7 July 2020
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The Economy Observer
Global inflation? You got to be kidding!
Disinflationary future is still more real
In 2008, when Global Central Banks (GCBs) expanded their balance sheets, it was seen as a harbinger of imminent
higher inflation. Thus, the 2010s decade was expected to be inflationary. In reality, it turned out to be the most
disinflationary since the 1980s. One layer of analysis explains the divergence – the inflationary fears were unfounded
because expansion in GCBs was not accompanied by broad money supply (called ‘M2’ in the US).
With another round of massive liquidity injection by the US Federal Reserve, the fear of inflation has once again
resurfaced. And this time, since M2 has posted record growth (of ~25% YoY), the 2020s decade is expected to be highly
inflationary. We, nonetheless, beg to differ. One more layer of analysis would again alter the conclusion significantly.
Irrespective of the US Fed’s size, M2 was bound to rise sharply in the current episode because bank deposits (the
primary source of M2, accounting for ~85%) have witnessed truly unprecedented increase post-COVID. The combination
of record growth in personal income and record decline in consumption has boosted deposits.
Credit growth in the US, however, has risen modestly – from an average growth of 6% in the past five years (and ~8%
YoY in 2015-16) to 9.4% in the past four months (and 8% according to the recent reading). The ratio of bank loans to
M2, therefore, has now declined to below 60% for the first time in more than three decades. Further break-up of bank
loans suggest that almost the entire incremental growth is led by ‘commercial and industrial’ loans, while loan growth
to other sectors (including ‘consumer’ and ‘real estate’) has remained largely unchanged v/s pre-COVID growth. Not
surprisingly then, loans to deposit ratio in the US has plunged to 68.8% in Jun’20, the lowest since the 1970s.
Broad money supply growth has picked up in other major economies (the Eurozone, the UK and Japan) as well because
higher personal savings have boosted bank deposits everywhere. However, like in the US, loans to deposit ratio is also
at an all-time low in other major nations.
Going forward, M2 growth in the US is more likely to remain in double-digit (say, 10-12%) by end-2020. This is because
we expect only gradual normalization in consumer spending, and thus, in deposits too, which implies slow recovery as
well. Without commensurate loan growth, inflation will remain at bay. In 2021, three possible scenarios could play out,
only one of which – with least possibility – will be inflationary:
1)
Under the worst-case scenario, US consumers will not increase their spending and maintain personal savings at
high levels (say, 10-15% compared to 7-8% pre-COVID). In such an event, bank deposits would remain high keeping
M2 growth also elevated. Nevertheless, with very weak consumer demand, it is highly unlikely for companies to
borrow and invest, which means that US economic activity will remain extremely subdued. 2021, thus, would not
be very different from 2020 (not our base case). This scenario would actually bring back disinflationary fears.
2)
Most likely, and hopefully, the recent spurt in US personal savings would taper off more speedily over time, as
consumers become more confident of their spending. As deposits growth comes off, it will bring down M2 growth
too. This is the best-possible outcome and the most likely one as well, which is also unlikely to be inflationary.
3)
Under the third and the least probable scenario, the US Fed will attempt to keep M2 growth high (say, 10%) by
replacing the fall in deposits by currency in circulation (CIC), which is the only other source of M2. Since CIC is only
~12% of deposits, the normalization in consumer spending and savings will lead to tapering in deposit growth from
double-digit in 2020 to 3-4% (incorporating base effect also) in 2021 and would also imply growth of 60-70% YoY in
CIC. Not only will this be super-inflationary, it would also confirm the end of Central Banking as we know it.
Overall, the 2008 Global Financial Crisis taught us a very important lesson that the expansion in central banks is not
necessarily inflationary. The current episode will leave us with another very important teaching – even double-digit
growth in M2 may not necessarily be inflationary. What eventually matters is credit growth.
Lastly, we note that there are some other forces – the permanent disruption in globalization and the unending pursuit
of modern monetary theory (MMT) – which may be inflationary in the distant future. However, at present, the Japan-
ification of the global economy is a bigger worry than high-or-hyperinflation.
Nikhil Gupta – Research Analyst
(Nikhil.Gupta@MotilalOswal.com)
Yaswi Agarwal
– Research Analyst
(Yaswi.Agarwal@motilaloswal.com)
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on
www.motilaloswal.com/Institutional-Equities,
Bloomberg, Thomson Reuters, Factset and S&P Capital.