Reply #16: Wars, the money supply, and inflation [View All]

[ticktockman]

From the M2 chart on your site I imagine inflation is looming. It looks like M2 (supply) leads CPI historically. If that's so, it also seems that a weak dollar, relative to other major currencies, would increase production in the USA as our goods become cheaper.

So the fed (OMBC?) has to raise the prime (overnight) even more if production increases here. But does the bottom drop out as the now-hidden money supply and presumably increased cash input causes US$ devaluation and US$ flight in the forex -all as inflation increases?

It's confusing to me. Especially when I try to understand why forex traders and big players would hold US$ if the debt is actually so large now, on top of it all. Receipts HAVE to increase don't they, or the bottom will fall out. No?

I'm not an expert on this but I have wondered what causes central banks and other big players to keep holding U.S. dollars during periods when they are experiencing devaluation. It may be that they are receiving some sort of benefit that is not immediately obvious to us but that compensates them for their losses. Or it may just be a lack of alternatives. Whatever the case, I suspect that they are looking for alternatives that they can resort to if necessary. That would seem to create a much less stable situation than would be the case if we had a strong or stable currency.

Regarding the graph showing M2 money supply and the CPI, I agree that it suggests that inflation is largely caused by a too rapid a growth in the money supply. In theory, I believe that the money supply can grow as fast as productivity without causing inflation. A faster growing money-supply, however, will tend to promote inflation. In any case, I noticed an additional event that seems to lead inflation. That event is war. If you look at the following graph and the corresponding table at http://home.att.net/~rdavis2/cpi_m2.html , you'll notice that five major spikes in the 10-year trailing inflation occurred in 1814, 1864, 1920, 1951, and 1982. These years are near or shortly following the end of the War of 1812 (1814), Civil War (1865), World War I (1918), World War II (1945), and the Vietnam War (1973). This is not surprising as wars often lead to large increases in spending which lead to growth in the money supply. The Iraqi War and the corresponding "War on Terror" could likewise do much to promote inflation. This is made even more likely by the fact that, for the first time in American history, we have cut taxes during a war.