Thursday, May 5, 2011
The amount of U.S. currency in circulation (most of which is in the form of $100 bills) is increasing at an historically rapid rate—almost 14% annualized over the past three months. As the chart above shows, currency has only grown this rapidly during times of crisis, when demand for dollars surged because the dollar was considered to be a safe haven currency. The world's demand for $100 bills surged in the wake of the Gulf War in the latter half of 1990, in the runup to Y2K in late 1999, when the dollar reached a multi-year peak against other currencies in early 2002, and during the financial/banking system crisis in late 2008. In all of those periods, the value of the dollar was relatively strong and/or rising against other currencies. In the past three months, currency demand has surged again, suggesting we may be in the midst of another crisis.
But there's an important difference this time. As this next chart shows, the growth rate of currency since mid-2010 is no longer correlating to dollar strength. In fact, currency demand has surged as the dollar has fallen. If currency demand were rising because the dollar is considered to be a safe haven during a time of crisis, why is the value of the dollar falling, and even hitting new all-time lows?
Could rapid currency growth over the past year be a precursor to a permanently higher inflation rate? I note that currency growth averaged about 10% per year during the high-inflation, 1974-1980 period, and the value of the dollar was declining throughout that period. (Currency growth remained rapid in the early 1980s even as inflation plunged, because demand for dollars surged and the dollar rose dramatically against other currencies).
Meanwhile, the M2 measure of the money supply (of which currency circulation is a part) continues to grow at a very normal 5-6% annual rate. For some reason the world has a fairly intense desire to increase its holdings of U.S. currency at the expense of other forms of money.
I'm open to suggestions.
Posted by Scott Grannis at 4:06 PM