Is the Fed Setting The Economy Up For Higher Inflation?

For the last few years, Thomas Hoenig, president of the Kansas City Fed, has been the lone voice of reason among Federal Reserve Bankers. He voted against the latest $600 billion bond purchase using freshly printed dollars (Quantitative Easing II), he advocates higher short-term interest rates, he worries about inflation, in short he seems to be concerned about the long-term health of the US economy rather than short-term fixes for the labor market.
Printing Money

In a speech today, Hoenig confirmed what we knew all along: The Fed is ‘monetizing debt,’ a fancy way of saying that it is printing money to fund the Federal Government. He argues that this will lead to asset bubbles and inflation. Some other Fed Presidents seem to be coming around to his point of view as the economy continues to gain strength. Charles Plosser, Jeffrey Lacker, and James Bullard all called for a review of Bernanke’s QEII.

Interestingly, the Fed Charmian, Bernanke, stated in a CBS interview last year that the Fed is not printing money:

“One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way.”

M2 Money Supply

Let us look at the Fed’s own data to see how true this statement is. The chart at right shows how the M2 money supply has changed from a year ago.

Money in Circulation

M2 is a measure of the money in circulation that includes currency in circulation, checking accounts, saving accounts, CDs under $100,000, and similar pools of readily accessible cash in the hands of the public.

The growth of money supply has clearly started to pick up, increasing from 1.4% in March of 2010 to 4.3% in January of 2011. This is not an especially fast growth rate yet, but together with the accelerating inflation rates we discussed a few weeks ago, this explains Hoenig’s fear that the Fed is setting us up for new bubbles and high inflation.

Posted by Martin Gremm (Pivot Point Advisors)

About the author

Marc Schindler, CFP®

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