Caroline Baum is asking, “Is Inflation Coming Back or Just Filling a Void?”
“All of a sudden, inflation is back.
“At least that’s what one would be led to believe based on a resurgence of inflation articles, if not the re-emergence of That ’70s Scourge itself.
“It seems that global growth is turning up the heat on prices. Remember those billion Chinese and Indian workers being inducted into the industrial labor force, offering their services cheaply to any and all bidders? That excess capacity is now gone, based on what I read.
“How about the forces of globalization, working to keep costs and prices down? A one-time event.
“And what about the adoption of inflation targets by central banks around the world, more committed than ever to price stability? Central banks by and large are currently engaged in raising benchmark interest rates.
“Sorry, that doesn’t fit today’s storyline either.
“Wednesday’s report on U.S. productivity and costs just added fuel to already glowing embers. In a quarter when real gross domestic product barely budged — the economy grew 0.6% in the first quarter of 2007 — output per hour worked slowed to 1%, half the previous quarter’s pace. Unit labor costs, or the cost of producing one unit of output, rose 1.8%, a little less than the average for the last decade.
“Which makes you wonder what all the Sturm und Drang was about…
“When I read articles about labor costs pushing up prices, it feels as if I’m living in a time warp. Labor unions have reduced bargaining power when corporations can shut a manufacturing plant and shift production overseas. And unionized workers have come to realize that their interests are increasingly aligned with management: If the company goes belly-up, a prospective pay raise is a moot point.
“Still, the idea that wages drive prices and inflation is something that never dies.
“‘This kind of thinking is deeply ingrained at the Fed,’ [economist Jim] Glassman says. ‘It’s as if wage gains are carved in stone. That may have been true long ago. It’s not true now. There are more price takers.’…
“All the hoopla over inflation is happening at a time when various inflation measures have rolled over. The core consumer price index, which excludes food and energy, rose 2.3% in the year ended in April, down from a 2.9% peak in September. The Fed’s preferred measure, the core personal consumption expenditures price index, rose 2% in the past 12 months, the smallest increase in more than a year, bringing the gauge into the top of the Fed’s comfort zone.
“That’s clearly no comfort to the folks unloading stocks and bonds. Inflation may lag the business cycle, but they see a new cycle dawning. The U.S. slowdown is over, capital goods orders and manufacturing are picking up, and exports are benefiting from strong overseas demand. Inflation is sure to follow.
“Don’t uncork the champagne just yet.
“‘It’s hard to get a U-turn in the economy without a corresponding rise in consumer demand,’ [economist Joe] Carson says. ‘And consumer spending is showing incremental weakness.'”
Hold the Champagne
Thanks, Caroline! When it comes to prices, I happen to agree with her overall theme, which I take to be “don’t uncork the [inflation-is-coming] champagne just yet.”
Before we can say whether inflation is coming or going or ever left in the first place (and before I get blasted with hate mail, like she did), we must first agree on what inflation is. Of course, this gets into religious arguments, and some prefer to leave the bruise marks from such debates to others.
I have taken up the cause (and I have the bruises to prove it). So have many others. But even among those taking up the cause, there are violent disagreements about the endgame. No, I am not going to rehash where we are headed. I have stated the case for deflation dozens of times, and I am not going to repeat it.
Instead, let’s focus specifically on what inflation is.
Gary North’s Position
Gary North is writing about “Ben Bernanke’s Post-Horse Barn Door-Locking Strategy for Real Estate”:
“Ben Bernanke’s June 5, 2007, speech on the real estate market was an exercise in futility.
“He did not refer to the obvious: his predecessor’s monetary policy, which created a real estate bubble. Instead, he promised new regulatory measures, which are, in fact, the old measures, which failed to prevent the bubble.
“He admitted that the present economic slowdown was heavily dependent on the fall in the real estate market: about one percentage point…
“‘As expected, we have also seen a gradual ebbing of core inflation, although its level remains somewhat elevated…However, although core inflation seems likely to moderate gradually over time, the risks to this forecast remain to the upside. In particular, the continuing high rate of resource utilization suggests that the level of final demand may still be high relative to the underlying productive capacity of the economy.’
“But what is causing this price inflation? He did not say. That’s because price inflation is a monetary phenomenon, and the Fed controls the monetary base.”
