I think our current method of measuring inflation against the CPI is nonsense, the basic premise that you can assume the price of e.g. milk is stable doesn’t even make sense. There’s changes in manufacturing, quality, brands, and market demand that aren't accounted for in the CPI.
Measuring inflation (or whatever you want to call the difference between an asset's nominal value and it's intrinsic value) is still useful, but the current method of pegging everything against the bag-of-goods in the CPI seems like an overly simplistic model. This approach of normalizing asset prices against the M1 supply seems more reasonable to me. The intrinsic dollar value of an asset is its value relative to how many dollars there are, not relative to whatever the price of milk is.
Edit: I am clearly not an economist, please see some of the informative comments below. In particular, it sounds like the CPI does account for some complexities, asset inflation is more commonly supported than I thought, but normalizing by M1 might not make any more sense than CPI.
Normalizing against the M1 is an not very meaningful because ignores the fact that the price of a dollar is subject to demand as well. In times of high demand for dollars (like right now), the supply of money (the M1) needs to increase to for the price of a dollar to not rise.
In other words, stock prices normalized to the M1 has the same amount of meaning as stock prices normalized to the number of loaves of bread the country produces, or the number of cars. It's nonsense — you're comparing a price to a metric that only takes into account half of the equation (only supply)!
Sidenote: When the price of a dollar rises, that's deflation; when it falls, that's inflation. That's also why "asset price inflation" isn't precise — inflation measures the change in price of a currency, not an asset. Maybe individual assets go up or down in price, but that happens in response to consumer demand shift. The Fed's mandate is to manage inflation, which is affected by changes in aggregate consumer demand. Therefore, Congress delegated it tools to influence consumer demand as a whole, but not tools to shift demand from one asset to another.
The phenomenon you're observing is: the Fed's monetary policy helps the US grow, which benefits corporations and increases stock prices. The only way the Fed can prevent that is to... stop the economy from growing by letting our currency deflate? Which sounds bad? I.e. the Fed can't do anything to shift consumer demand, short of causing a recession.
TD;DR: If you think stonks are overvalued, then blame Congress, not the Fed. They're the ones who have the power to change that without causing a recession.
I was thinking exactly this. Is there any reasonable measure economists use for the demand for dollars? Other than I suppose inferring it from CPI and M1...
Edit: According to this link, it would appear the foreign demand for dollars has declined? https://www.marketwatch.com/investing/index/dxy
When that cash flow stops — people stop eating out at restaurants, or consumers lose their jobs — they need cash (dollars) to pay their obligations. The supply of money is the same — the same number of dollars exist — but the demand is higher now.
Essentially, everyone is getting margin called all at once. If there is no intervention, businesses and people that are in sustainable & healthy in the long-term go bankrupt and fire workers, and our society loses a lot of organizational capital.
We don't want a short term shock (a pandemic) to hurt our long term growth. To avoid that, the Fed injects some money so that the supply can meet the demand. Then businesses can borrow money to pay their employees (and their rent), plus we don't fall into a deflationary spiral.
You need data that includes so called demand shifters or demand multipliers, to estimate the supply and vice versa.
That is, if you observe a supply independent shift of demand, you can use that measure of to identify supply parameters. Even if you di this non parametrically, you implicitly impose a model.
Supply and demand is one of the origin problems of the theory of statistical identification and causal analysis.
The argument is that the textbook definition of the way inflation is described has become detached from reality. people are undoubtly affected and suffering by the price increases in the asset markets.
look at the currency markets where the dollar has dropped 10% against a basket of the largest foreign currencies. Using your definition, would you call this inflation then? Because 10% is much higher than the 2.1 or whatever the fed had just declared.
Also, the Fed can't change asset prices without slowing growth. Is that desirable?
> dollar has dropped 10% against a basket of the largest foreign currencies.
No reasoning from a price change. Another explanation for the drop in the dollars value is decreased demand. And since CPI is still stable, more likely IMO that it's a decrease in demand.
It's not nonsense for policies that are directly concerned with consumer prices, which most that the CPI (or, more precisely, any of the CPIs, of which there are several) is used for do. We have lots of other inflation measures (, industry specific PPIs, for instance) for other purposes.
> Measuring inflation (or whatever you want to call the difference between an asset's nominal value and it's intrinsic value) is still useful
That's not what inflation is supposed to measure, because that's a nonsense thing to try to measure, because there is no such thing as intrinsic value.
