M1, Inflation and Interest in the US: Why Is It Important for Brazilian Investors?

“The Peter Lynch Way of Investing”, by Cash Manager and John Rothschild, is one of several books on investing. However, when I first read the work, I found an item in Chapter 17 that surprised me: the “trumpet effect”. In short, Lynch explains that in this item, investors, professionals and amateurs alike are plagued by recurring media reports (mainly in the United States). Most of the time, these messages are not fully understood by the people, yet they are constantly repeated by everyone (hence the name “drum beat”). At this point, he cites that there is a “trumpet” regarding the issuance of the M1 coin in the United States (this is not the current moment, the book was originally written in 1989). On my first reading, I had the impression that Lynch believed that knowledge of fundraising was not relevant to investors.

The reason I was surprised to read this passage is that I think M1’s behavior is particularly relevant information for investment decisions, especially at the present time. But, what is M1?

According to the Central Bank of Brazil [ii]: “M1 corresponds to the amount of paper money and demand deposits held by the public, generated by companies that provide cash assets”. Paper money held by the public is the total amount of money issued in the form of rupee notes and coins minus the reserves (reserves) of commercial banks and the Central Bank. Demand deposits, also known as “book-entry currency”, refer to the amount of money in a customer’s current account at a commercial bank (including credit institutions, including Caixa Econômica Federal, commercial banks and some cooperatives authorized to receive required deposits). In other words, M1, or “restricted payment” is the distribution of money in an economy.

In the case of the United States, the definition is similar. According to the Federal Reserve [iii]“M1 is a transaction deposit in publicly held currency and depository companies”, Which translates as: M1 is the amount of paper money held by the public with the required deposit in depository companies. The following figure shows the evolution of money supply (M1) in the United States since the beginning of 2018:

Source: Own extension based on FRED data [iv] (St. Louis Federal Reserve Bank)

Looking at the map, you can see an impressive increase in US money supply since April 2020. Covit-19 Crisis. In fact, the M1 has crossed the $ 20 trillion barrier, flooding both the goods and services markets and the financial markets with excessive cash flow. The effects of the strong increase in payment mechanisms on inflation in goods and services and the prices of financial assets have been the subject of intense debate, not only in the United States but around the world, as dollar markets have been flowing into the funds. From different countries. Image below (CPI – Consumer price index) In the last four years:

Source: Own extension based on FRED data [v] (St. Louis Federal Reserve Bank)

Consumer inflation in the United States, like most of the world’s economies (including Brazil), was significantly higher, which caused concern for the central banks and the Federal Reserve (FED, the US, which is actively debating the direction of monetary policy adopted by the central bank) in light of this context. However, they have not yet entered the elevation cycle, as we can see in the image below:

Source: Own extension based on FRED data [vi] (St. Louis Federal Reserve Bank)

Despite this, at the last FOMC meeting (Federal Open Market CommitteeOn January 25, 2022, the US Federal Reserve announced that it would begin a reduction in asset purchase plans from March 2022, and signaled interest rate hikes (Federal financial ratio) By 2022, inflation is proving to be stable (there is a great deal of debate in the United States as to whether current inflation is volatile or stable).

Rising interest rates in the United States are having a major impact on the world economy, and rising interest rates could trigger a revolving financial crisis. In 2008, many financial market analysts used the term “Minsky moment”. [vii]An increase in interest rates after a long cycle creates difficulties in meeting previously considered debt obligations and could result in the potential eruption of a general financial crisis.

Therefore, this moment is very sensitive for US currency officials. On the one hand, inflation has proven to be a worthwhile problem, and a concise monetary policy must be adopted. On the other hand, the vast majority of financial assets, especially in the United States, are at their peak at all times and a significant portion of companies rely heavily on debt and credit to carry out their operations. Thus, at a time when the global economy is not fully recovering from the Govt-19 crisis, rising interest rates have the potential to shake up financial markets.

These decisions have a significant impact on the Brazilian financial market, especially stocks. Although some analysts point out that there has been a positive correlation between US interest rate hikes in the past, such as the 1990s and 2000s, and the rise in Brazilian property prices, in general, the rise in interest rates indicates a slowdown in global liquidity. Tends to reduce the flow of international capital.

However, at present, some financial managers in the United States (e.g., Jeremy Granth) [viii]) Financial assets in the United States are overestimated, many of which are the highest of all time. On the other hand, they believe that emerging markets have financial assets with very attractive prices. In this way, it is possible for asset managers to look for investment opportunities in markets outside the United States, which could move large resources towards financial markets in developing countries, especially if there is a sharp reduction in the price of US assets. . On the other hand, it is important to remember that we are living in a unique moment, and that past circumstances may not be a good guide to future decisions.

Unfortunately in the financial markets, everything is a matter of probability, there is no certainty. In fact, the present moment shows interesting investment opportunities in the stock markets of developing countries, including Brazil. However, the real impact of the interest rate hike cycle in the United States is not yet known. We do not know exactly what the Federal Reserve’s next steps will be to this change in the central bank’s position or what the response of economic agents will be. The truth is that the present moment requires serious attention because great opportunities (and risks) arise in moments of high pressure in the markets.

For this reason, it is essential for investors in risky financial products, both here and in the United States, to know the meaning of money laundering and to monitor their behavior, as well as the debate over inflation and interest rates.

* Guilherme Ricardo dos Santos Souza e Silva An economist, Doctor of Economic Development and Associate Professor at UFPR.

Instagram: guilherme.economista

Email: [email protected]

[i] Lynch, Peter; Rothschild, John. Peter Lynch’s way of investing. 2nd ed. Sao Paulo: Penvira, 2019.

[ii] Technical Note from the Central Bank of Brazil 48. A methodological study of payment statistics. Brasilia, 2018.

[iii] Board of Governors of the Federal Reserve. Frequently Asked Questions (FAQs)

[iv] Board of Governors of the Federal Reserve System (US), M1. St. Louis Federal Reserve Bank.

[v] Organization for Economic Co-operation and Development, Consumer Price Index: Total All Commodities for the United States. FRED, St. Louis Federal Reserve Bank.

[vi] Federal Reserve System (US), Federal Funds Effective Rate Board of Governors. FRED, St. Louis Federal Reserve Bank.

[vii] The term “Minsky moment” was first used to describe the Russian crisis in 1998, referring to the economist Hyman Minsky and the weak hypothesis of finance.

[viii] Calling a super bubble: front row with Jeremy Grant.