Learning to Live with Inflation

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Today, we turn to our war correspondents for dispatches from the front lines, and we find an important insight:

“Learn to live with inflation,” begins the headline in the Financial Times.

The FT refers to England’s central banker, Mervyn King, who says inflation – already running hotter than at any time in 10 years – is going to heat up even more.

In America, the news is not so different. “Globalized Inflation,” is a headline in the Wall Street Journal , finally catching on. Input prices are running up at nearly twice the rate of the official CPI figure. Prices for goods imported from overseas are rising nearly four times as fast.

In Argentina, meanwhile, the inflation rate is officially more than 8%…unofficially, it is probably twice that high.

And across the Rio Plata, Horacio Pozzo reports on “Brazil and Inflation: the struggle continues.” Inflation in Brazil has just registered its biggest monthly gain in 12 years.

It looks like inflation is winning, in other words.

It looks like Ben Bernanke may be “regretting” his rate cuts, says former UK chancellor, under Maggie Thatcher, Nigel Lawson. Bernanke panicked in the face of the credit crunch and cut the key rate from 3.25% down to 2%. Deflation was the greater enemy, he believed. The Europeans saw it differently. The ECB held its rate at 4%…and now says it may raise them. It’s beginning to look like the Europeans were right.

On every front the news is the same – prices are rising more steeply than they were a year ago. Oil rose to $136 yesterday. Gold, sniffing the fear of rising consumer prices, rose $6 to $893.

Oil has been leading the charge for inflation. And T. Boone Pickens says it not only has the high ground…it’ll go higher. He says global oil production has peaked out at 85 million barrels/day while demand is running about 86.4 million barrels. The price will rise more, he believes, until demand for oil falls to equal the available production.

Of course, Pickens is “talking his book.” He’s heavily invested in oil and may want you to be too. But he could be right.

Inflation is gaining ground. Defensive positions are giving way…the forces of price stability (to say nothing of deflation) seem to be falling back. So far, the retreat is mostly orderly. But orderly retreats are hard to pull off. The retreating general is no longer master of the field. He takes what he can get. And what he gets, often, is a rout – when his troops panic. That’s when the casualties really mount up.

We are talking here of a different kind of war. It is a weird conflict…with some remarkable features. For one thing, even though inflation is clearly winning…the U.S. Fed is still fighting deflation, not inflation. The Fed’s key lending rate – at 2% – is barely half the official U.S. consumer price inflation level, last reported at 4.2%. But that 4.2% requires a torture chamber of number crunchers who twist and stretch every figure. “Seasonal adjustments,” they call them. “Hedonic pricing,” they add. As to the former, the seasons never seem to change. Bad raw numbers always seem to get better. As to the second, it is more a matter for metaphysicians than for economists. A computer may cost $1,000 one year. Next year, the statisticians may put the price down to $500 – even though a customer would still have to pay $1,000 in the retail shops. Why? Because ‘it’s a better computer,’ say the water-boarders. If they think it is twice as good, they imagine that the price has been cut in half.

We are not here to quarrel with the thumb-breakers. We are here at The Daily Reckoning headquarters for enlightenment. We read the news headlines. We study the figures. We pore over the opinions, ideas, crackpot theories, and hare-brained formulas. We get down our knees too…and spend hours in drunken meditation, calling on the gods for inspiration…or luck.

And where does it get us?

We’re never quite sure.

“Discovering…discovering…we will never cease discovering…
and the end of all our discovering will be
to return to the place where we began
and to know it for the first time.”
-T.S. Eliot

Back to the war:

The problem with this conflict is that it ranges over too broad a territory. A monetary policy that might be suited for one area is completely wrong for another. As the WSJ noticed, inflation is globalized now.