> but the current method of pegging everything against the bag-of-goods in the CPI seems like an overly simplistic model.
How? Consumer prices are final prices. Everything else is instrumental to producing final goods and services.
> The intrinsic dollar value of an asset is its value relative to how many dollars there are
No it's not, and even if it was, that wouldn't make M1 a sensible measure. Why not the actual number of actual dollars there are: monetary base. Or something that better captures the number of effective dollars, M2.
If and when that money injection moves around to affect the price of bread will be quite important though.
True, and that's great!
> but you can always buy more stock or real estate.
There is nothing innate about this state of affairs. What is "ownernship"? How many acres of land and I keep to myself with my own shotgun? Surely that's bounded too?
> Supply is harder to increase as well.
Every person deserves some amount of floor space near other people's floor space. They do not so deserve private land area.
Land area is held in common in parks, whose size, beauty, and other factors vary inversely with their accessibility. We can vary the park distribution and the vacation distribution to do nice things with the expected nature rejuvenation.
This is completely separate from housing.
I'm sure if it wasn't for the fact that bread expires we would see it traded like stocks too.
Personally I find grocery shopping quite affordable, as I'm sure do most in the HN demographic. However the rate of people experiencing food insecurity in the US was around 12% prior to the pandemic, which shows that grocery costs are a serious concern for many. People in that group, which has expanded this year, do not have the option to increase their grocery budget in proportion to price inflation.
But it's also true that the % of income spent on groceries on average has been dropping over time.
Groceries may have made more sense as a metric when the CPI was invented than they do now.
"Between 1960 and 1998, the average share of disposable personal income spent on total food by Americans, on average, fell from 17.0 to 10.1 percent"
But I'm not really sure how they calculate this number in the first place, the USDA page's only citation is "for more information contact", which is kind of lame. It seems likely that it's based on a survey sample though.
It makes sense to me though; we have whole categories of expense that our grandparents just didn't have, they had a lot less stuff than we have. But they needed about the same number of calories. (On the other hand, I bet average % of income spent on rent has gone up...)
Apparently Americans also spend less % of income on food than most other countries, which is kind of odd.
For this discussion, the reason it matters that less % of income is spent on groceries -- is that it makes a CPI based on groceries not as good a metric of relative buying power overall.
There's also the cost of healthcare, or the financial repercussion of not having coverage.
People are food insecure. It's freightening. But the root issue is more than food.
In this way, I expect the prices of consumer goods like foodstuffs to continue to decrease over time.
We are living with economic theory that was posited when the most advanced computer was a slide rule.
> I still don't see how the CPI is factoring this in, do you?
Because value = acceptable opportunity cost = foregone utility
And CPI measures (in closest approximation of any measure) changes in the prices of goods that provide direct rather than instrumental utility. Presuming monetary expansion affects prices but not, in first order effects, production possibilities and relative worth of non-money goods, a consumer price deflator is the most sensible kind of value deflator (one might still contest details of the construction of the CPI, of course.)
It is tempting to say that you can have asset inflation while other assets deflate, but it's not consistent with the general topic of inflation that implies the currency gets devalued.
If the government said that it would collect a special tax to all goods but stocks of 1$, it will increase prices of many goods but it will not be inflation. It's a change in the relative price of goods.
High inflation economies have also seen a surge in pricing in housing, relative to other parts of the economy.
I'm saying assets have had relative changes of value in high inflation economies, where everything is going up.
Say a bag of rice is 100, housing is 1000. In a 100% inflation scenario, it goes to 200 and 2000, but when you look at prices it is 200 and 3000. This points to two effects: inflation + relative price changes.
It's an informal argument against the notion that there is "asset inflation" because of dollar printing. Economies with high inflation have seen "asset inflation" even with all prices increasing. It points to a typical change in demand.
It’s similar to how certain industries can crash while others can boom at the same time. A non-uniform economy is such a basic and intuitive concept, it’s hard to believe it needs to be argued to the average layman.
I think most people agree there is a lot of asset inflation. Your link doesn't match your quote either.
Yeah, “there is no asset inflation” doesn't seem to actually be a common belief.
“Asset inflation is different in kind than consumer price inflation and not what normal people discussing inflation care about” is more common.
