Why Inflation is in America's Future

Miscellaneous Current Events
1

The ‘green shoots’ of economic growth are apparently sprouting–the Obamanomics flowers are blooming, the sky is clearing, and all will be right with the world. Revered liberal economist Paul Krugman says the recession will be over by September. The worst is over, all is right with the world. Right?

Wrong.

What is happening right now will likely be the subject of some of my future academic work. It is, after all, the symptoms of future inflation.

We’re a few months into a huge stimulus package in which billions of dollars were created by the Fed and banks through the process of credit expansion.

Because this stimulus followed a massive deflationary deleveraging of banks after the collapse of the real estate securities market, it is not necessarily inflationary in the popular sense, IE causing a rise in the general price level. However, a creation of new and additional currency is always inflationary in the sense that it causes prices to be higher than they would otherwise be. After the economic collapse, prices should have fallen. The fact that, instead, they have risen slightly shows that inflationary pressures have already exerted themselves.

But what we will see soon is a rising general price level, perhaps a quickly-rising, high-rising price level. I know this because of a few key signs which surely mean that new money is having its way with our prices.

First, corporate earnings are up, which is fueling a bull market.

This is something that always happens when new money is introduced into the money supply. Because corporate earnings are equal to monetary sales revenues minus costs, it makes sense that new money will cause increased monetary demand for goods and services as it is spent. Because the costs which are initially subtracted from these new, higher sales revenues are reflective of the old money supply, the corporate earnings numbers therefore appear to be higher.

Second, a prediction I made earlier this month has come true:
“NEW YORK (AP) – Oil prices are surging this month on fresh evidence
the U.S. economy is pulling itself out of recession.
A barrel of crude has jumped roughly $10 in four weeks…crude has
moved steadily higher even as the amount of oil placed into storage
grows, appearing to defy traditional rules of supply and demand.[emphasis mine]”

I would contend that the real price of oil is not rising in spite of the ‘traditional rules of supply and demand.’ What is rising is the nominal price, and this is a key indicator of inflationary pressures. Since nearly every price on the market has as a component the price of oil, the price of oil is one of the first prices to demonstrate an inflationary rise.

Third, the unemployment numbers which have been so vaunted lately still show a loss of about a quarter-million jobs, even after thousands of autoworkers were called back from lay-offs in response to increased, government created, unsustainable demand for new vehicles due to the CARS program.

Although there are literally millions of forces all working concurrently in such a complex machine as our economy, I believe that there are sure signs of a coming and dramatic rise in the price level.

Inflation is not necessarily a bad thing for those of us who see it coming, as we can hedge against it and not lose out because of it. But in this case it is especially and uniquely dangerous because the populist outcry which accompanies a high inflation rate will lead the current adminstration to implement wage-price controls. Price controls are one of the two ways to implement pure socialism, they lead to de facto government control of private property and socialism in the German sense, which is more commonly known as fascism. (see the work of George Reisman on this at www.capitalism.net for more on this).

If there comes a day when our government announces the implementation of price controls, in the name of ‘fairness’ or of ‘watching out for the little guy,’ it might be time to get out the travel brochures and the passport and consider a new home. If you must stay, then be sure to stockpile as many goods as you can, because it seems to me that America’s price controls will likely be, at least at first, without teeth, and black market operations may for a while be the norm.

But perhaps I am just being overly optimistic.

2

That seems like a good observation with the AP article, do you have a link to the full text?

3

I still have a Russian passport and my parents own some property in Moscow, but I doubt would be a better place in the world-wide economic meltdown. They don’t even allow private firearms ownership :frowning:

4

So you’re going to write about how printing money causes inflation? I think that’s been done before.

5

I’m not sure. I am thinking about moving back to Spain, despite their 20% unemployment. It depends on what inflation will be in two or so years.

6

The inflation has already been created with 25 years of below market interest rates. The recent deleveraging (bust) is just a result of it. As will be the next bubbles and busts. Of course with the helicopter Fed running wild we should see a speeding up of the booms and busts.

7

In Soviet Russia, hell goes to you! [:P]

8

No, I’m planning to work more in the direction of accurately forecasting changes in the price level,and differentiating normal, market-driven changes in prices from inflation-driven changes. It’s qualitiatively known that printing money causes inflation, I’d like to accurately quantify it, someday.

