More Invisible Signs of Looming U.S. Inflation!

Summary:  The inflationista’s are (again) hysterically sounding alarms about looming US inflation.  Or even hyperinflation.  Let’s review the data.  Can we see serious inflation?  No.  These fears are to a large extent fanned for political purposes.  Left and Right both see that Americans are most easily headed by fear, like sheep.  The more graphic, even outlandish, the greater the effect.

Before we start, some important notes about this complex subject:

  • No known metric reliably forecasts future inflation; data must be evaluated with respect to the overall context of macroeconomic conditions. 
  • Inflation is a monetary phenomenon.  Rising raw material prices is not inflation.  Also, raw materials are only a small fraction of end prices. 
  • Wages are a large fraction of end prices, and they’re flat. 
  • The combination of rising sector prices, flat wages, and tight money is deflationary.   Without wage growth, rising food and energy consume more of people’s budgets, expenditures on other things must drop.  Which looks like America today.  For more see this post and this post.
  • Inflation is rising in the emerging world, becoming a serious problem.  That’s natural, as they’re growing rapidly (we should have such problems).  This divergence between the developed and emerging nations could force the long-expected decoupling, and a new world order.  For more see this post.

Some indicators of inflation

  1. Monetary measures
  2. The Fed’s printing money!
  3. Money multiplier and velocity
  4. Watch the dollar drop in value!
  5. Energy Prices
  6. Direct measures of inflation
  7. For more information

(1)  Monetary measures

In 1976 Milton Friedman was awarded the Nobel Prize for ”for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy”.  Most importantly this, from The Counter-Revolution in Monetary Theory (1970):

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. … A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.

Friedman’s insight laid the foundation for modern analysis of inflation.  It’s widely ignored in laypeople’s analysis of inflation, of the sort now flooding the media.  Let’s look at some measures of the money supply.  First, a reminder of some vital details:

  • The supply of money is a broad concept; it’s not like counting apples.  There is no one right way to measure it.  Like the blind men examining an elephant, we must see it from different perspectives.
  • Experts construct alternative versions of these measures to produce new perspectives.
  • Private home-cooked versions abound of these measures.  IMO most are worthless.
  • There are good reasons to worry about future inflation.  And future deflation.  That’s one difficult aspect of our situation.
  • As Friedman explains, the money supply must increase as the economy grows, despite the oft-hysterical warnings that the money supply has increased to a new high.  Over time growth of the money supply should be proportionate to the economy’s rate of growth (in the real world this is a lumpy process).  Compare changes in the money supply to that of US GDP:  nominal (current-dollar) GDP up 3.8% in 2010 (not as relevant is that real GDP grew 2.9%, per the BLS).  
  • These variables vary.  Noise.  Only the longer-term moves have meaning (at least, meaning that we can understand).
  • Put the numbers in context; compare them to US GDP in 2010 of $15 trillion per year, and global GDP of roughly $62 trillion/year.

(a)  The adjusted monetary base

The adjusted monetary base is the monetary measure over which the Fed has the most control.  Down 0.3% in 2010; up 37.5% during the last 3 months.  Seasonally adjusted, annualized rate.  Very slow last year; rapid recently.


(b)  The narrow money supply, aka Money of Zero Maturity (MZM)

Money of Zero Maturity (MZM) is up 1.9% in 2010; up 1.9% during the last 3 months.  Seasonally adjusted, annualized rate.  Far slower than nominal GDP.


(c)  M2

The M2 is up 3.3% in 2010, roughly the same as nominal GDP.  Up 4.4% during the past 3 months (ditto, per most forecasts).  Seasonally adjusted, annualized rate. 


(2)  The Fed’s printing money!

We’re told that the Fed’s wildly printing money, causing inflation throughout the $62 trillion global economy.  As shown in this graph showing the result, a gentle rise in the size of the Fed’s balance sheet.  A few hundred billion — at that rate the Fed will have flooded the world with dollars in a few years.

This expansion of the Fed balance sheet may have had (and be having) large effects on US domestic financial markets.   As for the effect on world markets, the relevant measure to watch is the aggregate (total) action of the major central banks.  Including the big one, the People’s Bank of China.


(2)  Money multiplier and velocity

Monetary velocity and the money multiplier are facilitators of inflation, although explaining them is beyond the scope of this already too-long post.  They’re not rising, let alone at an accelerating rate.  They appear to be slowly rolling over, which would suggest deflation (data from the Fed).  These might be the most important metrics to watch!

The first graph is biweekly through 9 February; the second is quarterly through Q4 of 2010.



(4)  Watch the dollar drop in value!