I'm not sure why monetarily-driven asset inflation would be an issue at all, unless one expected the driving monetary force to not merely be removed (returning to a more typical long-term pattern of asset price changes), but undone (such that the current overall lift above the prior long-term trend would be unwound before returning to the prior long-term slope.) Producing a monetarily-driven transient bubble.
It's not implausible that that could occur under some circumstances, but I'm not aware of any evidence that there would be anyway of distinguishing circumstances that might indicate it. Certainly, there's no obvious reason to assume such a monetary bubble is the normal case with monetarily-driven asset inflation.
Its been one of the main causes in inequality and unaffordable house prices so is very important. It also makes the economy vulnerable to big drops in prices which could/will happen.
Money in band account that is not used is just a number. As Fed puts more money into the economy, the velocity of money decreases as the money is used less. https://fred.stlouisfed.org/series/M2V
Federal Reserve can increase and decrease effective money supply as it pleases. Money supply does not determine the prices as we have learned over last two decades.
Edit: some real issues affecting stock price valuation.
(1) Global savings glut https://en.wikipedia.org/wiki/Global_saving_glut
(2) low real interest rates, typically measured as yields on inflation-indexed government bonds https://fred.stlouisfed.org/series/DFII10 If real interest rate is 10%, only this years earnings matter. If the interest rate is very low or negative, like they are now, time horizons grow accordingly.
Edit2. "real" things in economy are things like real output.
The level of goods and services produced depends on the factors of production. How much capital, labor, level of technology rather than the amount of currency circulating. This means that the money supply can't affect the real level of output in the long run.
A couple questions because I don't understand this very well.
Do we have an idea how much is actually sitting in a bank account vs being put into the market?
And, if people put money into stocks and park it there, wouldn't the velocity still be much lower than it usually is (when people are spending more on goods and services)? My interpretation of what's being shown here is that a large amount of newly "printed" money has gone into the stock market, thereby inflating asset prices. I don't see how low velocity refutes that.
When more money enters the economy than stuff is created, the price that the person willing to sell/price you are willing to buy that stock for goes up.
However, we must also remember that dollars are effectively debt—banks create them by loaning money. So while it is true that dollars cannot be “parked” in assets since there are two sides to every transaction, if the seller goes on to pay down debt with the proceeds then the money in circulation will decrease.
They are debt in the most literal sense possible. They are listed as liabilities in the fed's balance sheet. The "note" in "Federal Reserve Note" written on every dollar bill is referring to the legal definition. It's a promise to pay.
That's assuming, contrary to the motivation for loose monetary policy, that there wouldn't have been deflation without it. It's not loose money produces low velocity but loose money as a reaction to low velocity.
I don't think we can just accept this as fact, based on two decades evidence. The Phillips curve held for much longer for two decades, until it didn't. 2 decades of verified observation cannot be extrapolated into an infinite future.
It can adjust monetary base as it pleases, effective money supply of the type measured by M1 and M2 relies on market behavior which the Fed can't control as well as monetary base, which it can.
Economy is a process. Companies are priced against their future cash flows. If you want to get some idea of what is going on, use ratios like CAPE or market cap to GDP.
It's intuitive. You increase the amount of money chasing assets, asset prices go up. It's not affecting the price of milk or electronics. But look at land, housing, tuition, medical, stocks, bonds, and gold.
Why would increasing monetary supply not cause inflation? I'm aware there is a group in macroeconomics that believes that, but I think they're crazy. Do you have anything to support your position?
If the Fed prints 1 trillion dollars and gives it to me, but I keep it in my basement and never spend it, why would inflation be expected? The velocity of that money is zero, hence its impact on prices is zero.
Inflation rises relative to the money supply multiplied by the velocity of money.
The velocity of money may still be low in this case, but asset inflation happened.
It may be that the money hasn't trickled out into the real world in large enough quantities to cause inflation yet.
Who's going to just keep $1T in a vault and let it rot for a century? And if we expected that to happen, why even print it?
Most importantly, without high M1, high M1V is not possible.
M1 can change day to day without change of the monetary base by behavior changes, and the Fed can reduce monetary base pulling down on M1 through open market policies. M1 is already out there means little, because it's not fixed.
> Most importantly, without high M1, high M1V is not possible
False. There’s no hard limit on V, so you can arbitrarily high “M1V” with any M1.
There's definitely a limit on the number of transactions. V ~ N_transactions_per_day * M1.
With the fixed M1 you can up V only by upping N_transactions_per_day. Am I missing something?
It also doesn’t take into the size of of transactions.