But USA Today finally noticed something too. “How rising home values and easy credit put your finances at risk,” was a headline in yesterday’s paper. The trouble was – Americans were given too much credit. Now, their backs ache and their legs buckle under the burden of it. True to his claptrap economic theories, Ben Bernanke is trying to fight a downturn in the only way he knows how – by giving them more. Not only that, but as we pointed out yesterday, they’ve built a life for themselves that is at odds with modern economic reality. T. Boone Pickens may be right and he may be wrong. But even if he’s wrong, he’s probably not too wrong. The days of cheap oil are over. And the days of living in big houses far from job centers, and driving big cars to get work, are probably numbered too. The best thing Americans could do is to adapt to the new situation, as quickly as possible. Which is what they’re doing. They’re driving fewer miles. Many are taking a “stay-cation” this summer, where they leave the family car parked in the driveway. And Ford had to put the brakes on an SUV plant, closing it down for nine weeks because of weak sales.

Bernanke is fighting the last war, not this one. He should have asked us first. You can’t reflate a bubble. You can only blow up another bubble. Bubble money moves fast…from one opportunity to the next. It doesn’t have any loyalty. It carries no passport. It says no pledge of allegiance and wears no flag on its lapel – not in today’s world. So, when the Bank of Ben Bernanke fights a slump, with more and more credit, what happens? The money gets on a plane and goes into the NEXT bubble, not the last. And the next bubble is not in U.S. assets. It’s in commodities, food, fuel…art…and gold.

It is also in emerging markets.

Ah yes, dear reader, the globalization street goes both ways. For 15 years, emerging markets helped hold down prices in the developed world. But now, the American consumer looks for the next truckload of cheap imports from Asia, and gets run over by a tanker truck carrying $4-a-gallon gasoline.

The Fed puts out more money and credit…which is spent on oil and other imports. The money ends up stimulating, not the economy of the United States of America, but the economies of the exporters. The Fed, in other words, is providing a monetary policy for China…for Russia…and for the Gulf States. Unfortunately, it’s the very policy they don’t need.

Why?

Because their economies are already burning white hot. Prices are rising fast. Emerging markets, at purchasing power parity, are now providing 70% of the world’s growth. No wonder they’re gobbling up the planet’s resources. And they’re piling up profits. They need to cool off…not heat up. When the dollars arrive in, say, China, the Chinese have to buy them up – creating more of their own currencies to buy them with. They end up with enormous piles of foreign currencies – mostly dollars. A chart of foreign exchange reserves shows them more than tripling since 2001.

While the U.S. lowers reserve requirements to try to heat up its own economy, China raises them. The yuan has gone up 11% against the dollar this year; still, the economy is growing at a breakneck speed. Other nations face similar problems – inflation, out-of-control speculation, and growth. They are raising rates and talking about breaking the link with the dollar – letting their currencies rise to offset the flood of greenbacks and dampen demand for their own exports.

Meanwhile, the Bernanke monetary policy turns out to be just the wrong thing for the U.S.A. too. The Fed pumps out a flood of liquidity…but that money no longer raises up the US economy and US asset prices. Instead, it raises prices all over the world. And now, thanks to globalized markets, U.S. consumers must pay world prices for their corn…and their cars…and their oil…and everything else. And those prices are going up.

Nominal commodity prices are nearing a 35- year high. The oil price has already reached an all-time high in both nominal and real terms. Inflation forecasts have practically doubled for the entire world – just in the last 12 months.

Thus is the weird world getting weirder. America faces a slump…with prices still going up. It is like the stagflation of the ’70s…but worse. Back then, Americans had only a third the debt they have now…and back then, the Fed could still bring inflation to heel, by raising rates and suppressing U.S. demand. Now, even if the fellow next door stops using so much oil, there are 20 fellows on the other side of the globe who will still use more. Could it stop inflation now? We don’t know, but our bet is that there will be a lot of casualties before we find out.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

Latest posts by Bill Bonner (see all)

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Comments

  1. Yes, and what about the hypocrisy of the yanks. Through the week there was news that the US Congress and/or Senate were convening a star chamber to root out some supposed rats’ nest of nasty speculators pumping up the price of oil. No mention from them of their delinquent US Fed’s role in inflating commodity prices by slashing their cash rate last year and allowing the dollar to fall to junk levels. Bloody incredible bare-faced hypocrisy.

