Thursday, 14 August 2008

US inflation accelerates

Why are people so confused about the relationship between money and prices. It really is quite simple; if a central bank prints lots money today, then 12-18 months down the line the economy will experience a rapid increase in prices.

The US Federal Reserve has been printing lots of money lately. Even allowing for all the dubious adjustments to their key measure of price stability - the CPI - those newly minted dollars will eventually show up in the data.

Well, today the CPI gave inflators at the Fed a slap in the face. US inflation is now at its highest level since 1991. It hit 5.3 percent. The monthly rate went up 0.8 percent; while the annualized inflation rate for the last three months is running at over 10 percent. Yes, we are one year into the credit crunch, which was supposed to reduce lending activity and bring inflation down, and during the last three months, the US is running a double digit inflation rate. So much for deflation.

If anyone thinks that things are suddenly going to turn around, just take a look at US policy rates. Currently, the Federal Funds rate is negative. We are not talking marginally negative; the Federal Funds rate is now about 350 basis points into negative territory.

Negative interest rates will pretty much guarantee rapidly rising prices. It will also distort savings and investment decisions, and if a Central bank persists with the policy long enough, growth will begin to slow. Negative interest rates are the defining feature of stagflation; zero growth, rising unemployment, declining living standards, contracting credit and accelerating prices.

This is exactly where the US is right now, and where the UK is about to go.


aSteve said...

The reason people are confused is exactly the same as the reason why there is a confusion about the value of assets.

"More money" (printing as you call it, lending as I insist) does not increase prices unless that money is used for consumption...

Suppose we have an economy where Widgets are assets - and A has a widget (and will need to sell it to meet debts) and B is owed money by A, but has no Widget and would prefer a widget to money. While widgets are profitable, the widget generates the earnings to pay A interest. B's bank balance increases as he saves to buy the widget from A, and A borrows from B to keep 'heads above water' and to pay interest to B. No additional money is available for A or B to "waste" on beer - as they're locked in this battle... so beer prices are stable. What is more, if A eventually decides to throw in the towel; sell-up and repay debts... and B buys, "money" is destroyed. It makes no difference if A owes B £1000 or £1m or £1bn... none of this money will influence the price of beer - unless bad debt is fraudulently presented as good debt.

The amount of money itself is only one variable... the other is velocity. The velocity of consumption money is far higher than investment money. The snag, however, is that it is impossible to clearly distinguish between the two.

Alice Cook said...

Velocity is stable asteve. In our current, anchorless monetary system, money begins as debt, bit it is also a means of exchange. It doesn't matter whether it takes the form of paper or an entry in an bank balance sheet, it chases a fixed about of goods. If there is more of it running around today than a year ago and the supply of goods hasn't increased, then prices will rise.


aSteve said...

Alice, I disagree.

The corollary to the velocity of money being stable is that the rate of transactions is stable.

If we look at mortgage approvals data, for example, this is clearly not the case for houses. I'd argue that this is not the case for all discretionary spending... Inflation for non-discretionary items will be greatly influenced by supply or demand - which will react, after lag.

Wesley said...

The US economy is a train wreck.