Inflation dynamics in one chart

Last week inflation was updated for the month of March. In short, inflation progress has stalled both on the Consumer Price Index (CPI) and the Producer Price Index (PPI). We’ve been saying that inflation is primarily a consequence of money supply and policies that affect money supply. The chart below shows three series: 1) the green line represents the year over year growth in money supply as measured by M2, 2) the red line represents the year over year growth in wholesale commodity prices as measured by the Producer Price Index, and 3) the blue line represents the year over year change in consumer prices as measured by the Consumer Price Index.

The relationship between money growth and contraction relative to the growth of prices of goods and services seems straightforward. A mountain of money was added to the economy in 2020 and 2021 which very clearly led to run away prices. Then, when the money supply began to contract, prices began to drop with a lag effect. Producer prices responded first and then consumer prices began to decline. Notice, as soon as the money supply stopped contracting, progress on inflation reduction stalled. It’s really that simple.

We note that if one looks at the space below the green line (money supply) from 2020-2022 and above the horizontal black line (sorry but yes this is visual calculus!) and compares the size of that area to the area above the green line and below the horizontal black line from 2023 to present, that the total size of the area below the horizontal line is not nearly as large as the area above. What does this mean? Not nearly enough has been done to extract money from the system to bring inflation down to target. When money growth hooked up on the right-hand side of the chart, inflation progress stopped.

Our interpretation of things is that inflation forces are still present and will be until the forces driving money supply higher recede. Last week we said we think the primary cause is Federal government spending. Given this is an election year, we think the spending will continue apace. Thus, we think the inflation stall problem is going to stay with us. Given economic growth is strong, we think the Fed will not have cause to cut interest rates this year.

We next turn our attention to corporate earnings reports for the first quarter of 2024, which is already underway. The volume of earnings announcements will accelerate over the next four weeks. As was the case with fourth quarter earnings, we think the reports will be relatively good, giving stock investors something to hang their hats on. The GDP picture remains strong and consumer confidence is stable. As the earnings are released, we will evaluate them in the context of our holdings and for an assessment of broader economic conditions.

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