Inflation Update: First Quarter, 2012

I have been writing this since the turn of the year. It has been subdivided already several times. A couple parts have appeared as other posts and several pages are just sitting around in this file, orphaned! I have again divided it so that I can get something out and the length will not evoke cursing. This section is my inflation update. Maybe some of the rest will appear in the future.

I realized recently that my most “favorite” group that constantly announced the coming of hyperinflation has only made one such announcement in the last several months, and that one was somewhat less frantic than normal. (Recently, they have been touting stocks.) In their last prophascy of doom, they did touch on issues that are important, but since they have only one economic note, hyperinflation, they don’t consider other, equally nasty, potentials, of which there are several. But apparently, hyperinflation is not the immediate threat they have often claimed. They haven’t said why they have changed their tune.

Yet, there is plenty of good reasons to be concerned about inflation in the next few years. For the fun of it, let’s divide up the issue into two separate (but certainly related) questions:

If by inflation you are asking about the money supply and its impact on asset prices and the economy: just look at the stock market! There is plenty of made up money sitting around that comes out and bids up assets when given even a glimmer of hope. True, company profits are healthy. My question is about the source of those profits. Is it just savings from leaner operations, or is it return on growing business. I fear that it is the former, which means little for future economic improvement. What reasons do we have to suggest that businesses are investing in the anticipation of growth?

There is new, made-up money floating around, for example, our balance of payments for last year was again a large deficit, perhaps smaller that in 2007, but still large. That means that a lot of electronic dollars left the country, billions of them ($110B in the third quarter, 2011; $124.7B in the second quarter, 2011), and didn’t return, won’t return (for those dollars to come back other currencies would have to be better than the dollar, and that isn’t happening). At the same time, notice that our money supply did not shrink by hundreds of billions. Think about this. We sent over $400B dollars out of the country last year, and didn’t notice it. Where did it come from? (Hint: International trade is done entirely on credit!)

The money supply within the country, in the broad measure that I use, MZM, shows the resumption in the upward trend continuing. The graph available, and widely used, is hard to read and the current trend is still only a few of months old. So what it means is unclear. What appears to be the situation at this point is that the increase is on the same growth line as before the meltdown. But since the base is larger, the growth will have less impact. Think of the difference it means to you to have a $10,000 raise when your income was $30,000 vs. $200,000. So, an additional $100B means more when the money supply was $1T in the 80s vs. today’s nearly $11T. The rate of growth in the money supply would need to be a lot steeper to be really important. The growth we see isn’t good, mind you, just not frightening.

Another important measure of the money supply is new loans made by banks. This is the method by which the Fed puts money into the economy. The Fed has been trying to push new made-up money into the economy since 2007 with little success. Recently, however, loans are beginning to increase again. Just new loans would not be an issue. After all, business needs credit, and amount would fluctuate over time. Further, with the deep recession, the amount of loans would have declined. A healthy economy would need credit to grow. If that new credit reflected new savings we would be seeing real growth soon. Of course, it doesn’t. Savings is being sucked into the Federal deficit. So, the growth of bank loans tends to indicate new made-up money being pumped into the economy, which could lead to another round of asset price inflation. The recent upward trend of new bank loans is worrisome, and needs to be watched. Again, the graph is too small to give good detail, but the slant of the upward movement isn’t too steep.

We are still sitting on a time bomb. If you look at the reserves (deposits) of banks who are members of the Federal Reserve (nearly all banks), you see that the amount of reserves they have is amazingly high. This is the Bernanke plan. Notice the last big jump to about $1.8T. That was QE2. That is to say that much of the massive amounts of money that Bernanke and his gang pushed into the economy is actually just still sitting at the Fed. It really didn’t do much except keep interest rates at stupidly low levels. It did help push commodity prices up, which is another type of asset boom. Does anyone believe that the interest rates actually reflect any element of the real economy? Low interest rates have not sparked new investment. They have merely given an unearned bonus to holders of federal debt and kept BO thinking that his deficits don’t really cost anything.

The time bomb will be the consequence when banks begin to think that they should move those reserves to their banks and expand their loan portfolios. Then we have a real inflation as the money supply explodes (once put into the economy, under current rules, each dollar moved from the reserve could become ten, or the $1.8T of excess reserves could become an additional $18T (our current money supply using MZM is almost $11T). The Fed actually knows that is a bad thing. When they first expanded the reserves with QE1 in 2008, there was a lot of talk about what they would do to sop up the excess reserves, which were then about $1T. That talk has completely disappeared as the economy failed to improve. But the problem remains and has gotten bigger. If the economy begins to grow the Fed will have to do something. Any action the Fed takes to sop up that money will raise interest rates, perhaps dramatically, and that would put a lid on the economy. That would also send interest rates up around the world and make things in Europe much worse. So ignored everywhere right now is this time bomb that will go off if the economy does begin to grow.

