Not Much of a Debate: Inflation is Part of the Plan

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Forget about lost decades. Forecasts that we'll be turning Japanese couldn't be further from the truth.

Here's why.

It's simple, really. Deflation is not in the interest of anybody in power, so it's very unlikely to happen.

The U.S. Federal Reserve's policy move to target inflation last week just re-emphasizes this point.

That's not to say deflation is a bad thing for everybody.

For savers and those living on fixed incomes, deflation would be a very good thing indeed.

Their income would gradually increase in real terms, and their savings would become steadily more valuable. Holders of Treasury bonds would also gain mightily from deflation.

However, the very people who would gain from deflation are not in power.

The People's Bank of China can't vote in the U.S. (yet!), Ron Paul is not president, and there is not an organized and powerful savers' political movement. After all, this is not Germany or Japan!

Meanwhile, in the real world, the U.S. government is spending far more than it takes in, and its debt is rising to dangerous levels. This has been happening on a bipartisan basis since at least 2001.

The Tea Party may have elected a Congress committed to reducing spending, but none of the battles of 2011 actually reduced spending – they just slowed the rate of growth somewhat.

Since much of the debt is borrowed long-term at low interest rates, the best way to reduce its burden on future generations is to encourage inflation.

Savers may lose out on the deal, but to those in Washington, the idea of inflating our way out of debt is irresistible.

Of course, sometimes we can depend on an independent central bank to resist this temptation. But at present, Fed Chairman Ben Bernanke is committed to near-zero interest rates in his fight against deflation.

Now you don't have to be a conspiracy theorist to realize that, if the power structure is committed to at least moderate inflation, inflation is what you are going to get.

In fact, it is already brewing.

Keep Your Eye on The Money Supply

One of the more reliable signs of future inflation, at least in the medium term, is monetary growth.

In the last year, the St. Louis Fed's Money of Zero Maturity, the nearest counterpart to the old broad-money M3, has risen by 9.5%, while the slightly narrower M2 has risen by 9.8%.

As for the monetary base, which monetary theory tells us is supposed to be the most accurate inflation indicator of them all, that's up 29.9%. What's more, there is no sign of M2 and M3 slowing down.

If you don't believe me, you can discover these facts by clicking here and seeing for yourself from the St Louis Fed's weekly data.

This 9% to 10% increase in the money supply is compared to a current rise in nominal gross domestic product (GDP) of about 5%. (That's including some acceleration in 2011's fourth quarter over earlier in the year.)

Since monetary "velocity" tends to increase continually with modern payment systems, that is far more money growth than you need to currently run the economy.

So the real puzzle is not whether we will get inflation, but why we don't have it now.

After all, interest rates have been near zero for more than three years now, and the money supply was rising faster than the economy for many years before that.

By all accounts, prices should be higher — but they are not.

Inflation Pressures Begin to Build

Part of the answer is found overseas.

The main factor suppressing inflation since the middle 1990s has been the Internet and modern telecoms. These have made it much easier to source products in low-wage countries.

So today we buy our clothes from China, whereas 20 years ago many of these same items were made in the U.S. The result has been about a 20% decline in apparel prices since their peak in 1993.

With this effect on consumer goods, and Moore's Law making technology-based goods cheaper and better all the time, even the rise in oil prices from about $10 per barrel in 1998 to about $100 today has been easily absorbed.

So the extra money that is sloshing around the world has pushed up commodity and energy prices, but has had much less of an effect on consumer prices.

However, there are signs that the price-suppressing effect of emerging markets manufacturing is coming to an end.

Chinese wages are rising rapidly, the currency has risen against the dollar, and China's balance of trade surplus has almost disappeared.

In fact, consumer price inflation worldwide began trending up in 2011. Now that commodity prices are rising again – as you would expect with expansionary money policy worldwide -2012 inflation pressures are beginning to build.

And now even Ben Bernanke finally weighed in last week as he tipped the scales even more decisively towards inflation.

By promising to keep interest rates at zero until the end of 2014, Bernanke has insured that interest rates almost certainly will remain below the inflation rate for the next three years.

That alone will cause inflation to rise, so we can expect the upward pressure on prices to continue.