9

But isn’t Spain basically socialist? At least in the US, when (many) people hear the word “government”, they put on their skeptic hat. I don’t know if things will be so bad that it’s worth leaving over, especially if you’ve taken steps to shield yourself from inflation.

Think of it this way- even with all our debt and big government idiocy, we’re still better off than Europe and Japan were after WWII. At least we have some remaining infrastructure for a real economy. And we also still have a damn good head start in productivity/capital vs much of the world. A major improvement (not perfect) may be as simple as swapping a political party out for one like the Libertarian, assuming they don’t morph into the Republican party too quickly. One or two generations of shrinking government would probably work wonders, IMO.

10

Disband the federal government with all its institutions and everything is going to work out. 99% of our problems are from it: taxes, regulations, wars, Federal Reserve, to name a few. Some of the states can be crazy (such as California), but they’re not even close. The Founding fathers made a big mistake when they pushed for stronger federal government with the Constitution instead of sticking to the Articles of Confederation.

11

One of the speakers during the Cato seminar two weeks ago was from France, and she said she had left France for the United States to escape Socialism. Now, she doesn’t know where to go next. It seems as if there are many who believe that the Obama administration will turn the United States into another “European” nation (~1% long-term growth). Not only because of increased government spending, but because of the reduction of tax havens and other tax programs the Obama administration is planning to implement.

Spain is socialist, but life is generally cheaper. Also, I could take advantage of Socialist laws and go to graduate school for cheaper.

Well, Spain is different from many European countries, because post-WWII Spain was a very poor State. It was under the Franco administration that the economy went through what is called a “miracle”. He basically liberalized the market. Under the economic freedom index, or whatever it’s called, I remember seeing that Spain was actually marginally economically freer under Franco than it was after his death. In any case, Spain’s economic socialism is not as bad as France’s or Germany’s. For example, generally speaking, Spain has smaller taxes on top incomes (which is why a lot of football players prefer to play and live in Spain).

12

There is no lag with monetary policy. There is no inflationary timebomb. Markets are forecasting low inflation.

“No, I’m planning to work more in the direction of accurately forecasting changes in the price level,and differentiating normal, market-driven changes in prices from inflation-driven changes. It’s qualitiatively known that printing money causes inflation, I’d like to accurately quantify it, someday.”

It’s called the TIPS spread. Its the best indicator of inflation we have. Also, printing money doesn’t cause inflation. Printig money in excess of the demand for it creates inflation.

13

There is a lag. Inflation, unlike what the monetarists believe, is not immediate nor is simultaneous. Jesús Huerta de Soto corrects this misconception in his book. The relevant section can be read here. Also:

I thought about this myself, but then there is always demand for money, so “in excess of demand” doesn’t make any sense. There is infinite demand for money, especially since inflation does not occur immediately. Jesús Huerta de Soto, and to an extent Hayek, and other Austrian economists argue that in a free market there would be deflation, or there would be an increase in capital, but not an increase in the money supply. So, to an extent printing money does create inflation, because it disallows deflation (it maintains the purchasing power of the unit of money).

14

I continue to scratch my head over what happens to some Austrians when it comes to money. I have a finite demand for food, I think you’ll agree. Now you claim that I have an infinite demand for money. So can you explain why I’m crazy enough to go and buy food, thereby giving up money?

When we talk about demand for money, what we mean is demand for holding money, which is not infinite. If it were, we wouldn’t spend any money. People can have different demands for holding money, expressible in terms of purchasing power - that is, in “happy” times I may hold one month’s expenses in cash, in times of great risk I may hold 6 month’s expenses. Under a free banking system, rather than reacting to political pressures, banks would react to economic pressures, and issue money (lower reserve percentages) when people want to hold more money, then print less when people want to hold less money. Like in all markets, the actions of the free market tend towards equilibrium. What if they overshoot and produce too much money? Any individual bank doing so faces the risk of runs and calls by its competition. If the banking system as a whole does so, consumers react by immediately turning in notes beyond their saving demand. This takes money out of the system.