    Reply
  2. You’re O.K. Bonner or as I would have said as a kid, you’re a bonza bloke.
    I too had a ‘different’ kind of youth – in the city, in the bush, here, there, no shepherd, no rudder. BUT, I loved to read and had a very curious mind. Took a while, but I think I was smart at sixty and I’m still going strong. I like your history. Suffice to say, we live modestly, have successful kids and we’re not sweating the coming inflation and downturn. I like beans and rice!
    Thanks for the free newsletter, it’s a great feed.

    Reply
  3. Folks like Bill Bonner and others do not get what is inflation and deflation. Falsely, they believe theres’ a “battle” raging between them — as if they are alive. Worse and wrongly, they believe, that inflation means the rise in a general price level, deflation the opposite.

    Inflation is a deliberate process launched by a Central Bank.

    Whenever any Central Bank cheapens the Price of Money their legal tender decreed monopoly money, that Central Bank attempts to inflate the Efficiency of Money.

    The goal of inflation is to increase the Efficiency of Money with the goal to cause Economic Expansion.

    The Efficiency of Money can happen only when New Credit Growth for Output Swapped rises faster than the amount of Notes and Coins (money in circulation). Output Swapped consists of things of goods wanted (inventory that sells).

    When inflation does not work as intended, new Credit Opportunties do not appear. Folks with piles of Money in Circulation bid up prices on future claims to resources for future manufacturing, future farming.

    On Working Inflation
    ================

    The rate of growth of New Commerical Capital in ratio to the money base (notes and coins) is the True Inflation Rate. Thus, the True Inflation Rate measures the Efficiency of Money.

    Should inflation work, more New Issues of Preferred Stock, Commerical Paper and other investment instruments arise to attract Money.

    Should inflation work, more folks gain goods and jobs as manufacturers, farmers, miners hire workers.

    Should inflation work, across-the-board prices should not rise.

    On Prices
    =======
    All swaps must have one commodity exchanged for another. When one thing gets calculated in terms of another, we call this a ratio. The result of the ratio, we call it a value. When we use money as one of the commodities in the swap, we give another name to the word value — PRICE.

    A rise in price means a change in the ratio has happened calculated at one time from being calculated at another time.

    Only two ways can achieve a price rise:

    [1] money bid and taken (bought) is rising quicker than the thing offered and given (sold)
    [2] the amount of the thing offered and given (sold) is falling quicker than the amount of money bid and taken (bought)

    On Inflation and Prices
    =======================
    Most folks will tell their false beliefs about inflation like this:

    “Inflation is a rise in all prices.”

    or

    “Inflation is a rise in the General Price Level.”

    Since there’s no such thing as a monolithic “one-price” consumer price for all goods, it’s impossible for consumer price inflation to be a true concept, a true belief about existence. In short, believing in a Keynsian Price Level is akin to believing in Tooth Fairies and Hobgobblins.

    On Inflation and Money Supply
    =======================
    Other folks will tell their false beliefs about inflation like this:

    “Inflation is a net increase in money supply”

    or

    “Inflation is a net increase in money supply and credit.”

    Folks never stop and then start to think about the phrase “money supply.”

    Buyers and sellers act and swap Commodities, one for the other.

    Money is a commodity. It’s the thing you trade for another thing, say oil for money and thus money for oil.

    Where you find offers of money (supply), you find calls for money (demand). What gets swapped (sold) is money down now (notes and coins in circulation) for a promise to pay more money through time. We name this future money with any of these — Capital, Credit, Debt.

    On Economic Growth, Credit, Capital and Gambling
    ================================================

    Good Commerical Credit built the world folks. When the focus of credit becomes Consumer Credit or Speculative Credit (margin money), moneyquakes follow.

    The Many confuse gambling (secondary market speculation that hopes for price appreciation, e.g., 401k “buy and holders”) with investment (cash rented for return; aka capital in primary markets).

