Inflation Update: Mid 2011

The U.S. Bureau of Labor Statistics just released its monthly announcement of the CPI (Consumer Price Index). The index showed some modest growth in consumer prices, .03% over the previous month. These numbers did not meet expectations, but the differences are small. Then there is the “core” and the broader index. The core is supposedly more important because it represents consumer goods that are less susceptible to short-term market swings, and thus are more dependable as indictors of the direction of prices. Maybe. It is obvious that there is a lot of manipulation of the data that the Statistics Department uses for the CPI. If that manipulation is for political reasons, as many suspect, or not, the consequence is that the index tends to be far removed from what residents experience on a daily basis.

More importantly, so what? What both the average economist today and most hyperinflationists tend to think is that if prices are going up there is inflation. What it means for that average person, on the other hand, depends upon whether his own income is rising at least as rapidly as the price increases. If a person’s income is not increasing as rapidly, it means making some difficult choices and seeing a constant drop in living standards. It a person’s income is increasing as fast, it means that one isn’t any better off. It is only an illusion.

But inflation is not increasing consumer prices. Inflation is the expansion of the money supply by a government. The expansion of the money supply is a form of taxation, making our incomes and savings worth less, It also makes government debt easier to pay off and defrauds the lender. That is one of the reasons it is popular with governments.

Looking at the data available from the Fed, it appears that our two-year hiatus from the threat of increases in the money supply is coming to an end. First, business loans, after a dive, have begun increasing. We will have to keep a careful watch on this, but the seeds of destruction are beginning to take root. If the interest rates were something near a market level, an increase in business loans would be a good sign. With interest rates as low as they are, the new loans could be anything from meaningless to bad news. Again, we have to watch.

The money supply indicator that I watch, MZM, has also begun to climb upward again. This isn’t surprising since the Fed has been trying to get it going upward for a couple years now and it was bound to happen sooner or later.

I want to point out a couple things about that chart that are important. I want you to avoid the knee-jerk response that many will have that the sky will fall immediately. This is a thirty-year chart, ranging from $1T to $11T. The dollar increments are evenly spaced per $1T steps. The slope of the recent increases is closely in line with the slope on the chart from 1995 to the present. (Admittedly, it is a little difficult to tell how steep short-term changes are on this small chart. The actual data is available, but it is too soon for us to tell the actual trend. For the sake of this discussion, let’s go with the appearance.) An increase of, say, $100M dollars in the money supply in 1985 moves the slope up at the same rate as an increase of $100M today. But the base from which it increases is considerably higher today. A new $100M today has much less impact than it did in 1985. Today, such an increase wouldn’t be noticed. The rate of increase we see beginning in 1995 and running nearly continuously through today, with two brief recessionary periods, has resulted in modest amounts consumer price increases, relatively speaking (you will find that I have damned even small levels of continuous consumer price inflation elsewhere in my blog, but here we are making comparisons to hyperinflation). For the rise in the money supply to have the impact it did even ten years ago, it is going to have to be an increase of a larger amount and a steeper rate of climb on the chart. For it to cause hyperinflation, the increase in the money supply, as shown on the MZM chart, will have to be nearly straight up.

The Fed wants to see a rate of price inflation (what it mistakenly calls inflation) running around 2%. This is already a betrayal of the American population. Any inflation is a disaster for all savers and those on fixed incomes. For many years, the Fed policy was to be willing to accept inflation of between 1 and 2%. Now it wants 2%. In a couple years it will be 3 or 4%. Such is their level of intellectual honesty and responsibility. Anyway…

So the Fed wants 2% of price inflation. The money supply is moving up, business loans are moving up, the Federal deficit is moving up, and, although commodity prices have backed off a little, they are still very high. Employment is not improving. What makes the Fed think that when price increases hit a two percent annual rate they are going to do anything but continue to increase faster and faster. We don’t have to postulate hyperinflation (20% or more annually) to suggest that increasing prices aren’t going to become a prominent news item. The Fed is going to have to react and the only thing it can do is to raise interest rates and take money out of the system. It is going to have to work hard and fast on the money removal program because of the amazing overhang of Fed member reserves that are just sitting there. If (I mean, when) prices begin to increase faster than the Fed wants, its curative actions will take some time to have any impact, even by its standards of the last twenty years, because of the $1,4T in excess member reserves just sitting there. The Fed is going to show itself as unprepared, intellectually ignorant, and ineffective. It will not be pretty. They do have one amazing, strong, successful capability: they blame everyone besides themselves. Ultimately, as has happened every time things have not gone well in the last century, it will be capitalism that will be blamed.

As I have often suggested, continue to watch your own situation. Be prepared for higher prices (these increases will not occur evenly, but in certain segments of your budget), and try to not be exposed to rising interest rates, i.e., don’t own bonds, have long-term fixed debt obligations if you can.

I don’t see this disruption from the Fed’s difficulty with interest rates as necessarily a step toward an economic depression. Government figures may show a recession (in the real sense, we haven’t left recession, not with our high unemployment).

My list for depression triggers is the Federal debt (higher interest rates could bring that issue to a boil), the default of one or more of the Eurozone countries (that situation could make the residential real estate mortgage meltdown of 2008 look modest), or the disruptions and craziness of the implosion of the China real estate market (who knows what kind of rioting, mayhem, crackdowns, and blaming of capitalism that could happen in that country).

Since the end of 2008 and that meltdown, the U.S. economy has kind of been drifting, not recovering, not being obviously self-destructive. That period couldn’t last for long. Since the powers-that-be weren’t willing to let the economy heal, our only real choice for the future will be difficulties. The possibilities range from painful to the worst depression in history. To some extent what will happen is in our hands. Let’s see if we can turn things back toward reason, freedom, and prosperity.