Price Inflation: It’s Here


This article originally appeared in The Daily Capitalist.

In an interesting article in the Wall Street Journal’s “Numbers Guy” column, it was pointed out that maybe the government’s reporting of price inflation is skewed to favor the government. Shocking. He notes that the government keeps fiddling with its methodology:

According to one rogue economist, John Williams at Shadow Government Statistics, if we still calculated inflation the way we did when Jimmy Carter was president, the official inflation figures would look about as bad as they did when … Jimmy Carter was president. According to Mr. Williams’s calculations, if we counted inflation under the old system the official rate wouldn’t be 1.5%. It would be closer to 10%.

I follow Shadowstats for price inflation, though I rarely report it. He uses the same methodologies used by the BLS in 1980 and 1990, depending on which chart you select. According to Mr. Williams:

The SGS Alternative CPI-U measures are attempts at adjusting reported CPI-U inflation for the impact of methodological change of recent decades designed to move the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.

His latest numbers per the 1980 methodology:

Compare this to the latest official chart on CPI-U from the BLS and the GDP Price Index which the Fed follows:

This is an important topic because with an expanding money supply, one would expect to see price inflation, yet the official statistics reveal no substantial price increases. And that begs the question: Why not?

Austrian theory commentators, including me, have been saying: just wait and price inflation will happen. Yet it the official statistics were not revealing significant price increases. Austrians say that money expansion, either through the Fed (money base) or the banks (credit creation supported by the Fed) is inflation and that rising prices are an effect of inflation. This theory makes sense because, if the money supply were stable, then if prices rose in one sector of the economy it has to be because of greater demand for those goods relative to the supply. Accordingly, that would leave consumers with less money to spend on other goods, the prices of which would go down. Thus it is a factor of supply and demand for goods in a stable money supply system and not all prices rise, as it does during a price inflation.

On the other hand, assume that the money supply increases overnight by 20% (assume that magically everyone had 20% more dollars the next morning). There is no new wealth created, just more pieces of paper. If everyone goes to buy stuff  in the morning, they would bid for scarce resources and drive up all prices for goods, ultimately by 20%. It’s not magic; it’s simple math.

True inflation, an increase in the money supply, is occurring. This is no surprise to my readers. Here is the latest data on Austrian Money Supply from Michael Pollaro:

Mr. Pollaro states:

The U.S. money supply aggregates based on the Austrian definition of the money supply, what Austrians call the True Money Supply or TMS, continued their recent surge, in December posting an annualized rate of growth of 38.9% on narrow TMS1 and 24.6% on broad TMS2. That brought the annualized three-month rate of growth on TMS1 and TMS2 to 22.3% and 18.1%, respectively, 8.6 bps and 2.7 bps higher than those posted in the prior month. …

Turning to our longer-term twelve-month rate of change metrics – more indicative of the underlying trends – and focusing on our preferred TMS2 measure, we find that TMS2 saw another healthy increase, in December growing at an annualized rate of 9.9%.  Not only was this a tick up from November’s 9.8%, but we think close enough to 10% to mark December as the 23rd time in the last 24 months that TMS2 posted a twelve-month rate of growth in the double digits. For new readers of the Monetary Watch, the last time TMS2 saw this kind of string was during the run up to the now infamous housing boom turn credit implosion, a time during which TMS2 saw 36 consecutive months of double digit growth.

With QE2 underway there is no reason to doubt that this trend will continue.

That is why the ShadowStats data is intriguing. If we measure price inflation by historical methodologies, the rate would be over 8%. If you study the ShadowStats chart you can see that price inflation took off in 2009 about the same time as did QE1 (QE1 expanded dramatically in March 2009), then backed off with the decline in QE and now is moving up again after the announcement of QE2 in September, 2010. This conclusion could, of course, just be confirmation bias or a logical fallacy on my part (post hoc ergo propter hoc), but it does fit into the general Austrian monetary theory: we would expect to see this occur.

I believe we are just starting to see the beginning of price inflation. The data reveals that the main drivers of the CPI at this point are food and oil, and part of those increases are related to supply and demand issues. We all understand the role of OPEC in oil and how they can let short supply chain issues drive up the price of oil. That is occurring now. The same thing is occurring with food where disruptions in production in a short supply chain world (we are just discovering this issue with regard to food) can drive up food prices worldwide.

Supply and demand issues don’t account for all of these price increases, but there is no practical way to measure that versus money supply-driven price inflation. The only way to determine it is to look at money supply itself: if money supply expands, we should see other secondary effects besides price inflation.

We should see a rise in the stock market. Since QE goes directly into the pockets of the Fed’s primary dealers (the big banks and financial institutions on Wall Street), those companies do what they do best, which is to invest the new money into financial media. Such as the stock market. Since the supply of stocks hasn’t grown, it may be that this new money is chasing the stock market and driving it higher. For a discussion of this, please see this article.

We should see a modest increase in consumer spending. While consumer spending as measured by retail sales has been modest (see this chart), I believe much of such spending is coming from upper income folks as a result of the wealth effect of the stock market boom. It isn’t coming from middle America since wage growth has been relatively flat, unemployment is still high, and the spending source from this sector has been from savings.

We should see a rather sluggish overall economy because monetary inflation causes the further destruction of real capital (i.e., savings derived from the actual production or services; not dollars from fiat money expansion). Monetary inflation distorts the business cycle, sends the wrong signals to business people, and they embark on projects that will ultimately amount to bad investments based on paper rather than wealth. Real capital is necessary for new economic expansion. Evidence of this lack of real capital is high unemployment, stagnant-to-modest growth, further liquidation of an oversupply of homes and commercial real estate from the last cycle, flat wage growth, lack of credit, and price inflation. All this is occurring now.

I believe this will drive our economy into stagflation: sluggish economic growth and price inflation.

The last time we had stagflation was in the Jimmy Carter/Arthur Burns era. The difference between monetary inflation now and, say the late 1970s and early 1980s as shown in the ShadowStats chart, is that bank credit isn’t expanding significantly now, but it was back then. The main source of monetary growth now is from quantitative easing, a rather poor inflationary tool versus fractional reserve bank credit expansion where you have a 10:1 advantage. The Fed is resorting to QE (direct injections of fiat money into the economy by the Fed) only because nothing else has worked for them. While QE does not have as great an impact as bank credit expansion, it does have some impact. It is not possible to inject $2.2 trillion of new money into the economy and not have an impact. Pollaro’s calculation of money supply reveals that is does. Even now we are seeing the Fed’s measure of M2 money supply expanding, finally.

Price inflation is here.

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