So forget about deflation, since it will be vigorously resisted by the Obama Administration, Congress, and the Bernanke-led Fed. Inflation will keep heading higher from here.

In fact, by Election Day in November, inflation could be at troubling levels.

As for turning Japanese? …. I don't think so.

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Join the conversation. Click here to jump to comments…

  1. Bill | January 31, 2012

    I agree that inflation is inevitable, but I disagree that we haven't already seen it. I'm not sure where you buy gasoline, groceries or other common goods, but here, we've seen at least 20% or more inflation on most everything. Pushing it north of where it is now is going to make a lot of people very uncomfortable if not out right unable to survive at current wage levels…if they even have jobs.

    If inflation pushes much higher, do you not think the potential for hyperinflation exists and with it martial law to control the uprising that is sure to follow?

  2. Joseph M. Gronka | January 31, 2012

    Devaluation of our currency has been going on since about 1933 when we replaced gold as our standard, then further aggravated by the decision to move to paper in 1963. As a world currency it is still desireable. The "world" knows that the powers in the U.S. will tax it's citizens without fear of revolt in order to make our Debt worth while to hold. So, inflation is what we have been living with since 1933. Congresses have thrown up their hands in despair when asked to get control. They claim that they do not know what causes it. To state that it is not going up even now is just disingenuous. Rising commodity prices cause "all" prices to rise. Especially energy. Go to the grocery store and gas station, tell me that consumersw are not paying any more. So clothing must be transported, that is more expensive as well just because of shipping cost. I began buying from Amazon in 2002 because for a one time fee I got "free" shipping. I am still paying the one time cost but no longer receive free shipping because the cost of shipping is built in to the product cost. So, shipping is the biggest cost factor and is dependent upon Oil cost. The FED is destroying our economy and is being aided by our Congress and executive branch. Talk about conspiracy. Almost all member of the aforementioned are members of CFR and TC. Get real.

  3. Tom | January 31, 2012

    I have to agree with Bill above. I do the grocery shopping and prices have gone up a lot as have gasoline prices. Living on a fixed income makes you watch where every cent goes.

  4. Andy | January 31, 2012

    Can't agree more. So far the stimulus packages that was put in place has been like trying to hold water with a sieve! It just flows out into the global markets especially the Asian region with China getting the most benefits.
    Doing the near 0 interest rate trick will only work if you can prevent or lessen funds from flowing out of your economy. Haven't Ben realize over the at least past 2 years of 0 interest rates policies and global inflation?
    On the other hand, looking at inflation through dark glasses is arrogant and dangerous as the FED is really out of touch with reality. It will only compound the suffering; likewise looking at the employment data is sickening as it does not really provide the proper insight into the real problem. What is the real unemployment rate? 20% or more? You still have to feed these people who have given up looking for a job doesn’t you?

  5. Ed the Grocer | February 1, 2012

    I quit worrying about the money. The real threat is coming from automation. We are now capable of building just about anything using robotic plants at a much lower price and of higher quality than products from China. Add in consumer driven design and demand, Just in Time manufacture and shipping, and the North American model will be unbeatable in our market. Then there will be a minor problem of "no workers", " no customers". It is happening now. It is the so called jobless recovery. I am hoping to cope by creating many more local suppliers and loyal 'shop local' customers. Imagine though, the foolish Chinese, who are bringing hundreds of millions of people to the city for jobs that will soon disappear. Can we say 'civil unrest?'.

  6. Bruce C. | February 1, 2012

    I don’t understand where this author is getting his data. I “clicked here” to see the money supply numbers and it showed nothing of the kind. Also, on what planet did GDP increase by 5% last year?

    Regardless, the germane question is why hasn’t inflation increased EVEN MORE than it already has? I have two answers: the methodology used to calculate the inflation rate continues to be manipulated to keep the headline rate low (For example, the headline inflation rate EXCLUDES the price changes of food and gasoline. Also, the bogus “rent equivalency” of housing continues to drop as real estate values fall.); and, there is constant debt destruction going on that counters the added liquidity from the central banks.

    These are unprecedented times, so it remains to be seen if the central banks of the world can monetize debt losses fast enough to keep asset values from falling. So far, housing globally is still falling, lending (which increases the money supply) has almost ceased, and if Europe becomes unhinged then look out.

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