflation, or the intentional reversal of deflation through a monetary action by a government. Depending on whom you listen to, re-inflation is a good thing, a bad thing, or the end of all civilization as we know it. The focus here doesn’t necessarily need to be who’s right and wrong, but what our current economic status means to your dollar.
Our focus here at Klaraos is towards the monetary base (money supply), and what it means. Our government has drastically increased the money supply recently with the financial crisis and the subsequent invention of TARP (remember TARP? It’s still around). Normally economists agree that an excessive growth of the money supply will lead to inflation and possible hyperinflation. That hasn’t happened… yet. As our curiosity grows from this significant growth in the monetary base, we strive to find out what reaction our economy will take.
As we take a look at the current money supply, as provided by the Federal Reserve Bank of St. Louis, we find the money supply to be at an all time high.
The spike in supply can be seen as very concerning, or nothing to worry about, depending on who you ask. The real question behind this spike is why we have not had to deal with inflation or hyperinflation yet? The answer is not how much money there is (more than ever), but how quickly that money is being put to use (velocity). The money has been printed by our government, but the banks and lending institutions are not releasing any of the money (through lending procedures) to the public. So the base has grown, but the money growth has yet to reach the public, creating little to no velocity (use).
While we wait for this large sum of money to gain traction, we can only anticipate the reaction of the general public. Stay tuned, as this is part 1 of a story we want to tell. Part 2 will speak more on the importance of the velocity of money, and how the velocity will dictate how we handle this current theme of deflation vs. inflation.