A falling currency can cause inflation.  We are often told that the US dollar is declining so fast it will soon be trash.  As shown in this graph, showing the value of the US dollar vs. that of other nation’s currencies – weighted by US trade with each nation.  Note the index is set for March 1973 equals 100. 

  • After almost 3 decades of decline the broad USD index is down aprox 2%.  And down arpox 2% since December 2009.  RUN for the HILLS!
  • The USD is down in terms of the major currencies, or rather what were major currencies (and now far less major). 
  • Like inflation, this is a potential danger.  There are good reasons to worry that the US dollar might decline or even collapse in value.  On the other hand, a large decline in the USD might (painfully) cure our persistent trade balance — making US goods and services more competitive on world markets.  However that’s not the ideal medicine.


(5)  Energy Prices

We are told that energy prices are skyrocketing!  Three problems with this inflationary story.

  • The price of crude oil (West Texas Intermediate oil) is aprox $92.  Where it was in October 2007.  Up aprox 10% from December 2009.  And down from its spike high of $140+ in Summer 2008.
  • Petroleum provides 35% of US primary energy (see this EIA graphic).  Natural gas provides 23%, and its price of aprox $4 is down from its 2003-2009 range of $5 – $9.  And far below its spike peaks of $12-16.



(6)  Direct measures of inflation

Like most macroeconomic measures, inflation cannot be counted like apples.  It’s largely conceptual, involving choices and assumptions.  The Urban Consumer Price Index is a well-designed metric, implemented by grossly underfunded experts.  We get the economic data we pay for, which is one of the great laws of economics.


The above graph shows annualized monthly changes in the CPI.  Here’s year-over-year changes, more akin to what we experience.  It’s not what most people feel, however.  Humans are not mentally equipped to sense these tiny changes in economic variables, any more than we can sense a 2% change in room temperature if it happens over several houses.


Another factor shaping people’s perception of inflation:  loud voices constantly blaring announcements of inflation RISING FAST.  From experience with the now-closed comments section of the FM website, I can testify that no amount of data quenches the inflationistas belief of imminent hyperinflation.  The seize on any evidence, however bogus, to demonstrate that it’s under the bed and about to pounce.

A recent example is the data from MIT’s Billion Price Project.  It’s a bold and brilliant concept, perhaps of great long-term value.  But today we buy only a narrow range of goods via the Internet, and hence this does not provide an alternative measure of consumer prices.  We do buy many goods on the Internet, and so far the BPP Index does track the CPI good-only index.  See Paul Krugman’s article for details.

(7)  For More information

Posts about both inflation and deflation

  1. Consequences of a long, deep recession – part I, 18 June 2008
  2. Inflation or Deflation? Nobody knows what path will we take., 21 July 2009
  3. Important things to know about QE2 (forewarned is forearmed), 21 October 2010
  4. A bad, likely, and seldom mentioned scenario for the US during the next few years, 8 February 2011

Posts about deflation

  1. The geopolitics of inflation, an introduction, 17 June 2008
  2. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  3. A situation report about the global economy, as the flames break thru the firewalls, 26 January 2009
  4. Economic theory as a guiding light for government action in this crisis, 10 March 2009
  5. Fetters of the mind blind us so that we cannot see a solution to this crisis, 1 April 2009
  6. A lesson from the Weimar Republic about balancing the budget, 10 February 2010
  7. All about deflation, the quiet killer of modern economies, 19 July 2010

Posts about inflation:

  1. Is the US Government deliberately underestimating inflation?, 8 November 2007
  2. A giant breaks his chains and again walks the earth: inflation, 10 June 2008
  3. The geopolitics of inflation, an introduction, 17 June 2008
  4. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008
  5. Beginning of the end of the Republic’s solvency. Soon come the first steps to a reformed regime – or a new regime., 14 August 2009
  6. The falling US dollar – bane or boon?, 14 October 2009
  7. A lesson from the Weimar Republic about balancing the budget, 10 February 2010
  8. Would a default by the US government help America?, 21 February 2010
  9. Can Obama turn America into something like Zimbabwe?, 22 February 2010
  10. The Fed is not wildly printing money, as yet no hyperinflation, we’re not becoming Zimbabwe, 2 March 2010
  11. We might default on our governments’ debt in the future. Do you know how often we’ve done so in the past?, 5 March 2010
  12. Why the U.S. cannot inflate its way out of debt, 15 March 2010
  13. Can Obama turn America into something like Zimbabwe?, 22 March 2010
  14. We can try to inflate away the government’s debt, but we’ll go broke before succeeding, 16 April 2010
  15. Inflation is coming! Inflation is coming!, 7 February 2011

Originally published at Fabius Maximus and reproduced here with permission.