Funny Story: When the Government Hands Out Trillions of Dollars

Let’s take a trip down memory lane with a good friend called inflation. Turns out that when the government hands out trillions of dollars, those with an interest in real estate, business or ANY financial markets have inflation concerns. This is not to suggest immediate helps aren’t needed. We’ve agreed that aid is necessary in these pages and said that the packages should be significant. But policy does not exist in a vacuum, so eventually the piper must be paid. The last time we faced real inflation was in the 1970s. Disco was in style, Jimmie Carter was president and a bank CD could pay a cool 15% interest.

What drives inflation, and is it as scary as one might think?Economists cite several reasons, with most agreeing that demand provides the root cause in a natural market. This can be demand for products or demand for wages, often leading to increasing income or price levels. If product demand pushes prices up and similar wage demand increases income, many workers have no problem. However, when prices increase without a corresponding increase in wages, trouble arises. During an economic shock like COVID, we would not expect to see wage increases as millions of small businesses struggle to keep doors open, but massive federal stimulus will likely put pressure on retail because of pent-up demand. So it is likely that we will see some price inflation, which could create imbalance. And some of the dollars which will be spent on products are “free,” or from direct stimulus payments, so consumers may be a bit less price-conscious. The impact is likely to push consumer prices up. Just this week, Federal Reserve Chairman Jerome Powell laid out his plan for clear policy of accommodation when he intimated that the Fed would keep interest rates low because if it doesn’t, the world will basically blow up. ’. (Jerome Powell, probably). OK, fine… that’s not an exact quote, but close (Cox, 2021)!

What is the Role of the Federal Reserve?

The Federal Reserve’s role in controlling inflation is a major part of their mandate of maintaining full employment and price stability. This is thought to provide a better standard of living for Americans. A tool in maintaining price stability is the use of interest rate policy. Lowering interest rates generally means that borrowing becomes less costly, so that borrowers have additional capital to spend on other things. As that spending filters through the economy, prices often creep up, which produces inflation. Financing a car at 7% interest over 48 months versus 4% interest would lower the payment almost $70 per month. That “extra” money allows consumers to spend on something else. Of course, total spending is the same, but the impact of distributing the dollars differently can create new economic growth. Keeping rates low is a means to offer incentives for spending. If rates creep up, consumers and companies begin to seriously consider purchase decisions, because there is a reduction in purchasing power.

Going back to our problem child for inflation for comparison, the 1970s, it may come as a surprise, but the average inflation rate for the full decade was a modest 6.8% (Hall, 1982). The problem came with eye-popping variable inflation which rose to as high as 20%, while mortgage rates rose and briefly touched 18%. Those types of shocks feel imprinted on our DNA; the awe-inspiring stress is seared into our collective memory. In the years since interest rates spikes in the ‘70s, we have seen a steady decline to today where mortgage rates hover around 3%.

When You Print Your Own Money

This is an important discussion due to where we find ourselves in the current economic cycle. We could call this, “How to live beyond your means… government style. Step One: Have this clear policy of ‘accommodation.’” Put simply, this means we will artificially adjust interest rates and money supply to help the country continue to live in abundance, while we lack this abundance. With great power comes great responsibility, and one knows what they say about absolute power. The ability to artificially alter the economic scape on such a grand scale seems to give the Fed tunnel vision at times. As if Chairman Jerome Powell believes we can keep the country running in its own bubble with such a ham-fisted policy of keeping interest rates as low as possible, for as long as possible. In the past, the Fed might have enacted rate hikes to support the jobs market, and hopefully drive costs upward to create a positive cycle. However, as of last year with the change in policy, inflation is allowed to expand; the Fed is using the pandemic on the pro side, claiming that due to the weakened economy we can afford to do this. Even as the job market rebounds, the agency chief said they would not cut rates even when annual inflation pushes past 2% (Cox, 2021).

Signs to Indicate Economic Expansion

While it is true that the Federal Reserve deserves some credit (or blame) for low rates, they do not solely determine long-term interest rates. Unfolding over time, rates are determined by investors as an indication of demand for repayment and – crucially for this discussion – as an indication of expectation for future inflation.

