During the noughties we saw two conflicting forces. Globalisation led to rises in commodity prices, and in asset prices such as property. But for manufactured goods, especially high tech products, inflation was either modest, or even negative.

The latest data from the US had the headline consumer price index falling by 0.2 per cent in May on the month before. Strip food and energy out of the equation, and prices rose by a trifling 0.1 per cent. The annual rate of inflation fell from 2.2 per cent to 2 per cent.

But maybe the real underlying force we should be looking at is the money supply.

You may recall that the Fed does not publish data on M3 (the broad money supply) any more. But Capital Economics has been publishing its own estimates of M3. This broader version of the money supply, the one that economists believe is most closely correlated with long term inflation, contracted 7.6 per cent in the three months to May. On a quarter on quarter basis, M3 has been contracting for nine months, and on an annual basis it has been contracting for six months.

It does not matter how much money the Fed creates, the money supply is falling. This pattern mirrors the experience seen in Japan for the last decade or two, and during the 1930s in the US.
There is no mystery behind this. The contracting money supply is caused by savers seeking safety. In the noughties, savers’ money boosted property prices, and home-owners borrowed against property. During this period the money supply growth, and maybe the Fed’s failure to try and stem this growth, was its biggest failure of all.

But now money is doing nothing. It is finding its way into government bonds, and maybe gold. The circulation of money is freezing. Because savers have become so risk averse, the arteries of the economy are furring over.

The global economy desperately needs to see its economic cholesterol drop. Saving is back in fashion, and we are seeing the deflationary force build.

See also Do we really face an impending food crisis? – 18 June

and US money supply contracts like a boa constrictor - 16 March,

and If money grew on trees, we would be in the midst of deforestation 1 February

© Investment & Business News 2013