The difficult part is in translating theorems into practical knowledge about the economy, but just because this is difficult doesn’t mean that the axiomatic approach is wrong.
Not in a meaningful way. (meaningful = related to real economy). If you just look at the numbers in a silly accountant fashion, and population doubles, analysis is meaningless.
You need want to keep money relatively stable (say 2% inflation) you need to keep adding money to match changes in demand or factors of production.
I was looking at that earlier today to try to get a feel for if the stock market is really at record highs, or if it's just the Dollar and other major currencies that are just at record lows.
Note, that massive crash on the chart after 1971 is the US abandoning the gold standard (where you could exchange US dollars with the government for a fixed amount of gold) and the massive devaluing of the US dollar, and massive surge in the price of gold that followed.
But I thought the most interesting part is it clearly shows we're not at 2000 bubble levels right now. Which it looks like we are if you just look at the dollar denominated stock market value.
As of now we haven't hit a regime of negative real yields on long dated treasuries in the US. After being at ZIRP for decades with new inflation fears, I'd bet gold will continue to be punished as yields rise, so you may never see that same signal from Y2K.
I think it's a pretty reasonable look at the value of stocks in something tangible.
Maybe you could compare the stock market to the price of a gallon of milk or something, but gold is a fairly natural choice.
My current portfolio is, say, 30 times my yearly living expenses. All I care about is that it will continue to grow in a way that stays at/above this ratio, so I will be able to retire early.
The pace at which my yearly expenses inflate is much more correlated to CPI than money supply. My expenses haven’t changed much between 2019, 2020 and 2021 (projected), despite the large money printing, and my consumption pattern has been the same.
So, why should I care? Genuine question.
What were the changes in your health insurance premiums(employer+employee)/deductible/oop max?
As an example, my parents’ deductible went from $3,450 to $6k, monthly premium from $1,137 to $1,232 between 2020 and 2021.
My expenses consistently go up quite a bit, far more than any government number. Both for my businesses and at home. My taxes also reliably go up more than CPI figures. Land has especially gone up.
Also, if you were planning on purchasing a home in any popular area of the past 10+ years, the lack of price increase in food or tech would have been meaningless in the face of land price increases.
Edit: The land problem is a thing also difficult to capture since amortized across entire country. Moreover, it's not Singapore in the USA, the land price problem points to various inefficiencies rather some kind of intrinsic supply/real value problem.
The price of milk or flights is irrelevant to me when the houses I’m looking at purchase go up a few hundred thousand.
Also, the person doesn’t really understand monetary policy or macroeconomics — inflation is measured by changes in the price of a currency. M1 only measures supply. The other half of the price equation (that is missing from this chart) is the demand of the currency.
Measuring the money supply is a trivial matter - if we observe a radical change in the money supply which correlates to asset price increases it's reasonable to question if our understanding of the economy is correct.
This may be in actionable information even if you buy the argument however. Holding assets while they inflate is the best move and at 0% interest rates there is no alternative to holding assets.
The M2 is growing because interest rates are dropping. But interest rates are at 0, so they can't drop anymore. So there is reason to believe that we can not sustain our current trajectory any longer.
Interest rates are not at zero , and interest rates, and their targets, can go negative. 
 target range is currently 0-0.25%, actual is 0.08%: https://apps.newyorkfed.org/markets/autorates/fed%20funds
They are interest rates and since they are essentially risk free, they ought to be roughly the floor of interest rates that aren't being subsidized by some other consideration.
> The 10 year is currently at 1% and the 30 year at 2%.
I would argue that 1% and 2% are even more clearly greater than 0% than is 0.08% (the recent effective federal funds rate), so that just reinforces the point, to the extent one agrees that they are the relevant interest rates, that interest rates are not currently at 0.
Presume a person with assets sees information like this and in combination with other factors causes them to agree a dramatic market pullback (on the scale of last year's but worse) is likely and soon.
The next logical step would be to enjoy all of the gains so far and sell out from the risk of the drop, and even after a nominal loss of value rebuy.
What I've seen is rather than deal with what that might require, people will present the above argument. They may refer you to 1973's "A Random Walk down Wall Street," or bring up capital gains taxes.
But what they will not do is confront the cognitive dissonance they're feeling between their own sense that something is wrong with the market and that they are in a position to take great advantage of a drop but will not.
My next logical step would be to assume the government will do whatever is necessary to pump those equity values back up, just like they did last year in Mar/Apr.