In other words, investors signal low expectation for inflation by not demanding higher interest rates from fixed assets. Of course, part of the equation must include a discussion on substitution or return expectations for alternative investments, to be addressed another time.

With this reflection, can we say that inflation wholly negative? As a natural factor in general economic growth, we can say no. However, the ultimate harm caused by substantial inflation is the loss of purchasing power by the consumer. We must effort to grow with the inflation; in this way, investment is necessitated. This is intuitive. If it costs more to fill up the gas tank you have fewer dollars to take the family out to eat. The total dollars spent may be the same, but the benefit is limited. And that is the real fear of rising rates, especially for grandma’s money that is hiding under the mattress. We generally spend similar amounts of money, meaning most of us have a generally fixed lifestyle cost. But when inflation becomes felt – when costs rise without a corresponding rise in income – inflation becomes painful unless your money grows with the economy. And when our economy is generally based upon consumption, well… there is a lot of incentive to control inflation.

Explosion of Money Supply

Depending on your perspective, that’s a scary looking chart. This illustrates the growth of M2 money supply over the past several years. M2 is the measurement of all currency in the economy, including cash and checking deposits, savings deposits, money market securities, mutual funds and others. You can see that money supply rose dramatically, but where did it go? When thinking about all the money in the economy, you may start with a mental picture of thick stacks of greenbacks, and that’s probably a good approximation of what the money is doing in banks. No one can spend right now, because many businesses are permanently closed or limited in offerings.

Consumers feel stilted, and due to not spending have more savings and less debt. Economists worry about the explosion of money supply, but without increased consumer spending, is this something to worry about? The velocity of money is significant because we can measure how quickly dollars are changing hands. For example, Friday payday: you receive a paycheck, fill up the tank and grab a cookie from Quick Trip on the way home, then pick up food from your favorite local restaurant. The staff members helping in these businesses take your dollars via their wages and turn them over into other purchases. The speed at which this occurs is called velocity.

In pandemic times, velocity has come to a near stand-still. So, while money supply has increased, there has not been a lot of consumer spending. As the economy continues to open up, will that change? Maybe, but even at that, the final word rests on whether it is actually a concern.

Is M2 Married to Inflation?

There have been many instances of rapidly increasing money supply without creating inflation (Vague, 2016). Here in the U.S., we have seen money supply steadily increasing over the past 10 years with little-to-no inflation. At this point we could all shout, “But milk is $4 per gallon… just a few years ago it was $2 per gallon. That’s a LOT OF INFLATION!” This is true (with four teens in the house we go through a lot of milk), but an HDTV that cost $4,000 a decade ago can now be purchased for $300. Some purchases have inflated, but there have also been massive price reductions on many consumer items. And it is true that inflation is felt in many areas of the economy not “officially” measured by the consumer price index. Neither housing nor healthcare are calculated in, and the measurement does a decent job in helping to determine the price of a typical basket of goods purchased by the average consumer (if not perfect). Again, according to official government measurement we have had close to zero inflation for the past several years. We tend to disagree, but the details aren’t central to this discussion.

Bottom line: investors should be concerned about inflation because rising interest rates could send equities lower. Why is this? Because investors seeking return would not need to take the risk of equities. That could signal a different environment for equity markets. And after the relative calm of the past 10 years, many investors are unaccustomed to markets that do not continually rise. Our role will be to continue to guide investment decisions as we seek reasonable returns and help you temper the effects of inflation on your assets. We continue to be risk-conscious and remain optimistic for long-term market prospects.


Cox, J. (2021, February 23). Powell says inflation is still ‘soft’ and the Fed is committed to current policy. Retrieved February 28, 2021, from

Hall, R. E. (1982). “Inflation: Causes and Effects.” National Bureau of Economic Research, Retrieved from Accessed 28 Feb, 2021.

Vague, Richard. “Rapid Money Supply Growth Does Not Cause Inflation.” Institute for New Economic Thinking, Accessed 26 Feb, 2021.

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