Wednesday, 16 July 2008

waiting in vain for deflation

The alarms bells are screaming; the warning lights are flashing red; US inflation is raging. Last month, the CPI inflation rate hit 5 percent.

In June alone the US CPI jumped up 1.1 percent. If it continues to grow at that rate, within12 months time, the US will have an inflation rate of 14 percent. Let it go at 1.1 percent a month for two years and prices will be up 30 percent. That is the miracle of compounding.

US inflation is now rising at the fastest rate in 26 years. Despite the growing inflationary disaster unfolding America, Bernanke and the Fed are waiting around for some providential deflation to suddenly appear.

Recently, the deflationary argument has rested on the belief that the credit crunch would lead to a slowdown in US monetary growth. In fact, US monetary aggregates are still growing extremely rapidly. For example, M2 is still rising at around 6 percent a year.

Another popular measure, MZM - which includes M2 less small-denomination time deposits plus institutional money - is rising at double digit rates.

Besides, when inflation was rising at more subdued rates, and house prices were the only thing growing at double digit rates, the Fed dismissed monetary growth data as irrelevant. The Fed even stopped publishing M3 data in March 2006, because it wanted to "de-emphasize it".

The simple fact is that ever since the Fed panicked over the health of the US financial system and began cutting rates, inflation has taken off. Interest rates are now negative in real terms. In the past, like for example, the 1970s, negative interest rates meant rapid inflation.

Monetary growth is important. With a lag of about 18 months, monetary growth numbers are rather good predictors of inflation. Despite the credit crunch, US monetary growth is still rising very rapidly. Unless the Fed reverses its insanely low policy rates, US inflation will accelerate.


vodka drinker said...

very interesting charts.

aSteve said...

If I were looking for deflation, I'd look outside the USA... perhaps Britain?

Anonymous said...

You're far too impatient. I could say "Waiting in vain for mass unemployment." - and be both right and wrong in the same way.

The last time I looked, M4 was ~25 times bigger than M0, so it would take a heroic expansion in currency to overtake even a small drop in debt.

What ratio the US MZM and M0 are is left as an exercise for the reader.

The price rises you see now, were baked into the system years ago. The price falls to come are also inevitable.

Not withstanding that, the prices for essentials will continue to rise. Supply and demand for food operates a little strangely anyway.

Anonymous said...

"Monetary growth is important. With a lag of about 18 months, monetary growth numbers are rather good predictors of inflation."

Well said. Too many central banks feign ignorance of the effects of rampant money supply growth, when the effects are quite obviously inflationary - hell even the definition of inflation ("inflation of the supply of money relative to the amount of goods and servcices") betrays them as charlatans.

Have you done a similar comparison for UK broad money supply growth, Alice? I think that would be interesting too.

Anonymous said...

I very much like and agree with your article, and agree with your take on inflation. The Fed's position on Interest Rates seems to be a very short term one, they will inevitably have to deal with inflation and all those people who are just clinging on with their mortgage payments will become the next casualties.

At that point the Fed have high inflation, high interest rates, huge debts from Franny and Freddy and falling tax receipts. It would be better to deal with inflation early, and have more tools available to go at the rest instead of what the Fed's done.

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