road to inflation representing the velocity of money and increasing supply

Inflation... Where Are You?

1 minute read
Jun 5, 2020

To understand where inflation could be going, it’s important to keep an eye on the velocity of money.

It is well documented that precious metals outperform most other asset classes during inflation periods.

Surprisingly, central banks have been printing money at record levels since 2008, yet there is almost no sign of inflation in the real economy.

As we can see on the chart below, the monetary base has skyrocketed!

graph showing the velocity of M2 money supply dwindling

If you remember your Economics 101 class, the quantity theory of money demonstrates that:

Inflation = Money Supply x Velocity of Money

In other words, inflation is a result of money supply times the speed of exchanges in an economy.

Therefore, if there has been a fivefold increase in money supply, yet no inflation, we need to look at the speed of exchange.

As we can clearly see, the velocity has been plummeting for the last 20 years. Money has been staying within the financial markets, inflating the price of different assets, and failing to reach the day-to-day economy.

But... as no tree grows to the sky, at some point velocity will come back. And with the current money supply, we could expect a strong inflation uptake.

And as Karl Otto Pöhl, former President of the Bundesbank, once said: "Inflation is like toothpaste. Once it's out you can hardly get it back in again."

Photo credit: Pixnio