    Speculating men corrupt capital. Gambling men pervert capital. Only Investors and Shopkeepers grow wealth and prosperity.

    Smack MacDougal
    June 25, 2008
    Reply
  4. Congrats Smack, you missed the sarcasim and humour of the Daily Reckoning. Like a drunken teenager fumbling with his first conquest of the opposite sex. Of course they dont beleive inflation and deflation are alive, you burke. Its been how the Reckoning has been written for years, makes it not such a bore to read, like your rant, I certainly wouldnt subsrice to listen or read what you have to say…..snore….
    You do have some points though…

    Reply
  5. Thank you Smack for helping me relive my Macroeconomics 101 nightmares.

    If memory, and intuition, serves me correctly then a few things don’t quite add up:

    1. “Whenever any Central Bank cheapens the Price of Money their legal tender decreed monopoly money, that Central Bank attempts to inflate the Efficiency of Money…The goal of inflation is to increase the Efficiency of Money with the goal to cause Economic Expansion. ”

    To paraphase: CB releases more paper money, in addition to existing circulation, than the aggregate increase in the value of goods & services produced, whose worth is delineated by the token representativeness of money as its proxy. Objective = stimulate growth.

    2. “When inflation does not work as intended, new Credit Opportunties do not appear. Folks with piles of Money in Circulation bid up prices on future claims to resources for future manufacturing, future farming.”

    Paraphase: when the accretion in money supply outstrips real productivity increments then everything becomes that extra bit worthless since money’s usefulness goes only as far as the bearer’s ability to exercise its purchasing power.

    3. “The Efficiency of Money can happen only when New Credit Growth for Output Swapped rises faster than the amount of Notes and Coins (money in circulation). Output Swapped consists of things of goods wanted (inventory that sells).”

    This is where it gets nonsensical. The above (quote 3) implies that EoM is evoked only if the value of additional real goods/services produced exceeds the nominal supply of CB issued tender. Money that’s in isolation and out of context is irrelevant. You even mentioned in your statement (quote 2) that dysfunctional inflation, ie. flawed monetary policy, will cause moneybags to bid up prices (and vice versa for spiralling deflation). Yet, your starting contention (quote 1) clearly indicates that “cheapening” the price of monopoly tender, ie. inflating money supply, is the precursor to EoM expansion and economic growth. To me that’s the equivalent of proposing that inflation drives growth (because it generates new credit) and yet it also impedes growth (since selling 55 movie tickets for a 50 seat theatre doesn’t help anyone).

    “The rate of growth of New Commerical Capital in ratio to the money base (notes and coins) is the True Inflation Rate. Thus, the True Inflation Rate measures the Efficiency of Money…Should inflation work, across-the-board prices should not rise.”

    This purports that static prices denote a ‘True Inflation’ rate of zero. In an expanding economy where real wealth is created, zero TI means proportionate increases between the supply of credit and the additional of incremental goods/services. Securitization, ie. engineering new investment issues, soaks up the subsequent liquidity. Again, somewhat of a contradiction to your initial statement (quote 1).

    I agree with your take on the carelessly loose flaunting of the ‘inflation’ terminology. Inflation is an erosion of purchasing power – whether caused by goods/services dropping off the face of the earth or otherwise the exuberant friskiness of a central bank printing press gone haywire.

    Furthermore, I understand the surrealism of assigning a generic index to measure comsumer prices. However, in the absence of a better alternative, the best measure we have of economic inter-activity and price equilibration is the one based on a basket of (mis) representative goods which (poorly) approximates the underlying supply-demand interaction.

    “Where you find offers of money (supply), you find calls for money (demand). What gets swapped (sold) is money down now (notes and coins in circulation) for a promise to pay more money through time.”

    Lets assume that we live in a world where the underlying base (currency) of exchange is ‘back scratches’. If you scratch my back 10 times at T=0 and I promise to scratch you (your back that is) 12 times at T=1 then that’s a creation of 2 back scratches in a single period with the result being a token (money) supply of 12 back scratches at T=1. A nominal interest rate of 20%pa.

