The Grand Illusion: Cheap Money, Expensive Consequences
April 04, 2025
Money is the great illusionist. When central banks flood the system with liquidity, the first act of the performance is mesmerizing: interest rates drop, borrowing becomes cheap, and investment surges. The economy hums with artificial energy, stock markets rally, and consumers feel emboldened to spend. But the illusion is fleeting. Behind the curtain, inflation lurks, waiting to emerge when the conditions are ripe. History has shown that an expansion in the money supply almost always leads to an inflationary climax once the velocity of money starts to accelerate.
Monetary Policy: A Balancing Act Between Growth and Inflation
Central banks wield the money supply like a double-edged sword. They manipulate interest rates to either stimulate growth or restrain inflation. The problem? Their actions come with a lag, and an overcorrection in either direction can set the economy on a path toward instability.
Phase One: The Push for Growth
- In times of economic slowdown or recession risks, central banks lower interest rates and increase the money supply. They inject liquidity through bond purchases and loosen reserve requirements.
- This lowers borrowing costs, making loans cheap and encouraging businesses to invest and consumers to spend.
- Employment rises, economic activity picks up, and it all looks like a perfect recovery.
- But the risk is excessive liquidity—if too much money chases too few goods, inflation is inevitable.
Phase Two: The Inflationary Reckoning
- As inflation takes hold, central banks reverse course—raising interest rates and tightening the money supply.
- Higher borrowing costs slow down consumption, reducing demand and cooling down inflation.
- But this is a risky game. If the economy is tightened too aggressively, it can lead to a sharp economic contraction, possibly triggering a recession.
- The real problem? Lag time. Central banks often react late, causing boom-bust cycles rather than stability.
The Velocity of Money: The Hidden Catalyst of Inflation
Inflation is not just about the money supply; it’s also about how fast money moves through the economy. This is where the velocity of money (VM) comes into play. A high VM means money changes hands quickly, amplifying price increases. A low VM, on the other hand, keeps inflation subdued.
For decades, inflation remained relatively under control because the money supply expansion was trapped within the banking system. The Federal Reserve pumped trillions into the system post-2008, but VM continued to decline. Why? The money never reached the average person—it stayed within financial institutions, parked in reserves or low-risk investments.
Then came COVID-19, and everything changed.
COVID and the Acceleration of Velocity
Unlike past crises, the COVID response injected direct cash into people’s hands. Stimulus checks, unemployment benefits, and other relief measures dramatically increased VM. The result? Inflation exploded as demand surged.
When stimulus money dried up, the government found new ways to keep the velocity engine running—one of the most notable being massive illegal immigration. This was not a coincidence but rather a calculated move. Providing housing, food, and financial aid to millions of undocumented individuals ensured that money flowed through the system.
The government’s priority has never been the well-being of its citizens; it has always been about maintaining control over economic levers. Using immigration as a financial tool, policymakers sustained inflationary pressures while diverting blame to external factors.
The Jobs Market Mirage
Another illusion in this grand monetary experiment has been the labour market’s strength. The Bureau of Labor Statistics (BLS) has repeatedly revised job numbers downward, with recent admissions showing that 1.2 million jobs overestimated non-farm payrolls.
This is crucial because a weak labor market should, in theory, slow down inflation. But as long as money is being funneled into circulation—whether through stimulus programs, immigration, or government spending—VM continues to rise, sustaining inflationary pressures.
The Bond Market and the Deflationary Counterforce
Historically, when VM starts to rise, bond prices fall. This relationship has held firm since 1997, when M2 velocity peaked. However, what we are witnessing now in bond markets is an anomaly that suggests either a structural shift or a temporary distortion.
If historical patterns hold, deflationary forces could emerge once VM peaks and starts to decline. China, for example, is already grappling with deflation, and without tariffs, the U.S. could easily import these deflationary pressures. The only thing preventing this is artificially maintained demand through government intervention.