There you have it: Two people who could not possibly disagree more about the final outcome (Mish and Gary North) are at least in agreement about the problem (presuming I can throw in the expansion of credit into Gary North’s statement about the monetary base). Gary, are you with me on this? Even if not, let’s proceed.
Marc Faber’s Position
Inquiring minds might also want to consider “Marc Faber Shatters Prevailing Market Myths”:
“Q: How important is it to understand the role of the Federal Reserve to understand the world economy?
“A: I think it is very important to understand the fact that we have a central banking system where the central banks can indicate, theoretically drop dollar bills from helicopters. You won’t be able to do that because all American helicopters are in Iraq. But they can print money, that is a fact, and they can flood the system with liquidity.
“Then you have to find a measurement of inflation. We measure inflation by rise in money supply. It would be wrong to think that the inflation is just consumer price increases. Inflation is a loss of purchasing power of your currency, dollar, or rupee. It can manifest itself by rise in consumer price, but it can also manifest itself by a loss of purchasing power of money against real estate, or against stocks and real estate.
“Q: What is the public enemy No. 1 in your book, would it be inflation or deflation?
“A: In my book public enemy No. 1 are the central banks. I think the world will be much better off under a gold standard. Other than that, I think the asset inflation is much more dangerous than consumer price inflation because asset inflation is driven by a huge credit bubble.”
Paul Kasriel – Economist, The Northern Trust
“Mish: Does that mean you believe that inflation is a monetary phenomenon related to increases in money supply and credit, as opposed to rising prices?
“Kasriel: Yes, and that is exactly why Greenspan was so lucky. Inflation was masked by the factors we just mentioned…
“Mish: How does inflation start and end?
“Kasriel: Inflation starts with expansion of money and credit. Inflation ends when the central bank is no longer able or willing to extend credit and/or when consumers and businesses are no longer willing to borrow because further expansion and/or speculation no longer makes any economic sense.”
Gary H. Stern, President of the Federal Reserve Bank of Minneapolis — 1995
“One of the few topics about which most macroeconomists agree is that inflation is first and foremost a monetary phenomenon. It results from a long-term pattern of money creation which is excessive relative to the economy’s ability to produce real goods and services. Further, there is widespread agreement that the supply of money is determined by the central bank in the long run.”
Dr. Willem F. Duisenberg, President of the European Central Bank — 1998
“Ultimately, inflation is a monetary phenomenon.”
Otmar Issing, ECB
“Given that inflation is ultimately a monetary phenomenon, monetary aggregates are a natural first choice as a ‘nominal anchor’ and guidepost for monetary policy.”
“The long-run connection between money and price developments is among the most robust economic relationships. ‘Inflation is always and everywhere a monetary phenomenon.’ This statement by the late Nobel laureate Milton Friedman has never lost its validity.”
My own thoughts on what it is can be found in “Inflation: What the Heck Is it?”
On the basis of the agreed-upon definition from those listed above (that inflation is an expansion of money and credit), one can look at M3 and clearly see that inflation is soaring. (I have never said otherwise and my deflation outlook is about endgame expectations.)
Although the cork of the credit bubble bottle popped long ago, that magic bottle of credit supply seems endless. It’s not endless, of course (but as promised, I am not going down that path in this post).
As for right now, Caroline Baum makes the case that price inflation is decelerating. One can believe that or not, but regardless, the Fed is amazingly disingenuous to be harping about inflation just as its own measures show that its preferred measure of inflation is heading south. That is a major thesis of her article, and few seem to have caught it.
Interestingly enough, it was not that long ago when it was widely understood that inflation was about money as opposed to prices. Those who believe inflation is about monetary policy now happen to be in the minority. What happened to the definition? Was the change happenstance, or constant, purposeful chipping away at the truth?
Please consider “The Origin and Evolution of the Word Inflation” by Michael Bryan, assistant vice president of the Federal Reserve Bank of Cleveland, 1997:
“For many years, the word inflation was not a statement about prices but a condition of paper money — a specific description of a monetary policy. Today, inflation is synonymous with a rise in prices, and its connection to money is often overlooked.