    Let’s also assume that the only commodity traded in this economy is ‘foot massages’. If at T=0 there are 5 foot massages available each costing 2 back scratches then, assuming constant foot massage supply, that same foot massage at T=1 should cost 12/5= 2.4 back scratches – inflationary. For your TI to hold, foot massage supply must increase by 1 from 5 to 6 in order to hold prices at 2 back scratches per foot massage. Therefore inflation IS a net increase in money supply – only that the increase in legal tender surpasses the supply and availability of the counter commodity.

    Speculative credit – agree with you all the way on this issue. Unless everyone turns into Jesus tomorrow, the only way to quarantine this cancerous behaviour is to excise derivatives trading for starters. Otherwise, market turbulence stays and retirement pension goes.

    All in all, your comments cleared up some misconceptions.

    Reply
  6. Tom, Always, joy comes when helping another.

    Always, too, parroting and preaching the Dogma of Macroeconomics 101 from Academia never leads another to truth.

    You write:

    “… “cheapening” the price of monopoly tender, ie. inflating money supply, is the precursor to EoM expansion and economic growth.”

    “inflate the money supply”

    “Inflation is an erosion of purchasing power – whether caused by goods/services dropping off the face of the earth or otherwise the exuberant friskiness of a central bank printing press gone haywire”

    Here’s where you get off track immediately. You hold two concepts for Inflation.

    In these, you express belief that inflation is a cause when central banks “print money” and inflation is an effect when “goods disappear”

    On Money
    ========

    Folks never stop and then start to think about the phrase “money supply.”

    Buyers and sellers act and swap Commodities, one for the other.

    Money is a commodity. It’s the thing you trade for another thing, say money for wheat.

    Man must depend on the graces of nature to deliver wheat, even with his science of farming, while he can wily print as much money as he thinks he can scam others with until credit relationships break down.

    Where you find offers of money (supply), you find calls for money (demand). What gets swapped (sold) is money down now for a promise to pay more money through time.

    Said another way, notes and coins that you can spend now get swapped for the right to collect more notes and coins in any future.

    What becomes key, is that NEW money down now cannot arise unless attached to some claim on money of a future.

    Folks only take on new money now when they know they must pay it back in any future. Folks only give up new money down now when they know that they have the right to claim that money back in the future.

    On Money and Capital
    ====================

    When Money Men swap money for right to collect more notes and coins in any future, money buys capital. Capital comes from cash rented (money down now) put to use for manufacturing, mining or farming.

    Capital is not a thing that you have that you invest. There is only money, a commodity, which can be swapped for rights to other commodities — wheat, corn, gold, shirts, pants, brake pads, future money. When men swap now money for rights to future money, we call those rights — CAPITAL.

    The man who buys capital, buys a right to claim either a stream of payment — a bond — or the payoff of a bet — expected dividend. Capital comes from cash rented used for manufacturing, farming or mining.

    The Cash Rentee who sells his rights to future income (Capital) gets cash down now sold to him from the Now Money Seller. Next, the Cash Rentee buys resources — workers and their labor capital, metals, fuel.

    Money is the highest form of Credit and Credit is another word for Debt. Credit and Debt are other names for Capital.

    On Central Banking
    ==================
    A Central Bank holds a Monopoly Charter for the manufacture and distribution of the Commodity of Money.

    Since money is the common way by which men engage in Economics (the science of exchange of one enforceable right for another), any change to the Price of Money (the value of the ratio of money down now spent to buy money in a designated future), changes all relationships between the Commodity Money and all other commodities.

    On Inflation
    ============

    Central Bankers launch Inflation when wanting to increase internal trade (Home Economy) through these: increased number of opened contracts, increased rate of cash payment for transaction settlement.

    A wanted increase in Commercial Credit relative to Money is the wanted EFFECT of inflation.

    Under Central Bank systems, Central Bankers cheapen the price of money hoping that existing money migrates to credit and not to futures betting.

