Expert Commentary

Highest Inflation in History Points to 1987 Redux and Asset Deflation

Money and credit growth has never been this fast.

Contrary to popular belief, inflation is not the positive rate of change in consumer prices. The true meaning of inflation is the positive rate of change in money and credit in an economy. Monetarist economists, most notably Milton Friedman, have noted a link between the growth rate of money and the growth rate of consumer prices, but this Quantity Theory of Money is not infallible. Consumer prices across the multitude of sectors in an economy inflate and deflate for many different reasons, so we cannot say there is a direct link between the quantity of money and consumer prices. Nevertheless, the more money and credit in an economy, the more chance there is for prices, be that of consumer goods and services, or assets, to rise.

So, what are we to make of the chart below? It shows the annual percentage change in EWI’s Money and Credit Index (MACI) for the U.S.A. The index consists of M2 money supply and the total amount of debt (public and private) in the economy. As we can see, the year-on-year percentage change is the highest it has been in data going back to 1960 as the Federal Reserve has created trillions of new dollars with which to fund government and private debt, with corporations gorging on issuing new debt amidst the loosest financial conditions in history.

At 16.9%, the annual growth rate in MACI is now higher than the previous peak of 15.2% achieved in 1985. That was in the middle of a rampant bull market in stocks. So rampant, in fact, that it resulted in the biggest one-day percentage decline in the Dow Jones Industrial Average, in 1987. This is the danger of such strong money and credit growth. If it isn’t fueling higher consumer prices, it may well be fueling higher asset prices which, at some point, can correct lower quite violently. This could be what is happening now, with stock market valuations at extremes, house prices through the roof, and speculative behavior everywhere.

The danger of a 1987-style asset price deflation calamity is, therefore, high. Note that it wasn’t until the growth rate of MACI slowed slightly that the stock market took fright. With M2 money supply growth slowing quite sharply now, it could be that we are past peak growth in money and credit already. With this autumn being a Fibonacci 34 years since that 1987 shock, it’s going to be fascinating to see if the stock market suffers a similar fate this year.


USA Money and Credit Index- MACI YoY%-July 2021