Sunday, December 6, 2009

Inflation Watch Update

These are some thoughts and observations about inflation: the prospect and what we are seeing specifically in prices.

As a reminder: inflation refers to the money supply
I use the term “price inflation” to talk about prices and the cost of living.

I saw someone saying that the price for small things like candy, fruit juice, stuff for less than a dollar or so, has gone up significantly in the past year or two. I don’t spend money on these things and don’t have a perspective. It would be interesting to hear form some people and their experiences of recent price changes.

I have also seen reports that segments of our produce production have been wiped out by weather. While this might have an impact on prices, it is not inflation and would be remedied by imports and the next harvest. It is important to keep a perspective on what is caused by government manipulation and what is caused by natural or market forces. Another example is oil or gasoline prices. The oil market is also heavily regulated and constricted domestically and in many other countries, which would tend to push the prices up due to shortages. A rising oil price due to government imposed shortages is not inflation or price inflation, however.

At the same time, housing prices and markets have been held up artificially over the last several months, which means that housing prices still have a ways to fall. If you are contemplating selling, do it soon.

Unfortunately, many, if not all, of the people who are arguing that significant price inflation is coming are very strident and projecting very extreme scenarios. Perhaps it is the result of the apparent indifference or ignorance of the American people. Maybe it is because of the propaganda emanating from the Fed, the Treasury, and the administration. Whatever, the stridency has a tendency to either make people anxious or drive them away. I am trying to offer a reasonable discussion and inference.

The major problem that is presented in looking into the economic future is the timing. In generally good conditions, you have considerable uncertainty mainly because of the multiplicity of actors and their perchance of doing things you don’t expect, usually good things, but still things different than you expected, so your decisions do not pan out.

In this situation, you know that what the government is doing is not good and will have adverse consequences. In fact there have already been adverse consequences, really bad ones. What you don’t know is how much worse the situation can get and when.

Price inflation can come at us from many different directions. We can see the dollars overseas come storming back, which would increase the circulating money enormously. (This is a favorite scenario of the scare mongers.) The Fed might try to stop or reverse the potential of price inflation by increasing interest rates, in which case we would see a business slow down and possible a reduction in availability of goods, while the money supply continued to go up, and we have price inflation during a recession, the 70’ again.

In a few years we will see inflation when the baby-boomers hit Social Security and Medicare, especially if their retirement funds continue to be wiped out.

We will see price inflation as Obama continues to spend money and the Fed accommodates him by buying the debt and pump money directly into the economy and keeping interest rates low. (This is actually not as bad as what they normally do which is expand bank credit, which has a multiplier effect.)

In other words, with all the money that the Fed is creating and will create, it is nearly impossible that price inflation won’t descend upon us. The ground has been laid for general inflation, i.e., the expansion of bank credit and thus many different messes, including price inflation.

Right now the banks have unlimited opportunity to make loans. There is plenty of demand and their Fed reserves are 10 times what they need. Bankers, however, are businessmen, government controlled businessmen, but still profit driven. They are conservative, cautious, and frightened by the mortgage crisis. They do not want to be taken over by the government. So they aren’t lending right now. Haven’t been for maybe a year or more.

You can see the problem of a lack of credit available in many of the business failures and the coming wave of commercial real estate foreclosures. Further, the Fed is trying to keep them from loaning out the money by giving the banks interest payments for the money in their reserves. I don’t really understand the reasoning here. Why did they give them the reserves only to pay interest on them to keep the banks from using it. Doesn’t make sense to me.

What the banks are really waiting for is the rebuilding of their capital structures (and for the banks forced to take government money, they are waiting until they can also pay that money back). Once their capital structures are in place, they will look for very secure, “safe” opportunities to loan money. We are not likely to see any asset bubbles soon. (Some say that the recent, rapid rise in the gold price is a bubble, but that is only true if it were financed by Fed created credit, for which I have seen no evidence.)

The Fed says that it will be able to soak up the excess reserves before it becomes a problem. Ha! Who can believe them. They will not own up to creating the last two asset bubbles (for starters). They won’t own up to what inflation really is. They are self-deluding. They think low interest rates are vital to a growing economy. They will also be pressured to keep interest rates low to support Obama’s spending plans. They will also want to keep interest rates low to keep the interest payments on the national debt from swamping the budget. The way they keep interest rates low is by creating bank credit. Increased bank credit is inflation. There is no way that the Fed is going to manage this mess without real inflation that will reach consumer prices. You can’t fault the hyper-inflation bugs. Any serious look at the situation has got to make you frightened!

So, what is going to happen. Here is where I find a limb to go out on.

Things are going to drift for a while. It may seem like the economy is going to recover, and it will in important ways. This is one problem with some of those who are expecting the worst, they do not give the American economy any credit. The American economy has a lot of strength and productive capability which is trying to dig its way out of the mess the government created. It is cutting costs where it can and looking for ways to become more productive, to carry the new burden placed upon it, just as it has done for years. Businesses are beginning to show profits, real ones. Unemployment seems to have reached its peak. I don’t think that the credit situation has worked its way out of its problems and that could cause a problem. If the Fed comes running in with more made up money, we could go back into recession. Things are touchy.

The banks are continuing to recover and build their reserves. The banks are, I think, the weak link, because in spite of their business orientation, they are creatures of the government. They have to be, with all the regulations and interference from the government. Some people complain that the regulators and the banks have become too buddy-buddy. The critics don’t understand that everyone in that community understands who is in control. It isn’t the bankers. So when the banks recover, they will try to do as their masters want, and open the credit window. It will start slowly at first, but over time, probably not a long time, the bankers will be back to lending profusely. Then it will be Katy bar the door, because the money, created money, will flow.

Sometime within the next two to five years we will be seeing significant price rises. This is my expectation now. I don’t feel as if I am being overly pessimistic, just as reasonable as I can be.

In a wider perspective of preparedness, I also think that oil prices will still have some upwards pressure. Commodity oil prices have gone up to the $70 range in spite of the worldwide recession. If the recovery is beginning why wouldn’t there be more demand for gas and other oil products? The supply has not grown in any significant way. Also, it was noticed this week that China is now buying more cars than the U.S. Isn’t that a demand for oil? Oil futures are showing higher prices.

I would say that we have some time to make some preparation, if you haven’t already. Don’t go overboard. You want to consider gold and dollar protection, as well as where profits might lurk, both short and long-term.

So, there is lots to consider in making your own plans. Just don’t expect the end of civilization, not based upon today’s information.

On the other hand, who knows what Obama’s supporters will do when it is obvious that his efforts are to no avail? They could riot and destroy everything in their path. They are the next storm troopers, just waiting for their opportunities. See, it is easy to expect the end of civilization!

More on inflation as I actually have something to add.
I have comments on gold, the dollar, and the Fed’s actions coming.


  1. Why do you say there is plenty of demand for loans? I think the people I know have shifted to wanting to pay off debts, not to take on new debts.

  2. What I said was, "Right now the banks have unlimited opportunity to make loans." This was, I see now, not written well, almost, I would say now, badly.

    The thrust of your comment is correct, there is a great demand for loans. Certainly not amoung qualified borrowers. I saw a few days ago that consumer credit had declined (this is written mid-January, 2010).

    What I was trying to say is that with the member bank reserves at the Fed bloated with made-up money, if the banks wanted to make loans, they could do all they wanted to. Fortunately, for several reasons, they aren't.