    Central Bankers seek to expand Capital Opportunties (inflate) through cash renting for manufacturing and production (mining, farming) purposes.

    Inflation Fallacies
    ===================
    Most folks will tell their false beliefs about inflation like this:

    “Inflation is a net increase in money supply”

    or

    “Inflation is a net increase in money supply and credit. Deflation is the opposite.”

    or

    “Inflation is a rise in all prices.”

    or

    “Inflation is a rise in the General Price Level.”

    On Academia Fantasy
    ===================
    Tom, you want to prove your beliefs about economics using a hypothetical never-could-happen world two goods world — typical of academia theorizing.

    You write:
    [1] “Lets assume that we live in a world where the underlying base (currency) of exchange is ‘back scratches’.”

    [2] Let’s also assume that the only commodity traded in this economy is ‘foot massages’

    Academians love to play with two goods and two players. These models never reflect truth.

    Always, sticking to what are the rules of the actual game — central banking, money market, money for goods markets — keeps us clear of academic foolery.

    Smack MacDougal
    June 26, 2008
    Reply
  7. Hi Smack,

    I think you may have misunderstood. The statement regarding…

    “Whenever any Central Bank cheapens the Price of Money their legal tender decreed monopoly money, that Central Bank attempts to inflate the Efficiency of Money.

    The goal of inflation is to increase the Efficiency of Money with the goal to cause Economic Expansion.”

    …was extracted from your original comment. I pointed out in my argument that this proposition was a contradiction of another comment further down…

    “When inflation does not work as intended, new Credit Opportunties do not appear. Folks with piles of Money in Circulation bid up prices on future claims to resources for future manufacturing, future farming.”

    …and…

    “Should inflation work, across-the-board prices should not rise.”

    This is an obvious flaw in reasoning because diluting the representativeness of paper money (inflation) will increase notional prices because real output fails to keep pace with government issues of legal tender. Yet, you were also inclined to mention, and using the term rather loosely, that “inflation”, employed to enhance Efficiency of Money, is to promote economic growth. The dilemma is uncanny. This is a notoriously vague assertion because an increase in real inflation will certainly harm the economy through unsustainable nominal growth and the subsequent pains of a correction – the magnitude of which is implied by the extent of “hot air” blown into the veins of the economy. If you were referring to nominal inflation, then that would result in equal dubiety since nominal, or perceived, inflation is useless, pointless and completely incontextual as an isolated measure.

    As for goods dropping off the face of the earth, that was just rhetoric though it appears that the analogy may have been unsuccessful. Goods don’t disappear, obviously, just the same as rational people of sane mentality do not wilfully tear up the money in their wallets. This was meant to demonstrate that the erosion of purchasing power, which money serves as proxy, is derived from fiscal irresponsibility where CB increases money in circulation to a greater extent than the increase in goods produced and services rendered.

    Reply
  8. Tom, anyone can make the claim you make “flaw in reasoning”.

    Your contradictory false beliefs about inflation causes all of your problems in thought.

    You write:

    “inflate the money supply”

    “Inflation is an erosion of purchasing power – whether caused by goods/services dropping off the face of the earth or otherwise the exuberant friskiness of a central bank printing press gone haywire”

    In these, you express belief that inflation is a cause when central banks “print money” and inflation is an effect when “goods disappear”

    Inflation is process undertaken deliberately, willfully by central bankers who seek to increase the Efficiency of Money.

    The Money Supply is the sum of money offered for sale, Money Demand is the sum of offers to buy Money now with promises to pay with future money.

    When a clearing price gets decided, money gets sold. It’s Money in Circulation supporting Commerical Credit Growth or Decline that counts, not Money Supply alone.

    Money Supply is only one half of the puzzle. You must account for the Money Demand and the Price of Money set by decree since a single player has the Monopoly Charter for the Manufacture and Distribution of money.

    Until you grasp the basics of money, money in circulation, you cannot grasp any other concept in Modern Economics.

    Good luck Tom.

    Smack MacDougal
    June 27, 2008
    Reply

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