In the recent Wall Street Journal article “Inflation Surge Earns Monetarism Another Look,” Greg Ip writes that a recent surge in inflation is not likely to bring authorities to reembrace monetarism. According to Ip, money supply had a poor record of predicting US inflation because of conceptual and definitional problems that haven’t gone away.
The head of the monetarist school, the late Milton Friedman, held that inflation is always and everywhere a monetary phenomenon. Friedman and other monetarists believed that the key driving factor for general increases in prices is increases in money supply.
This viewpoint has come under scrutiny since the early 1980s because the correlation between inflation and money supply disappeared. According to Ip in 2020, Alan Detmeister, an economist at UBS Group AG and formerly of the Fed, found inflation’s correlation to M2 since the early 1980s was weak and its correlation to both the monetary base and M1 was negative. Most economists have stopped using money supply as an indicator for inflation since the early 1980s.
Many mainstream economists have attributed the breakdown in the correlation between the money supply and inflation on the unstable velocity of money. What is it? According to the famous equation of exchange, MV = PT, where:
- M stands for money,
- V stands for the velocity of money,
- P stands for the price level, and
- T for the volume of transactions.
This equation states that money multiplied by velocity equals the value of transactions. Many economists employ GDP (gross domestic product) instead of PT, thereby concluding that
MV = GDP = P (real GDP).
The equation of exchange appears to offer a wealth of information regarding the state of an economy. For instance, if one were to assume stable velocity, then for a given stock of money one can establish the value of GDP. Furthermore, a given real output and a given stock of money enables us to establish the price level.
For most economists the equation of exchange is regarded as a very useful analytical tool. The debates that economists have are predominantly with respect to the stability of velocity. If velocity is stable, then money is seen as a very powerful tool in tracking the economy. The importance of money as an economic indicator however diminishes once velocity becomes less stable and hence less predictable.
However, an unstable velocity could occur because of an unstable demand for money. Most experts believe that since the early 1980s, innovations in financial markets made money velocity unstable. This in turn made money an unreliable indicator of inflation.
We believe the alleged failure of money as an indicator of inflation emanates from an erroneous definition of inflation and money supply. This failure has nothing to do with an unstable demand for money, and just because people change their demand for money does not imply instability. Because an individual’s goals may change, he might decide that it benefits him to hold less money. Sometime in the future, he might increase his demand for money. What could possibly be wrong with this? The same goes for any other goods and services—demand for them changes all the time.
Defining Inflation
According to Murray Rothbard and Ludwig von Mises, inflation is defined as the increase of the money supply out of “thin air.” Following this definition, one can ascertain that increases in money supply set economic impoverishment in motion by creating an exchange of nothing for something, the so-called counterfeit effect.
General increases in prices are likely to be symptoms of inflation—but not always, however. Note that prices are determined by both real and monetary factors. Consequently, it can occur that if the real factors are “pulling things” in an opposite direction to monetary factors, no visible change in prices is going to take place. If the growth rate of money is 5 percent and the growth rate of goods supply is 1 percent then prices are likely to increase by 4 percent. If, however, the growth rate in goods supply is also 5 percent then no general increase in prices is likely to take place.
If one were to hold that inflation is about increases in prices, then one would conclude that, despite the increase in money supply by 5 percent, inflation is 0 percent. However, if we were to follow the definition that inflation is about increases in the money supply, then we would conclude that inflation is 5 percent, regardless of any movement in prices.
Defining Money Supply
Prior to 1980, it was popular to employ various money supply definitions in the assessment of the changes in the prices of goods and services. The criterion for the selection of a particular definition was its correlation with national income. However, since the early 1980s, correlations between various definitions of money and national income have broken down. Some analysts believe that this breakdown is because of changes in financial markets, making past definitions of money irrelevant.
A definition presents the essence of a particular entity, something no statistical correlation could ever provide. To establish the definition of money we have to explain the origins of the money economy. Money has emerged because barter cannot support the market economy. Money is the general medium of exchange and has evolved from the most marketable commodity. Mises wrote:
There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.
