The Dollar or Toilet Paper… Which is Shrinking Faster?

In the middle of last month, before Bernanke’s dream of QE2 became a reality, he described that “inflation is running at rates that are too low.” By “too low,” he meant of course that inflation is too low to keep artificially propping up asset prices, like the major market indices which in his opinion ought to give the US economy a shiny veneer of growth despite little underlying improvement in production.

Given this intended outcome, quantitative easing is at best a gimmicky strategy. What makes it far more pernicious though, is the weak premise that inflation is actually too low. When you consider the methods he’s relying upon for measuring it, you get the impression he wouldn’t note so much as a mild inflation uptick for a hot air balloon lifting off of the ground… but, we’ll explain more about measuring inflation below.

First, assuming Bernanke will in fact be successful in sparking inflation, how will a rising-prices environment impact the average wage-earner? Gonzalo Lira takes a closer look:

“Even in the best of economic times, wages and salaries do not rise in lockstep with an expanding economy. And we are currently not in an expanding economy. It is reasonable to assume that, during a period of steadily rising prices coupled with stagnant economic growth, wages and salaries will not rise for at least six months, if not longer…

“Wages are key. If inflation hit consumer prices as well as wages in equal measure, the net effect would be zero—which is more or less what you see in ordinary expansion-driven inflation, the kind prevalent in healthy economies: There are price pressures on commodities, which eventually translate into higher prices at the supermarket—but there are also price pressures on wages, as the economy in toto is expanding, and therefore bidding up scarce labor as it grows. In an expanding economy, prices might be rising—but wages are rising too, so no complaints.

“However, in a stagnating or contracting environment—such as what we are experiencing now in the American economy—there are obviously no pressures on wages: If anything, there are downward pressures on wages and salaries. So if commodity prices rise, people—especially the poor, the working poor, and the middle-class, but maybe even the upper-middle class—are really going to take a hit, as more of their after-tax income goes to paying for basic necessities.

“Some people might think that the debasing of the dollar via QE2 will mean that the real cost of housing will fall, as rents and fixed mortgages will be undermined by inflation. They might think this is a good thing. But this only makes sense if your earnings are absolute: If you’re boss is paying you in gold coins, or silver ingots. But if you live on a dollar income, especially a fixed income—as so many seniors do, let alone the average wage earner—even if your housing costs remain nominally static, rising food, transportation and clothing prices will still take bigger and bigger bites out of that dollar-based income.”

So what’s problematic about measuring inflation? A vivid modern-day example can be seen in this infographic, which shows how even lowly toilet paper is shrinking in size right under our noses, so to speak. According to Gonzalo Lira, this subtle type of inflation, which occurs in stripped-down utility but not reduced prices, is not tracked by the CPI. As long as the same product is sold for the same price — despite markedly reduced customer value — prices are computed as holding level.

Domestically, Bernanke and the Fed are likely anticipating that shoppers won’t notice when they’re paying the same price for less merchandise every time the cashier rings them up. Internationally, the Fed’s employing a similar tactic, diminishing the dollar so US exports look less expensive abroad and so the US’ massive debt appears a little bit less so. The US isn’t the only nation adopting this “currency war” approach to global trade, but — given that the dollar is in many ways leading the major currencies in the devaluation race — let’s hope Bernanke doesn’t end up taking a few too many cues from toilet paper.

You can read more details in Gonzalo Lira’s post on how QE2 will have a boiling frog effect on the bottom 80 percent of the US population.

Best,

Rocky Vega,
The Daily Reckoning

The Daily Reckoning