First, a few graphs. The first is of M2, the money stock, showing its meteoric rise over the last few decades.
It took fifteen years for the stock of money to roughly double (from 1980 to 1995), then another about twelve for it to double again (1995 to 2007, just before the beginning of the last recession). It is on pace to double again in another five years from now, ten year total (2007 to 2017). Very obviously, the quantity of goods and services the money is intended to represent hasn’t grown even remotely as fast as the quantity of money (else real per capita GDP would be something over a couple hundred grand a year). Real GDP over the last thirty years has roughly doubled, as the following chart indicates (start at GDP of 6,000 in 1980 to compare with previous chart). The money stock has roughly quintupled over the same period.
Inflation, i.e., rising prices explains the difference in growth rates between the two:
The excess money creation not captured by the CPI can be found in the prices for long and short-term assets, such as houses, stocks and bonds, commodities, etc. The “savings glut” Mr. Bernanke and his predecessor, Alan Greenspan, liked to use to explain low long-term interest rates is really a money glut. Interest is the price paid for renting money. Ceteris paribus, prices decline as supply increases. The more money, the lower the interest rate (on a real basis). Long term real interest rates (the interest rate less the inflation rate) have been negative now for about the same length of time as the unemployment rate has been above 8%. Surely the correlation is completely fortuitous.
As the money creation curve has steepened over the last several years (see slope of the top graph since roughly the middle of the last recession), indicating an accelerating pace of money creation, the velocity of the money has declined. Velocity is a measure of how many times each dollar changes hand in a transaction over the course of a year. It could also be used as a proxy for those “animal spirits” Keynes sought to inflame with his programs of money printing and fiscal deficits (much as the Fed has been trying today). Here’s what velocity has done lately:
The bulge in velocity beginning in 1990 closely parallels the bulge of baby boomers settling into adulthood and child rearing (the leading edge of the boomers would have been about 45 years old in 1990, so their children would have been entering their highly consumptive and consuming teen years).
But look at what velocity has done in response to the Fed’s furious money printing lately. Dollars lie dormant the more and more of them are made. If the plunge in velocity continues, the Fed will soon enough be able to shut its presses for good. A dollar sitting in a bank vault collecting dust doesn’t wear out, and so never needs replacing.
That steady march downward in money velocity is why all the extra money since the recession has had little impact on retail prices. The excess money has certainly, like before, found its way into the asset markets, but little of their price appreciation is captured in the CPI.
The Fed has filled the money troughs full. It has dragged the economic horses to the troughs. But the horses are getting old. Their metabolism is shunted. They needn’t drink so much as before. You can lead a horse to water, but you can’t make him drink.