FRIEDMAN FRIDAY The Fed should pay attention to Milton Friedman’s wisdom.

Too Much Money Portends High Inflation

The Fed should pay attention to Milton Friedman’s wisdom.

By John Greenwood and Steve H. Hanke

June’s inflation index jumped 5.4% from a year ago, the highest reading since August 2008. The experts were surprised. Clearly, Federal Reserve watchers never bothered to consult Milton Friedman. Lost is a core Friedman dictum: “Inflation is always and everywhere a monetary phenomenon.”

In his Feb. 23 testimony to Congress, Fed Chairman Jerome Powell said that the growth in the money supply, specifically M2, “doesn’t really have important implications.” The experts, the press and the bond vigilantes were as quick to unlearn monetarism, if they ever had learned it, as Mr. Powell. Reporting about U.S. inflation rarely contains the words “money supply.” We are repeatedly told that the most recent upticks in inflation are anomalous and “transitory.”

Wrong. The inflation upticks aren’t temporary and were predictable, driven by an extraordinary explosion in the money supply. Since March 2020, the M2 has been growing at an average annualized rate of 23.9%—the fastest since World War II. There is so much money out there that banks don’t know what to do with it. Via reverse repurchase agreements, banks and money-market funds are lending money to the Fed to the tune of $860 billion. That’s unprecedented.

According to monetarism, asset-price inflation should have occurred with a lag of one to nine months. Then, with a lag of six to 18 months, economic activity should have started to pick up. Lastly, after a lag of 12 to 24 months, generalized inflation should have set in. That’s the standard monetarist sequence, and it’s been followed to a T.

To get a handle on what the recent money supply explosion implies for inflation, consider a monetarist model for determining national income. That famous model was displayed on Milton Friedman’s California license plates. It’s compact: MV=Py, where M is the money supply, V is the velocity of money (the speed at which it circulates), P is the price level, and y is real gross domestic product.

Plug numbers into the model and solve for M, and money supply (M2) should be growing at around 6% a year for the Fed to hit its inflation target of 2%. With M2 growing at nearly four times the “ideal” rate since March 2020, inflation is baked into the cake, and it’s likely to persist. By the end of the year, the year-over-year inflation rate will be at least 6% and possibly as high as 9%.

Some who like to throw cold water on monetarism argue that the velocity of money has collapsed and will mitigate the inflationary impact of the rapid growth of the money supply. While velocity did collapse with the onset of Covid, it’s on track to pick up until the end of 2024. Consequently, velocity will grease the monetary wheels. That’s why inflation might hit the high end of our forecast range.

Mr. Powell and his colleagues should start paying attention to the money supply. Money matters. Indeed, it dominates.

Mr. Greenwood is chief economist at Invesco in London. Mr. Hanke is a professor of applied economics at Johns Hopkins University.

In 1980 I read the book FREE TO CHOOSE by Milton Friedman and it really enlightened me a tremendous amount.  I suggest checking out these episodes and transcripts of Milton Friedman’s film series FREE TO CHOOSE: “The Failure of Socialism” and “What is wrong with our schools?”  and “Created Equal”  and  From Cradle to Grave, and – Power of the Market.“If we could just stop the printing presses, we would stop inflation,” Milton Friedman says in “How to Cure Inflation” from the Free To Choose series. Now as then, there is only one cause of inflation, and that is when governments print too much money. Milton explains why it is that politicians like inflation, and why wage and price controls are not solutions to the problem.

In this episode Friedman notes, “Inflation is just like alcoholism. In both cases when you start drinking or when you start printing too much money, the good effects come first. The bad effects only come later.