Since the general medium of exchange was selected out of a wide range of commodities, the emerged money must be a commodity. Rothbard wrote:
In contrast to directly used consumers’ or producers’ goods, money must have pre-existing prices on which to ground a demand. But the only way this can happen is by beginning with a useful commodity under barter, and then adding demand for a medium to the previous demand for direct use (e.g., for ornaments, in the case of gold).
Through an ongoing selection process, individuals settled on gold as standard money. In today’s monetary system, the core of the money supply is no longer gold, but rather coins and notes issued by the government and central bank that are employed in transactions as goods and services are exchanged for cash. Hence, one trades all other goods and services for money.
Part of the stock of cash is stored through bank deposits. Once someone places money in a bank’s warehouse, he is engaging in a claim transaction, never relinquishing his ownership of the money. Consequently, these deposits, which are labelled demand deposits, are part of money.
This is contrasted with a credit transaction, where the lender relinquishes his claim over the money for the duration of the loan. In a credit transaction, money is transferred from a lender to a borrower, but the overall amount of money in the economy does not change because of the credit transaction.
The introduction of electronic money seems to cast doubt on the definition of money. It would appear that deregulated financial markets generate various forms of new money. Notwithstanding, various forms of electronic money or e-money, like digital currency, do not have a “life of their own.”
Various financial innovations do not generate new forms of money but rather new ways of employing existing money in transactions. Irrespective of these financial innovations, the nature of money does not change. Money is the thing that all other goods and services are traded for. Once the essence of money is established by excluding various credit transactions, one can identify the status of inflation. Changes in prices are not going to be relevant here.
Conclusion
Contrary to popular thinking, inflation is not about increases in the prices of goods and services but about increases in money supply. Following this definition, we can establish that the key damage caused by inflation is economic impoverishment through the exchange of nothing for something. What matters as far as inflation is concerned is not the correlation between money supply and the prices of goods and service but increases in money supply.
Contrary to popular thinking, the essence of money did not change because of various financial innovations. Money is a thing that is employed as a medium of exchange. Furthermore, according to Mises’s regression theorem, the historical link between paper currency and gold is what holds the present monetary system together.
Editor’s Note: We recommend two America First precious metals companies. Our Gold Guy specializes in physical gold and silver bullion. Goldco offers a wide array of products, including gold and silver IRAs. Both are excellent choices for wealth and retirement protection.
About the Author
Frank Shostak‘s consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. Contact: email.
Image via Shutterstock. Article cross-posted from Mises.
Two Storms, One Harvest
Every food crisis in living memory has been a one-shock event. The 2008 price spike was a commodity bubble. The 2020 shortages were a logistics failure. The 2022 grain scare was a war on one exporter’s ports. Each time, the system bent, adjusted, and recovered, and each time the experts assured us afterward that global markets are simply too big and too diversified to fail.
What nobody in Washington seems eager to discuss is that 2026 is shaping up to be something the modern food system has never actually faced. Two independent shocks, one climatic and one geopolitical, are converging on the same harvest cycle at the same time. Not sequentially. Simultaneously.
Start with the weather. The Pacific Ocean is currently building toward what forecasters now openly call a record event. NOAA’s Climate Prediction Center puts the odds of at least a strong El Niño near 88 percent, with roughly two in three odds it reaches “very strong” status, the tier reserved for perhaps three or four events in the entire satellite era. Every major global model now projects a median peak in Super El Niño territory, and most of them project it exceeding the 2015-16 event, which until now held the modern record. Sea surface anomalies were already brushing the super threshold in mid-July, months before these events normally peak. The atmosphere has already shifted into El Niño mode, and the event is forecast to crest in late fall and early winter.
This is not about “climate change.” It’s about the standard cycles of weather, and the cycle we’re currently in is one that has likely devastated societies in the past. We’re better prepared as a society today, but not all Americans are equally prepared.
Serious households have started doing the quiet math on their own. Grocery bills tell part of the story, and the forecast maps tell the rest, which is why long-term food storage has moved from fringe hobby to mainstream line item in the family budget, with established suppliers like Heaven’s Harvest seeing demand from people who five years ago would have rolled their eyes at the idea. That instinct is not paranoia. It is pattern recognition, and the pattern is worth walking through carefully.
