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Author: Ben Tan   |   Latest post: Fri, 4 Jun 2021, 12:59 PM


Debt, Money Printing, and Inflation: The Economics of a Pandemic (Part 1)

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Debt, Money Printing, and Inflation: The Economics of a Pandemic (Part 1)

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sanjanx good write up bro. Are you an economist student?
03/05/2021 7:45 PM
Ben Tan sanjanx, thank you for your comment. I am not a student for quite some time now, but I have an academic background in Economics, yes.
03/05/2021 8:04 PM
observatory Hi Ben, let’s see if I get your central idea in this article.

You mentioned the “unrealized monetary value depreciation”. This was the result of Fed money printing (and more importantly government handing out cash directly to people, meaning printed money won't just sit idly as bank reserves)

You mentioned that “inflation can only get realized when countries start decisively going out of the pandemic”. The key evidence is high personal saving rate is at a record high. When the saving gets spent down as economy normalizes, inflation could follow because lots of money would chase after limited goods and services.

I agree that the high personal saving now would contribute to inflation later. However, I believe the the impact is modest and only temporary. For the rest of this comment I would focus on the personal saving.

Below is the data on US personal saving in absolute term (which should match your chart in percentage term), as published by the St. Louis Fed.

There are a few key data points which I would refer to later:
Feb-2020 (eve of Covid-19 outbreak in US): USD1.4 trillion personal saving
April-2020: USD6.4 trillion saving
Nov-2020: USD2.1 trillion saving
Jan-2021: USD3.8 trillion saving
Feb-2021: USD2.5 trillion saving
Mar-2021: USD3.0 trillion saving.

For perspective, the total US personal income in 2020 is about USD20 trillion. Therefore, throughout the last 1 year, the saving rate fluctuated between 1 to 4 months of personal income.

There are two spikes in the personal saving chart. The spikes correspond to the first two rounds of stimulus passed by the US governments.

Under the first round of CARES Act most tax paying adult received up to USD1,200 per person. There were also increased unemployment benefits. They were largely responsible for the first spike that peaked in Apr 2020. Notice the USD6.4 trillion personal saving in Apr 2020 got spent down to only USD2.1 trillion by Nov 2020. It didn't cause any inflation concern (not a surprise given the weaker economy during the pandemic)

The second spike in personal saving up to USD3.8 trillion in Jan-2021 corresponded to Trump’s second stimulus bill in Dec 2020. It came with a smaller USD600 stimulus cheque per person. That is why the spike is smaller. The personal saving got spent down to USD2.5 trillion by the next month. Again the spending down did not create high inflation.

The third spike in personal saving is building up now. It is largely the results of Biden’s USD1,400 per person stimulus cheques that started flowing out since Mar 2021. Although the April data has not been published, I expect a new height would be reached in April.

Given the economy is much stronger now, the spending down of this third spike in personal saving could be more inflationary. But not much more. More importantly it won’t last. There is no more stimulus cheques! (The other USD2.3 trillion infrastructure bill currently under negotiation is another matter, which can be discussed separately)

In other words, despite the incredible spikes in personal saving rate as shown in your chart, the impact to overall inflation has been really minimal. We’ve already seen two rounds where a few trillions USD were spent down, topped up and spent down again without overheating the economy. Throughout the pandemic last year US CPI never exceeded 2% (only now it was at 2.6% based on latest Mar-2021 data)

Yes, most people agree that US inflation would pick up in the coming months. But the contribution from the trillions of personal savings would be limited and only transitionary.
11/05/2021 6:23 PM
Ben Tan observatory, thank you for your detailed note.

I probably should have made it clearer that while the intrinsic depreciation is undeniable, the method of its unlocking is certainly a matter for debate. I am on the side of believing that it will be unlocked through economic activity, and the savings rate is just one expression/example of it. Velocity of money for instance, as with during every period of major turmoil (in the past usually war), has been grinding to a halt. So it is highly like that the return to normal economic activity is what will unlock inflation.

Unfortunately most observers are focused on jobs data, which in my view can only be a consequence, and not a leading factor of inflation. Traditionally, during war times, a significant part of the labor force was, sadly, dead or incapacitated for a prolonged period of time. That was one of the unlocking factors of inflation. Fortunately, in most countries in the world that dark scenario didn't take place. There are still people who are worried to work certain kind of jobs and that is what might be driving labour shortages in certain segments of the economy, but that is truly transitory as people will return to work once the handouts and the fear of the pandemic ends.
11/05/2021 8:31 PM
observatory I agree the velocity of money is picking up. But take a look at this velocity of M2 Money Stock chart from St. Louis Fed.

I have two observations:
(A). The velocity is only picking up now, from a very low base. The current situation is actually just a reflation. There is no sign high inflation or overheating.

(B) The velocity of money has been dropping steadily over the past 20 years. Even after 4 rounds of QEs since 2009, with trillions “printed”, the velocity of money is still trending downward. This is a strong evidence that there are larger deflationary forces at work. That's why deflation rather than inflation has been a greater enemy in the last decade.

It’s difficult for me to talk about risk of inflation without quantifying the inflation. So I shall discuss 4 different inflation scenarios:
1. 2% or below
2. 2% to 4%
3. 4% to high single digits
4. Double digits

As can be seen from the chart below, core inflation (which excludes the volatile energy and food prices) have been trending downwards, another sign of structural deflationary forces at work. In the past decade, there were more years where inflation was below 2% than years above 2%.


That’s why Fed wants to pursue a more “robust” inflation. As the new Fed policy now targets an “average” 2% over a period, the Treasury market expectation for inflation 5 years from today is at 2.37%

I noted this is at the lower end of the 2% to 4% range. I think it's very acceptable. The stock market could tolerate it.

*** continue next ***
11/05/2021 11:44 PM
observatory *** from above ***

It only becomes a concern if inflations morph into the 3rd scenario which is above 4%. If that happens (current market consensus is it won’t), the Fed’s ability to rein in inflation will be questioned. To retain its credibility, the Fed will have to tighten forcefully, potentially triggering a recession. This will be bad for equity.

Of course, it will be a catastrophe if US goes back to its double digit inflation days (scenario 4). Foreign creditors will see their US Treasuries holdings evaporate in value. The USD reserve currency status will become shaky. With the fiat currency in turmoil, physical gold will be a very sought-after asset.

However, the reality today is US is still in scenario 1 (which is 2% or lower inflation). 2021Q1 core PCE (a preferred measure of inflation by Fed) is only 1.5%

We’re only taking about entering scenario 2 (2% to 4%) territory. I think it’s a bit premature to worry about scenarios 3 or 4.
11/05/2021 11:45 PM

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