Status of inflation and prices today, September 2009

I have four things to say about inflation, prices, and the state of today’ economy, late September, 2009.


NO CREDIT EXPANSION CURRENTLY
One, since inflation is introduced into our economy by means of credit expansion, which means bank lending. Currently, because of the nature of our current mess, i.e., a financial panic, bank lending has shrunk and credit availability has all but disappeared due to the liquidation of bank capital and reserves. You might ask about the money that the federal government has put into banks. It was a lot of money. That money went into three areas. Some did go into the credit area, as the government purchased bad debt, those sub-prime, mortgage-backed bonds. But the government bought them at an extreme discount, so it did not replace much of the credit. The other two areas in banking that received money were those of reserves and capital accounts. These accounts within a normal functioning bank, consist of a significant percentage of fund, maybe as much as 50% of the bank’s checking deposits. However, these funds are not spent, not really invested. They must remain available for the bank’s needs. Consequently, they have never been part of the money supply, M1 or MZM, and cannot really be considered inflationary. The real problem with all of these measures by the government is that the recession hasn’t been allowed to do its work. The misallocations and created money have not been worked out of the system.

FALL OF THE DOLLAR
The upperward pressures on consumer prices today come primarily from two sources: one, the fall of the international value of the dollar. Foreign goods and services are now considerably more expensive that they were just a few years ago. The dollar has dropped in value almost 50% in just a couple years.

There is a second consequence for prices. U.S. goods and services are much cheaper for foreign buyers. That might sound good, but what it really means is that there are more dollars chasing our domestic production, which will mean higher prices for us. It is a double whammy of price inflation.

The current fall of the dollar is happening because foreigners hold so many dollars. They are finally spending them instead of holding on to them. They have been accumulating dollars for almost three decades, from our trade deficit. There is almost $11T in dollars overseas. All of these dollars that we have exported were created dollars. Notice that during the time that foreigners accumulated $11T, we still had constant 2% to 3% price inflation as our domestic money supply grew to over $10T. New money was being created at a tremendous rate. Now the overseas money is beginning to return. It is from our past inflation.

OIL PRICE SPIKE COMING!
Third, there is probably another event that is going to happen soon that will affect us financially. The conditions that produced the oil shock a couple years ago are returning. The world has no new capacity, and none coming on line in the foreseeable future. The existing industrialized countries have not reduced their requirements for oil, and will not do so, unless they retreat from industrialization. Finally, the two largest countries in the world, which are slowly moving into the modern age, and slowly increasing their need for energy, are slowly reemerging from the recession. We are all slowly reemerging from the recession. As we reemerge, more demand for energy will drive the spot prices for oil beyond what it was two years ago. This is not inflation. It is forced shortages. Prices will go up. All goods and services are dependent upon energy, and as energy prices go up, so will all the others.

MEDICARE AND SOCIAL SECURITY SHORTFALL: A REAL MESS!
Finally, in the relatively near future, we come to the fruition of the Medicare and Social Security mess. Medicare already costs more than the annual Medicare taxes bring in, and is consequently taking money out of general taxes. Social Security will follow suit within just a few years. Both programs will begin growing faster than realistic taxes can support. What will happen then? Depends a lot on who is in power and whose voices are being heard. As these two programs grow they will force out everything else, including Obama’s programs, and national defense! If instituted, Obama’s programs will just bring on the mess earlier because the poorer the economy performs, the sooner the shortfall between Medicare and Social Security costs and their direct revenues will occur. Also, the faster consumer price levels rise, the sooner the problem because both programs are tied to the price levels, either directly or indirectly.