Editor’s Note: Heaven’s Harvest IS a sponsor, but the warnings of this article are real and would be written even if we didn’t have a survival food sponsor. With that said, those who take advantage of what they offer can use promo code “Patriot” for 15% off.
The Fertilizer Clock Is Already Running
While the Pacific warms, the second shock has been unfolding in the Strait of Hormuz. The conflict with Iran turned the world’s most important energy chokepoint into a contested waterway, and the consequences reach far beyond the gas pump. Roughly a third of global fertilizer trade moves through Hormuz, and the disruption sent urea prices up 86 percent year over year by March, with a 53 percent jump in a single month.
The World Bank projects energy prices rising about 24 percent in 2026 and fertilizer about 31 percent. By its own accounting, fertilizer prices ran 35 percent higher in the first five months of this year than the same period last year.
Here is the mechanism the nightly news will not explain. Fertilizer is not a grocery item. It is a time-delayed input. The nitrogen a farmer in Iowa or Punjab could not afford to apply this spring does not show up as a problem this spring. It shows up as a thinner harvest six to twelve months later.
The World Bank’s own food security brief concedes that the effects of reduced applications earlier this season “are likely to become visible only later in harvest outcomes.” Translate that from institutional language into plain English and it means this. The damage is already done, it is already in the ground, and we are simply waiting for it to arrive on the shelf.
Now check the calendar. Six to twelve months from the spring planting season lands us squarely in late 2026 and early 2027. Which is precisely when the strongest El Niño in the instrumental record is forecast to peak, bringing its signature droughts to Southeast Asia, Australia, southern Africa, northern Brazil, and South Asia, the very regions that grow the world’s rice, sugar, and oilseeds.
The World Bank warns openly that a strong El Niño “could disrupt multiple crop belts simultaneously” on top of the conflict-driven input costs. Their baseline projection assumes the Middle East disruptions ease by autumn. What in the last two years of Middle East history suggests that assumption is safe?
The System Has No Slack Left
The comfortable answer is that global markets always adjust. But adjustment requires slack, and the slack is gone. Global cereal production is expected to decline from last year’s records even before El Niño does its work. The UN World Food Programme, hardly a den of right-wing preppers, is calling this the most significant disruption to its supply chains since Covid and the invasion of Ukraine, and its supply chain director put the stakes bluntly.
Today’s supply chain challenges are tomorrow’s hunger crisis.
There is also a political dimension that markets cannot price. When food gets scarce, governments do not behave like economists. They behave like politicians. Export bans, hoarding mandates, and panic buying at the national level turned the modest rice shortfall of 2008 into a global crisis, and analysts are already warning that import-dependent nations are the first dominoes.
The 2015-16 Super El Niño, a far weaker event than what is now forecast, threw tens of millions into food stress across Africa and Asia. This one is projected to be stronger, and it arrives with fertilizer already rationed by price and shipping lanes already contested by missiles.
What Joseph Knew
Scripture does not treat preparation for lean years as faithlessness. It treats it as wisdom delivered in advance to those willing to act on it.
Behold, there come seven years of great plenty throughout all the land of Egypt: And there shall arise after them seven years of famine; and all the plenty shall be forgotten in the land of Egypt.
Joseph did not respond to that warning with a hashtag or a committee. He stored grain during the years of abundance, and when the famine came, Egypt stood while its neighbors begged. The lesson is not that famine is certain. It is that the time to prepare is precisely when preparation still looks optional.
Nobody who filled a pantry in a year of plenty has ever regretted it, and nobody standing in an empty aisle has ever been glad he waited for certainty.
None of this calls for panic, and panic is the enemy of sound judgment anyway. It calls for the same unglamorous prudence our grandparents considered ordinary. Keep some cash margin, know your local growers, and put real food in deep storage while it is cheap and available, because the entire arc of this story is that cheap and available is a closing window.
Families looking for a straightforward place to start can visit Heaven’s Harvest and use promo code Patriot for 15 percent off long-term storable food. The forecasts may yet soften, the strait may yet reopen, and we should pray they do. But hope is a fine thing to hold and a foolish thing to eat.