That’s why in both cases there is a strong temptation to overdo it. To drink too much and to print too much money. When it comes to the cure, it’s the other way around. When you stop drinking or when you stop printing money, the bad effects come first and the good effects only come later.”
Pt 3
Germany, 1945, a devastated country. A nation defeated in war. The new governing body was the Allied Control Commission, representing the United States, Britain, France and the Soviet Union. They imposed strict controls on practically every aspect of life including wages and prices. Along with the effects of war, the results were tragic. The basic economic order of the country began to collapse. Money lost its value. People reverted to primitive barter where they used cameras, fountain pens, cigarettes, whiskey as money. That was less than 40 years ago.
This is Germany as we know it today. Transformed into a place a lot of people would like to live in. How did they achieve their miraculous recovery? What did they know that we don’t know?
Early one Sunday morning, it was June 20, 1948, the German Minister of Economics, Ludwig Earhardt, a professional economist, simultaneously introduced a new currency, today’s Deutsche Mark, and in one fell swoop, abolished almost all controls on prices and wages. Why did he do it on a Sunday morning? It wasn’t as you might suppose because the Stock Markets were closed on that day, it was, as he loved to confess, because the offices of the American, the British, and the French occupation authorities were closed that day. He was sure that if he had done it when they open they would have countermanded the order. It worked like a charm. Within days, the shops were full of goods. Within months, the German economy was humming along at full steam. Economists weren’t surprised at the results, after all, that’s what a price system is for. But to the rest of the world it seemed an economic miracle that a defeated and devastated country could in little more than a decade become the strongest economy on the continent of Europe.
In a sense this city, West Berlin, is something of a unique economic test tube. Set as it is deep in Communist East Germany. Two fundamentally different economic systems collide here in Europe. Ours and theirs, separated by political philosophies, definitions of freedom and a steel and concrete wall.
To digress from inflation, economic freedom does not stand alone. It is part of a wider order. I wanted to show you how much difference it makes by letting you see how the people live on the other side of that Berlin Wall. But the East German authorities wouldn’t let us. The people over there speak the same language as the people over here. They have the same culture. They have the same for bearers. They are the same people. Yet you don’t need me to tell you how differently they live. There is one simple explanation. The political system over there cannot tolerate economic freedom. The political system over here could not exist without it.
But political freedom cannot be preserved unless inflation is kept in bounds. That’s the responsibility of government which has a monopoly over places like this. The reason we have inflation in the United States or for that matter anywhere in the world is because these pieces of paper and the accompanying book entry or their counterparts in other nations are growing more rapidly than the quantity of goods and services produced. The truth is inflation is made in one place and in one place only. Here in Washington. This is the only place were there are presses like this that turn out these pieces of paper we call money. This is the place where the power resides to determine how rapidly the amount of money shall increase.
What happened to all that noise? That’s what would happen to inflation if we stop letting the amount of money grow so rapidly. This is not a new idea. It’s not a new cure. It’s not a new problem. It’s happened over and over again in history. Sometimes inflation has been cured this way on purpose. Sometimes it’s happened by accident. During the Civil War the North, late in the Civil War, overran the place in the South where the printing presses were sitting up, where the pieces of paper were being turned out. Prior to that point, the South had a very rapid inflation. If my memory serves me right, something like 4% a month. It took the Confederacy something over two weeks to find a new place where they could set up their printing presses and start them going again. During that two week period, inflation came to a halt. After the two week period, when the presses started running again, inflation started up again. It’s that clear, that straightforward. More recently, there’s another dramatic example of the only effective way to deal with rampant inflation.
In 1973, Japanese housewives going to market were faced with an unpleasant fact. The cash in their purses seemed to be losing its value. Prices were starting to sore as the awful story of inflation began to unfold once again. The Japanese government knew what to do. What’s more, they were prepared to do it. When it was all over, economists were able to record precisely what had happened. In 1971 the quantity of money started to grow more rapidly. As always happens, inflation wasn’t affected for a time. But by late 1972 it started to respond. In early 73 the government reacted. It started to cut monetary growth. But inflation continued to soar for a time. The delayed reaction made 1973 a very tough year of recession. Inflation tumbled only when the government demonstrated its determination to keep monetary growth in check. It took five years to squeeze inflation out of the system. Japan attained relative stability. Unfortunately, there’s no way to avoid the difficult road the Japanese had to follow before they could have both low inflation and a healthy economy. First they had to live through a recession until slow monetary growth had its delayed effect on inflation.
Inflation is just like alcoholism. In both cases when you start drinking or when you start printing too much money, the good effects come first. The bad effects only come later.
That’s why in both cases there is a strong temptation to overdo it. To drink too much and to print too much money. When it comes to the cure, it’s the other way around. When you stop drinking or when you stop printing money, the bad effects come first and the good effects only come later. That’s why it’s so hard to persist with the cure. In the United States, four times in the 20 years after 1957, we undertook the cure. But each time we lacked the will to continue. As a result, we had all the bad effects and none of the good effects. Japan on the other hand, by sticking to a policy of slowing down the printing presses for five years, was by 1978 able to reap all the benefits, low inflation and a recovering economy. But there is nothing special about Japan. Every country that has had the courage to persist in a policy of slow monetary growth has been able to cure inflation and at the same time achieve a healthy economy.

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