Subject: What is money? What is inflation?
All METARs are both consumers and investors. We are unhappy when consumer prices rise (consumer price inflation) but happy when the value of our investments rise (even if this means inflation of the P/E ratio).

It's pretty clear that consumer price inflation results when the demand for a good or service exceeds the supply. We pay with money.

What is money?
The definition of money is "a medium of exchange." Historically, most forms of money had clear uses. Cowrie shells could be used for personal decoration. Tobacco could be smoked. Bronze could be turned into weapons. Copper, silver and gold have important commercial uses to this day.

Inflation occurred historically when rulers diluted the valuable metals in their coins with base metals. It said something ominous when the U.S. changed the penny from copper to zinc in 1982 and finally decided to stop minting pennies because the cost of minting was higher than the value of the penny. It says something ominous when nothing -- not even "penny candy"-- can be bought with a penny anymore. Even an honest copper penny (pre-1982) costs $0.02 based on its copper content.

We are all familiar with the Consumer Price Index.
https://www.multpl.com/inflati...

The M2 money supply consists of money that can easily be spent by consumers -- cash, checking accounts, plus (1) small-denomination time deposits (time deposits in amounts of less than $100,000) and (2) balances in retail MMFs not in retirement accounts. Real (inflation-adjusted) M2 grew pretty smoothly between 1995 and 2020.
Click on the "Edit Graph" button in the upper right to see rates of change.

Consumer price inflation was kept under control during those years due to a growing flood of low-cost goods imports. However, inflation of services was much higher
than goods inflation.

The burst of high inflation in 2020 - 2022 was due to a combination of helicopter money sent by Congress directly to consumers (fiscal stimulus) and supply chain problems. It's clear where consumer price inflation is coming from. Partly monetary stimulus (extremely low interest rates for years) and partly fiscal stimulus.

https://fred.stlouisfed.org/se...
https://fred.stlouisfed.org/se... -- This series deflates M2 money stock (https://fred.stlouisfed.org/se...) with CPI (https://fred.stlouisfed.org/se...).

Where is asset price inflation coming from? Why are stock prices continuing to climb when Congress is no longer dropping money onto investors, the Federal Reserve is finally (slowly) shedding its immense book of bonds and the bond market is bringing real interest rates closer to the historic norm?
https://fred.stlouisfed.org/se...
https://fred.stlouisfed.org/se...

Where is all the money coming from to inflate the asset markets -- stocks and real estate -- so much faster than the economy's growth rate?
https://www.multpl.com/s-p-500...
https://www.multpl.com/inflati...

Where is the money coming from to inflate the bubble?
https://www.multpl.com/shiller...

Many METARs are heavily invested in stocks and pat themselves on the back for being so smart and so rich. But is this bubble sustainable? Where is the money coming from? It's not M2 because money that is in bank accounts isn't in the stock market. It's not the Federal Reserve which is actually selling its Treasuries and mortgage bonds.

The bubble is being inflated by the truly awesome tsunami of borrowed money created by the Shadow Banking System.
From Google Gemini:

The term "shadow banking system" (SBS)refers to a diverse collection of non-bank financial institutions and activities that provide credit and financial services similar to traditional banks, but with less regulation. These entities include, but are not limited to, investment funds, money market funds, and finance companies....

It is important to note that the term "shadow banking" can be defined in different ways. Some definitions are broader and include entities like insurance companies and pension funds, while narrower definitions focus on financial intermediaries that engage in bank-like activities like maturity and liquidity transformation without regulatory oversight. ...

According to a 2022 report from the Financial Stability Board, the global shadow banking system, which they refer to as non-bank financial intermediation (NBFI), held over $239 trillion in assets. This represented approximately 49.17% of total global financial sector assets...

The FSB, which uses the term non-bank financial intermediation (NBFI), reported in 2023 that U.S. NBFI assets totaled approximately $20.5 trillion in 2021. This was compared to $23.7 trillion in assets held by U.S. insured depository institutions in the same year. This figure represented about 30% of global non-bank assets... [For comparison, U.S. GDP = $30 Trillion.]

They do not create traditional "money" (bank deposits), but they create a vast amount of credit, which functions similarly to money in the broader financial system.... [end quote]

Whereas the regulated banks create money by fractional reserve lending, the SBS system is unregulated. I could copy a bunch of stuff from Gemini but basically SBS creates money to lend using "The Collateral Multiplier." When one institution borrows cash using collateral, the lender can then "rehypothecate" that collateral—meaning they can use it as collateral for their own borrowing. This re-use of collateral allows a single security to support multiple layers of borrowing and lending.

This seems risky to me -- like mortgaging the same house several times. The money that's borrowed can then be invested in many ways. Some in the stock market where margin borrowing is at an all-time high.

https://www.finra.org/rules-gu...

Some in illiquid investments like real estate which is also at an all-time high driven by investors who are competing with actual home buyers.
https://fred.stlouisfed.org/se...

But the maturity mismatch and illiquidity which is regulated in the banks is unregulated in the SBS.

I am very uneasy about this whole situation because it's bigger and badder than 2007.

Would an ordinary, run-of-the-mill recession be enough to turn this into a financial crisis and pop the stock market bubble which is inflated by SBS lending?

Will tariffs be enough to induce a recession?

Wendy