So unless you think you can time it so that you sell when asset prices drop, and buy before the government pumps them back up, the logical step would be to stay the course, and keep your wealth in inflation resistant broad market indices.
All other things equal, unless they start burning money I expect prices to grow or remain stable.
This attempts to show the “real” inflation so to speak.
There were interesting arguments for this change of course, and pages of economic research. But the whole thing reeked of finding a justification for a foregone conclusion.
Ultimately there are many factors the CPI simply cannot include, or due to the lack of ground truth can be argued away. If tomorrow real estate prices 10x'd but this price change never made it to residential rents then CPI wouldn't budge. If every farm in the US shuttered due to commercial real estate shooting up 10x but consumers could still import food the CPI wouldn't budge.
Which ultimately goes to say that the use of CPI as the GDP deflator in monetary theory is arbitrary. Treating it as a gold standard measure of inflation risks ignoring inflation in other prices (and in turn systematically miss-estimating GDP).
Money supply is a lot simpler than inflation, because something like M2 is a pretty simple sum while inflation is a weighting that is a bit hard to follow the implications of (the handbook for how to calculate inflation is a bit of a doorstop, from memory).
Plus if an investment aren't even keeping a constant slice of the monetary pie an investor has good reason to be nervous about their strategy. There is a monetary firehose out there and it makes sense to get in on it.
Assume doodads are $1 today. If tomorrow money supply is doubled, they will be $2.
A reasonable definition of the intrinsic value of a stock market index is the discounted net present value of all the profit streams of all the firms included in it. If it is 100 today, and the money supply doubles, it will be 200.
What good are the returns to your investments? At some points, those returns are to be spent on real stuff. If your returns went up by 100% but the prices of the stuff you spend money on went up by 200%, the returns are not that good, to put it mildly.
Over 2020 and continuing in to 2021, governments around the world have chosen to burn GDP, and lower the future growth trajectories of their economies. Ceteris paribus, that would mean the intrinsic value mentioned above will be much lower. Given the expansion in the money supply, asset prices will be inflated (i.e. keep going up despite physical reality). As governments fear asset price crashes, inflationary policies will be their refuge.
See stagflation in the 70s and the so-called inflation-unemployment tradeoff.
> The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced. I nevertheless regard it as fundamentally false, and to act upon it, as we now experience, as very harmful.
If you double every persons account, yes. If you do it through interest rates, you need to pay attention to the Cantillion Effect. The Cantillion Effect states that money flows from people who have it to things that those people want to buy.
If you give money to rich people who have already reached capped consumption, they won't then go out and buy more apples. They will choose to save it(as they know with an ever-growing money supply, if they save it in assets they will have more buying power when they choose to spend it), and therefore investments will rise in price while consumption goods will stay the same price.
This is exactly what the fed has done. The more wealth inequality there is, the less the fed has control over inflation.
1. Economy isn't doing as well as we hoped.
2. Central banks lower the interest rates.
3. Households and governments go further into debt now that they can get cheaper loans.
4. We get a boom! Asset prices rise.
5. The boom gradually ends as all available credit has been lent.
6. People start paying off their debt, and the savers who they are paying end up saving more and more. The wealthy don't buy 200x as much food, etc...
7. Economy isn't doing as well as we hoped.
> In words, this implies that if the richest households’ wealth rises by 10%, the interest rate has to come down by 32 basis points
I’m super sure why tho. Can’t we expect that printing dollars has an effect on its value? Aren’t stocks measured in dollars? If the value go down and I sell, aren’t I getting less purchasing power than I would have otherwise?
MMT is being tried in realtime, even as the debate roundly defeats it.
Overt Money Financing (OMF) is a policy option that MMT opens up, and there are probably shades of that in what’s going on, but I don’t see a whole lot of fiscal or monetary policy that actual MMT economists would say is a good idea.
Except the reverse doesn't happen (since the gold standard was dropped), so it's at best "half-Keynesian":
Now, since the memes are actually very potent force, I wonder if they create a self-fulfilling feedback loop where assets do rise first and foremost because everyone believes there is an inflation.
But because of all the money printing, they have to run in place just to stand still, so they funnel their money into assets like stocks, which the general public also invests in and gets a benefit from the rising stock price. Meanwhile, the actual day to day items that the general public relies on to live that are tracked by the CPI are mostly unaffected by this.