15

Increasing the money supply automatically raises expectations of future nominal GDP growth. Almost all non-commodity prices are based on this expectation, meaning that an increase in the supply of money will automatically lead to an inrease in many prices. Commoditiy prices and wages will be affected with a lag. The TIPS spread, as well as standard long-term bonds, incorporates expected commodity price inflation.

Demand for money basically means two things: demand for bank deposits and demand for currency. An increase in the demand for money generally refers to an increase in the demand for checkable deposits. There is infinite demand for all goods; that’s what is meant by scarcity. Excess demand means a greater quantity demanded than the supply price will bear. This is true of money as it is for any other good.

Austrians like Selgin and White, working off Hayek, believe that a free banking system would match the supply of money with the demand for it. They accept the concept of demand for money as did Mises, who was one of the artichects of the idea. This is not a non-Austrian concept as the Rothbardians would have you believe.

16

Inflation is an increase in the supply of money. A potential consequence of inflation is a rise in prices; which of course never happens equally or simultaneously. The TIPS spread is a joke. The government bases “inflation” on the CPI index, which aside from having the completely wrong definition of inflation is a real laugh. “Oh gee, the price of beef is up, well, let’s take that out and put in chicken because people will just buy chicken of course. Let’s reweight this item, move this one,…” Nothing is constant in that index, it’s really laughable that anybody even pays attention to it anymore.

I will tell you why there will be drastic price increases due to a complete destruction of the US dollar:

  1. There is a ton of dollars being printed

  2. The dollar will be ousted as the reserve currency, whereupon the vast majority of dollars in circulation (most held abroad) will have to come back in the US to be spent - take a guess what happens next

  3. As the productive capacity of the US continues to fall through the floor ans the US has even less to offer to the world, people won’t have any real reason to hold US dollars and value them very highly if at all.

  4. The Fed will never tighten. The monetary authorities in the US like many other places only know how to inflate, that’s it. They will panic like they have already been doing and continue down the road to ruin. Does anybody really think that if the Fed tightens monetary policy and raises rates that when their precious GDP forecasts fall through the floor they won’t simply start up the expansionary policies again?

  5. Debt, unfunded liabilities, and the ignorance of the American populace (including the government of course). Simply put, with $12 trillion in national debt, $56 trillion in unfunded liabilities for Medicare/Social Security alone, and $99 trillion total unfunded liabilities (probably higher those are government numbers I believe) will never be financed through direct taxation. If taxes are raised to the point it would have a snowball’s chance in hell of paying this debt and liabilities, the economy would be crippled to the point that there would be no tax revenue. Great, so now that we understand that let’s move along. The US is fascist and has been so for a very long time although now it is in a transition to socialism. The American people voted for this, and the government knows no limits. The US apparently wants socialism, so now they will get it. The government will not shrink by the slightest amount possible. Therefore, in order to take on more debt, not raise taxes (maybe slightly but not anywhere enar enough to pay for all this), and increase spending, the only option for the government is to print the shortfall (which as pointed out us astronomical).

Don’t worry though, keep looking at the TIPS spread and relax.

17

You’re equivocating. The definition of inflation doesn’t matter; the concept is what matters. You haven’t countered my point. Why is the TIPS spread a joke? Because it doesn’t conform to your priors?

There is a lot of base money being created but banks aren’t lending it, meaning the supply of money hasn’t increased very much. Besides, what we care about is the interaction between the supply and the demand for money, not just the supply. There is no evidence that the dollar will be “ousted” as the reserve currency.

Your last point makes sense but I never denied it. In fact, that is perhaps the only possible source of hyperinflation and it’s a long way off.

How much are you willing to bet on your beliefs?