Inflation, Deflation, and the Great Unknown
It is critical to understand that inflation and deflation can coexist. Inflation is the money supply expansion, while deflation results from falling demand or external shocks. The interplay between these forces determines the future economic landscape.
Historically, after an inflationary surge driven by rising VM, deflation follows. This could happen again unless governments find new ways to inject liquidity into the economy. Without new stimulus, velocity may slow, and inflationary pressures may ease—unless another crisis is manufactured to justify more intervention.
The Billion-Dollar Question: Is the Past Still a Guide?
For over a century, monetary trends have followed predictable cycles. But are we entering a new world order where disorder becomes the rule?
- Inflationary pressures could ease if M2 velocity fails to break its long-term downtrend.
- Inflation could become entrenched if VM continues to rise due to sustained government spending and forced liquidity injections.
- A deflationary shock could hit financial markets if the Federal Reserve overcorrects with excessive tightening.
The real challenge is determining whether we witness a temporary distortion or a fundamental shift in economic cycles. Either way, the outcome will shape financial markets, interest rates, and global stability in the next decade.
When Easy Money Bites Back: Historic Lessons
Yes, history is filled with examples where an increase in the money supply initially lowered rates, stimulated growth, and eventually led to inflationary surges. Here are some key cases:
1. The Weimar Republic Hyperinflation (1921–1923)
- What Happened: After World War I, Germany printed massive amounts of money to pay war reparations and support economic recovery.
- Impact: Initially, low rates and easy money spurred growth, but as the money supply exploded, hyperinflation took hold. Prices doubled every few days, wiping out savings and collapsing the economy.
- Lesson: Expanding the money supply beyond economic capacity leads to catastrophic inflation.
2. The 1970s Stagflation (U.S.)
- What Happened: The U.S. abandoned the gold standard in 1971 (Nixon Shock), leading to an uncontrolled expansion of the money supply. Simultaneously, oil shocks and supply chain disruptions worsened inflation.
- Impact: Inflation soared beyond 10%, while economic growth stagnated—resulting in stagflation, where inflation and unemployment rise together.
- Lesson: An increase in money supply doesn’t guarantee economic growth—if supply-side constraints exist, it fuels inflation instead.
3. The 2008 Financial Crisis & Aftermath
- What Happened: The Fed launched Quantitative Easing (QE), injecting trillions into the financial system to lower interest rates and stimulate recovery.
- Impact: Initially, inflation remained subdued because banks hoarded the money instead of lending it, keeping the velocity of money low. However, asset inflation surged—stocks and real estate boomed while wages stagnated.
- Lesson: Money supply growth doesn’t always cause consumer price inflation immediately—it can inflate asset bubbles instead.
4. Post-COVID Inflation Surge (2020–2023)
- What Happened: Governments worldwide injected trillions directly into consumers’ hands through stimulus checks and unemployment benefits, rapidly increasing the money supply and velocity of money.
- Impact: Inflation, which was dormant for years, suddenly surged to 40-year highs, peaking above 9% in the U.S. (2022). The Fed then aggressively raised rates to counteract it.
- Lesson: When new money directly enters consumer circulation, inflation can spike much faster than when banks control liquidity.
These cases prove that an increase in the money supply will always have downstream effects—first fueling growth and liquidity, then often leading to inflation or asset bubbles, depending on how and where the money flows.
Final Thoughts: The Endgame is in Motion
Every inflationary cycle starts with a money supply expansion, followed by a deceptive period of economic growth. Then, as VM picks up speed, inflation emerges, and central banks scramble to reverse course. But by the time they act, the damage is already done.
We are now in a dangerous game—one where policymakers are playing both sides, using economic tools to maintain control while publicly pretending to fight inflation. The truth is, they need inflation to erode debt and sustain government spending.
The real question isn’t whether inflation will persist—it’s whether governments will allow deflation to take hold. If history is any guide, they will fight tooth and nail to prevent it. The only certainty in this game is that the rules are changing, and only the cunning will thrive.
