LOOKING AT THE MONETARY EQUATION AND PREDICTING THE FUTURE
So what does M X V= P X Q mean for our future economic conditions? As we have learned from the velocity chart, money velocity remains down but is steadily recovering. Prices are stable and growth appears to be rebounding. However, we have increased the money supply by 10%, and since growth is not going to get any better than 4% annually over the next several years, the excess portion of the money supply and the rebounding velocity can only translate into higher prices.
Higher prices occurred in 2007 as inflation was around 5% but right before it became a mainstream media issue, the financial crisis destroyed any inflationary pressures and turned everything into deflationary pressure. If we don’t get higher consumer prices in the areas of goods and commodities, then the money will rush into more concentrated areas, like it did with housing.
I believe that in the last run up, any excesses that were created and did not come out of growth and consumer prices ended up in real estate and fixed asset markets. This “excess” of money created the real estate bubble. So, where does the money go next? In my opinion, it can go to one of two places.
First, it could go into the debt markets and be used to finance higher government spending. This spending will create inflation where the government commits the money to, like it already has in the areas of education and healthcare. Increased government spending (combined with decreased efficiency) has also made the per person cost of social programs grow faster than inflation over the past few decades. Expect social program costs to continue to rise especially if the government concentrates on these areas with its increased spending.
Second, it could go to the private market to be invested in an industry, creating a bubble that would again burst and create another recession (and/or panic). This repeating story began with investments in the savings and loan industry, which crashed in the late 80s. It could have been a cause of the 1998 currency crisis. The financial crisis of 1998 led to the easy money policies that were invested in technology companies causing the technology bubble that burst in 2001 and created the first recession of the decade.
The easy money that followed created the real estate bubble that burst in 2008 and took down the financial system. As we have jacked up the money supply by 10% or more than one trillion dollars since, the excesses are there to be placed again either in the hands of the government or the people to create the bubble.
So what should the average person do? Identify the bubble and get in early, then get out before the “punch bowl” gets taken away. If the Federal Reserve continues to handle crisis by creating more money, then inflationary bubbles will continue to grow and burst over and over again until we stabilize the monetary equation.
The age of the bubbles is not over. In fact, it is the beginning of a new way of life.