18

I agree the concept is what matters; but in order to have a sound concept, I think we first have to recognize that the shift from defining inflation as an increase in the supply of money to a rise in a price “level” (another fantasy) was nothing more than a means to assist in justifying credit expansion (see the 1920s). As far as the demand for money goes, of course it is a factor just like the supply of it. Using a point von Mises makes, the demand for money can’t be considered limited, but the demand for money for cash holding is of course limited. People hold money as a medium of exchange, to make future purchases. A point I made in my previous post was that there will most likely be a drop in demand for dollars simply because there will continue to be less and less that can be purchased with dollars. Every foreigner is going to want to cash in before the prices get bid up by his neighbors. This is precisely the only thing keeping Treasury yields from going through the roof; it’s a cat and mouse game. No large holders want to begin dumping their Treasuries because of fear that the USD will fall so hard and so fast they won’t be able to get anything for their money. Yet none of them want to be the one holding the bag. None of them want to buy more US government debt, but if they all out refuse to buy it at all the value of their holdings diminish. If you think this is viable and will go on forever, I guess there won’t be massive inflation. If you recognize the absurdity, you understand what will happen.

Keep in mind that more dollars are held abroad than domestic, and when the music stops and the panic ensues, they will all come flooding back in. Secondly, how long do you think banks are going to sit on this money? They are getting paid by the Fed at what, the effective Fed funds rate? What is that hovering around, 0.16%? The national average for a current one month CD is 0.54%. How much longer can the already undercapitalized banks continue to hemorrage money? We’ll find out. But once the problem I described above comes into being, and rates begin to go through the roof, you can rest assured that this will put even more pressure on banks to not simply sit on their dollars.

I told you why the TIPS spread is a joke, because it based on the CPI. If you can’t figure out why the CPI is a joke I don’t know what to tell you. There is plenty of evidence the dollar will be ousted as a reserve currency judging by what China, Russia, Brazil, etc. and others have been saying. China has even been planning out ways to stop conducting trade in dollars with some countries which will become a significant amount of transactions within the next decade. If you doubt that China and on a larger scale Asia will be (if they aren’t already) the economic pwoerhouse of the world, I’m curious as to where you think it will be. To quote Jim Rogers, nobody has ever said “I wanna go where all the debtors are, they want to go where the money is” (not an exact quote but close).

How much am I willing to bet? I will say this: a substantial portion of my investments are not in the US but rather in Asia (Singapore, Taiwan, Hong Kong) and other creditor nations. The small amount of investments I own in the US are in agriculture, but I own agricultural funds not located solely in the US as well. I also own precious metals such as gold and silver (much more silver than gold at the moment). Even if the US dollar were to somehow not plummet in the next 3-5 years or so, it sure won’t hurt to be where all the money is instead of where all the debt is.

Best regards,

Chris

19

The definition of inflation I used was an excess supply of money. The supply of money by itself is irrelevant without the context of the demand for it. My point is that the current supply of money is too low. What is your proposed alternative to the TIPs spread for estimating inflation?

Your entire analysis is based on the idea that the Fed can’t remove money from the system. I find this implausible. Lowering the supply of money to match a lower demand for it is not deflationary and so I don’t see why they wouldn’t do it. Actually, flooding the market with money during a recession and then removing it when the recession ends has been standard practice for central banks around the world for years. They just didn’t increase the money supply enough this time.

I agree with you that if the US was forced to monetize its debt, there would be hyperinflation. I doubt that will happen though. The government doesn’t have to pay unfunded liabilities. That’s why they are not on the budget. Maybe in 30 years there will be problems, but not during or because of this recession. Treasury bonds are still seen as a basically risk-less investment. I don’t know why you are so quick to question the market’s predictions.

Also, China may have a growth rate of 8%, but it won’t have the productive capacity of the US for many years. It has a per capita GDP of about $4000 while that of the US is around $30,000. Again, maybe your scenario will be relevant in about 30 years or so, depending on how things go.

20

Maybe because in the past couple of years much of the newly created money was brought into existence by buying up assets for prices well above what the market would have paid for them? Much of the Fed’s recent balance sheet expansion is buying up of MBS and other assets of questionable value. How are they going to sell them for the same prices they bought them at?

Seriously, with the quality of their balance sheet drastically reduced, what are they going to sell to mop up the excess M1? Their own bonds, like what has been hinted at? That just delays the day of reckoning a bit more (after all, they have to pay interest with more newly created money on such bonds). It’s long since turned into a game of smoke and mirrors.

What is really holding the dollar intact is the faith in it by foreign central banks. If and when that disappears, trillions of dollars will flood back into the US economy, and then what?