Buried in the FOMC’s (Federal Open Market Committee) latest report is the belief that the economy is doing well enough that the Federal Reserve can stop its’ program of pumping money into the economy. Since July of 2007, the Feds have pumped $3.62 trillion into our economy. Their balance sheet now stands at $4.5 trillion dollars (compared to $882M in July of 2007).
It’s a basic rule of economics that the more one has of a particular item, the less valuable each item is. If there someone were to find one billion five carrot diamonds, the price of diamonds would go down because they would be more common. If Dairy Queen decided to server one million more milkshakes in 2015, the price of those shakes would go down, unless demand for them diminished proportionally.
In the last seven years, we have seen the number of dollars in circulation increase by 3.62B. I’m not seeing demand for each of those dollars increasing proportionally such that the buying power of each dollar has remained constant. Instead, the dollar has lost nearly 15% of it’s value in the last 7 years, according to the US Inflation Calculator (and here).
I think the long-term effects of the Feds actions will not be known for another five to ten years. Don’t ask me how they’ll extract these dollars from the market – if they even intend to do so. But if these dollars ever get serious velocity in our economy (see the third story in this Friday Five), we’ll see significant inflation. We’ve seen consumer spending slow down in the last few years due, in part, to lower confidence in the economy. This helps keep prices more stable if spending slows down. If confidence ever gets revved up and people start to spend a lot more, there will be more money to spend because it’s already in the market.
I’m glad QE is over. I hope they can retract a good portion of these dollars before something serious happens.