An Inflation Inferno is Expected – but When?

Daniel Thorn­ton, an econ­o­mist at the Federal Reserve Bank of St. Louis, argues thatthe Fed’s pol­icy of pro­vid­ing liq­uid­ity has “enor­mous poten­tial to increase the money sup­ply,” result­ing in what The Wall Street Journal’s Real Time Eco­nom­ics blog calls “an infla­tion inferno.” [Personally,] I think it’s too soon to make sig­nif­i­cant changes to a port­fo­lio based on infla­tion fears. Here’s why. 

So says Russ Koesterich (http://isharesblog.com/) in edited excerpts from his original article* which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has edited further below for length and clarity – see Editor’s Note at the bottom of the page. 

Koesterich goes on to say, in part:

Given the recent rise in bank lend­ing, growth in the money sup­ply and unprece­dented nature of the Fed’s mon­e­tary exper­i­ment, infla­tion is cer­tainly a sig­nif­i­cant risk. While there is a healthy the­o­ret­i­cal debate on whether increases in the money sup­ply lead to infla­tion, however, I believe the logic is sim­ple. As the sup­ply of money goes up, the value of money drops, caus­ing inflation.

To be sure, the Fed is likely to try to use tools in its arse­nal to com­bat the real­ity of…[my] the­ory. Accord­ing to The Wall Street Jour­nal, the Fed is con­sid­er­ing imple­ment­ing a new bond-buying pro­gram along with future pos­si­ble stim­u­lus to “relieve anx­i­eties that money print­ing could fuel infla­tion later.” How­ever, this pos­si­ble approach, like other recent Fed tools, is untested and it’s unclear how it would work in real­ity if it were implemented.

What’s cer­tain is that his­tor­i­cally, rapid increases in the money sup­ply have his­tor­i­cally led to infla­tion in the United States, though there typ­i­cally is a lag between money cre­ation and infla­tion. His­tor­i­cally, it gen­er­ally has taken two to three years before growth in the money sup­ply has trans­lated into a mean­ing­ful accel­er­a­tion in infla­tion…So far, the Fed’s asset pur­chase pro­grams — QE1, QE2 and Oper­a­tion Twist — have not resulted in infla­tion. This is because, until recently, the extra money the Fed cre­ated sat qui­etly on bank bal­ance sheets as banks con­tracted their lend­ing.

With­out bank lend­ing, the money sup­ply didn’t rise very much (although the mon­e­tary base, which includes bank reserves, has shot up) but the sit­u­a­tion, has started to change. Out­side of the mort­gage mar­ket, bank lend­ing has been ris­ing since last sum­mer. Com­mer­cial and indus­trial loans are now grow­ing at 11% year-over-year, the fastest rate since 2008. As bank lend­ing has risen, money sup­ply growth has also started to accel­er­ate; in Jan­u­ary, M2 was up over 10% from the year before.

Conclusion

With M2 growth just start­ing to accel­er­ate in late 2011, I’d be sur­prised to see a sharp spike in infla­tion this year. [While] head­line infla­tion is likely to rise in the near term due to higher oil prices…this, however, should not be inter­preted as the start of a broad spike in over­all infla­tion, which over the long term will be about the same as core infla­tion.

While higher near-term head­line infla­tion will be a drag on con­sumers, it’s unlikely to change my infla­tion out­look unless ris­ing prices spill over into core infla­tion. [As such,] in my opin­ion, the risk of inflation is not an immi­nent one and is more of a risk for 2013 and beyond.

*http://advisoranalyst.com/glablog/2012/03/08/inflation-inferno-maybe-in-2013-and-beyond/#ixzz1optwoF2k