If you are thinking of prices as an indication of your cost of living (quality of products is often forgotten), the news is mixed. For example, the costs of health care and health care insurance is going to continue to skyrocket, especially if the quality of care is considered. (This increase in cost is only partly due to ObamaCare. Wait until that really begins to kick in!) Government interference in healthcare has never lowered cost or improved care. It has only made people feel like they were getting something for nothing.

Gas prices have risen, and will remain at higher levels until various international issues have been resolved. The last few years the pressure on prices has been due to new demand from countries that actually were developing. The current problem is due to the threatened supply because of Iran’s level of irrationality, Iran being a major oil producer. Again, the West’s willingness to allow its technology and industriousness to be hijacked by local warlords and savages becomes the source of economic shocks.

(The problems with higher food commodity prices that we had a while ago have abated, mostly due to higher crop results, e.g., the end of the draught in Russia. There are countries that are still seeing lower supply and thus more expensive food supplies. Most of these countries have governments who are controlling the markets. I can’t help but wonder if their problems are due to their governments inability to continue to subsidize food distribution.)

Reports from some U.S. food processors report that they have had to raise their prices from between 5% and 7% in the last year. No doubt we will see some upward movement in prices and no upward movement is good. Even price inflation rates of 2% are damaging. But there is no indication on the horizon that we are moving toward hyperinflation.

I just read another of Peter Schiff’s monologues. Among other things, he claims that price inflation is running at 10% (He just said inflation, but I assume he meant prices, in his writing he often switches back and forth.). He and others have constantly asserted that the CPI has been politically corrupted and that actual prices increases have run much higher. I do think that the CPI has been manipulated in many ways, and a lot of it was politically motivated, at least implicitly. But I have a problem with rates of price increases much higher than a few percent. Why? Let’s say that prices were going up at the rate of 7% a year, which is in the ballpark of many such claims. That would mean that prices today would be double what they were ten years ago (rule of 72, see below). Is that your experience? It isn’t mine. Some have argued with some justification that the quality level in many products has improved at the same or nearly the same price and that lots of technology prices have dropped. As I suggest in my review and comments of his books, I think Schiff often shoots from the hip, which I don’t find admirable. He has been right on some important things, but I’m not sure that it was because of good insight or just accident.

I did say that the situation is mixed, didn’t I. What I meant is that the news is that mixed in with the reports that prices are generally drifting upward are some reports of some really bad spots. In December, I would have said that foodstuff commodities prices had dropped, but the thinking that loosening of credit in China and Europe was going to stimulate demand has run them back up a little.

As I see it, the problem that could most affect us immediately is a financial crisis brought about by the European governments. The finance ministers in Europe are saying that they aren’t sure that this bailout will succeed. The Greeks have shown that they fail to live up to their promises, and curse others when that is pointed out. The other tottering European economies are very dependent upon low interest rates and the availability of massive amounts of made-up money. Remember, the euro zone’s long-term plan is a “fire wall” of several hundred billion euros. Where is that money going to come from?

So, my expectations for the next year or so is that our economy will continue to totter along. If unemployment moves up, or people become to understand the figures that are before them, we could see a big pull back in equities and consumption slow. That would lead to QE3 and more of a mess.

Prices will continue to inch up. Commodities will continue to have upward pressure. Basically, we will have more of the same.

There are two other considerations to watch for: The implimentation of the new rules for banks and derivatives and the actions that BO might take in anticipation of the election latter this year. Neither of these will be good for us and will be inflationary.

Having said that I should also say how reliable I regard my expectations. (Do you notice that nearly all of today’s prognosticators never look at how they did in the past?) Reliability of economic predictions is dependent upon two separate issues: One – how reality oriented is the analysis; Two – lack of omniscience. There is also one other point to keep in mind, good economic events require rationality, at least to some extent, and productivity. As good economic events are in short supply, for obvious reasons, the question is then how far off on the down side are my comments. I noted the areas that I thought that we could have major problems. There could be problems coming that I, or anyone, has not noticed. The most recent example, aside from people missing what is under their noses (the residential real mortgage meltdown), is 9/11. Another major terrorist strike could upset everything, and we would have a hard time recovering, too. So, I have tried to cover the economic bases that I can spot. But there could be others. Just keep on your toes.



P.S. I just read an article about investments in Turkish companies by venture capitalists, Now I don’t know how true the article was, although it did make Turkey sound like a much better place than I would have imagined. What I thought was so amazing about the article was that it didn’t mention the Turkish government or nationalized companies once! (Except to imply that the government wasn’t an issue!)