“Consider the opening quotations, taken from Federal Reserve Bulletins spanning a period of almost 60 years. The first defines inflation as a condition of the currency, while the latter makes no reference to money. Indeed, it would seem that in 1978, inflation was about many things other than excessive money growth…
“What was once a word that described a monetary cause now describes a price outcome. This shift in meaning has complicated the position of anti-inflation advocates…
“‘Even if we agree that an inflationary situation is to be taken to imply something about prices, precise definitions vary…Part of the difficulty here is that definitions of the more popular variety such as “too much money chasing too few goods,” not only purport to define inflation, but also imply something more about particular inflationary processes.’ –R. J. Ball (1964)…
“Keynes spoke about different ‘types’ of inflation, including income, profit, commodity, and capital inflation. Today, little distinction is made between a price increase and inflation, and we commonly hear reports of energy inflation, medical care inflation, and even wage inflation. Some go so far as to argue that the monetary definition forces the word to take on too specific a meaning…
“‘”That’s a great deal to make one word mean,” Alice said in a thoughtful tone. “When I make a word do a lot of work like that,” said Humpty Dumpty, “I always pay it extra.”‘ – Lewis Carroll (1872), Through the Looking Glass…
“An anti-inflation strategy is concerned with a particular type of price increase — a rise in the general price level stemming from excessive money creation. When viewed in this light — the light provided by the word’s original meaning — a zero-inflation objective for the central bank becomes a much more sensible goal.”
Note: That is a very interesting article that I suggest everyone read in its entirety. I found it thanks to Matt Ford on Minyanville, who penned an excellent article called “The Semantics of Inflation”:
“It is both interesting and ironic that Bryan’s (1997) study of the word ‘inflation’ was sponsored by the Federal Reserve Bank of Cleveland. There is perhaps no entity more motivated to deflect attention from a money supply-based definition of inflation than a central bank. Bryan himself noted:
“As a condition of the money stock, an inflating currency has but one origin — the central bank — and one solution, a less expansive money growth rate (1997: 1).
“Indeed, if Federal Reserve or other government officials set out to purposely reframe inflation as to deflect attention away from the Fed’s connection to money supply growth; it’s hard to argue that such a plan has been anything other than brilliantly executed. Today, we find a dollar whose supply (as measured by M3b and other metrics) is dramatically increasing and produced by fiat, exploding debt and deficits, and a currency that has lost more than 95% of its purchasing power since the Fed’s origin. Yet, despite these consequences, the Fed is largely perceived as a vital institutional element of the U.S. financial system.
“While the price-based definition of inflation dominates the popular mindset, viewing inflation as an increase in money and credit supply provides valuable perspective (see Rampant Inflation by Professor Succo) on the health of economies and markets.”
Conclusion: The meaning of inflation has evolved significantly over the past 100-plus years, but the original meaning is the proper one. But it is in the interest of the bubble-blowing Fed and the government that people not understand what inflation is. That way, they can always give some BS answer as to what they are doing and why, and that also helps explain the change in the meaning of the word in the first place.
If you think Bryan’s article challenges that conclusion, think again. For proof, carefully read the last paragraph in the article. Bryan changes the original meaning of inflation and talks of zero-inflation as a target but only in the context of “a rise in the general price level stemming from excessive money creation.”
I have pointed out many times that it is virtually impossible to know why prices are rising or falling (e.g., Is oil rising because of Peak Oil or the inflationary policies at the Fed? Are food prices rising because of idiotic governmental policies on ethanol from corn or from inflationary policies at the Fed?). Furthermore, the current fixation on prices allows the Fed to blow asset bubble after asset bubble, given that asset prices are not included in the mix of prices monitored.
Whether or not anyone objects, the Fed has set itself up to be the sole arbiter as to why prices are rising or falling. This lets the Fed do what it wants when it wants (as long as the market will cut it slack). That is a BIG reliance on the market, and will ultimately be the Fed’s undoing.
With nearly everyone fooled about what inflation really is (by the way…add Ron Paul to the list of those NOT fooled), the Fed can and does talk complete nonsense about capacity utilization, jobs, trade deficits, oil, productivity, inflation expectations, etc., and comes to any conclusion that it wants.
Ironically enough, the Fed never talks about the expansion of money and credit, runaway borrowing to fund IPOs, debt-financed share buybacks, the war deficit, or the fact that government is spending far more money than it takes in year in and year out. In other words, the Fed talks about anything and everything but inflation (and this is on purpose)!
The current sad state of affairs can be condensed down to the fact that the Fed sets U.S. monetary policy but never mentions credit or money supply itself. Nonetheless, if you read between the lines, reckless expansion of credit has to be what has the Fed spooked, because as Caroline Baum points out, none of the other story lines seem to fit.
Mike Shedlock ~ “Mish”