There is a good article by Mervyn King, then Deputy Governor and subsequently Governor of the Bank of England, published in 2001 that is very pertinent to today's quantitative easing (QE) program and its consequences in time. Specifically, in Chart 1 he shows rather convincingly that expansions in the money supply, with an appropriate lag, will lead to an proportionate increase in consumer price inflation with a 99% correlation. With today's QE program, we already see 1-to-1 correlation between increases in the monetary base and assets prices, particularly stock prices as seen in Chart 2 where the ratio of the S&P500 index / US monetary base has flat-lined since 2009. In other words, the strong growth we have seen as of late in the US stock market is being equally offset by the growth in the monetary base. This increase in the S&P500 index can be dubbed in general, asset inflation, and financial assets such as stocks tend to be among the first things 'bid-up' in price due to an expansion in the money supply. And as clear as day turns to night, with an appropriate lag, eventually that asset price inflation will spread into consumer prices and formally enter the 'inflation' metrics as commonly computed; the CPI.
|Chart 1 : Money growth shows a 99% correlation to consumer inflation with an appropriate time lag.|
|Chart 2 : Ratio of the S&P500 / US monetary base|
|Chart 3: Money growth shows no correlation with real output growth.|