Worldwide Inflation Is Hitting Home

Worldwide Inflation Is Hitting Home

March 21, 2011

DailyCapitalist.com - Whichever way you look at it, price inflation is climbing:

From the BLS:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5 percent in February on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.1 percent before seasonal adjustment. Though the seasonally adjusted increase in the all items index was broad-based, the energy index was once again the largest contributor. The gasoline index continued to rise, and the index for household energy turned up in February with all of its components posting increases. Food indexes also continued to rise in February, with sharp increases in the indexes for fresh vegetables and meats contributing to a 0.8 percent increase in the food at home index, the largest since July 2008.

The index for all items less food and energy rose in February as well [1.1% annualized]. Most of its major components posted increases, including the indexes for shelter, new vehicles, medical care, and airline fares. The apparel index was one of the few to decline. The 12-month changes in major indexes continue to trend upward. The all items index increased 2.1 percent for the 12 months ending February; the figure was 1.1 percent as recently as November. The 12-month increase in the index for all items less food and energy reached 1.1 percent in February after being as low as 0.6 percent in October. The 11.0 percent increase in the energy index is the largest since May 2010, while the 2.3 percent rise in the food index is the largest since May 2009.

This is not surprise to readers of The Daily Capitalist (“A Note on Inflation: It’s Here“). A recent article by Austrian theory economist Frank Shostak put it very succinctly:

Let us examine how prices in general could go up. The price of a good is the amount of dollars paid per unit of this good. So with all things being equal, an increase in the amount of dollars in the economy must lead to a general increase in prices of goods and services. Now, when we talk about economic growth, we mean an increase in the production of goods and services, i.e., an expansion in real wealth. Obviously then, for a [fixed] amount of money, an increase in economic growth means a greater amount of goods and services, which must lead to a decline and not an increase in the prices of goods and services in general. (We now have more goods for the same amount of dollars.)

One need only look to the Fed’s efforts at quantitative easing to see that they have injected massive amounts of money into the economy by purchases of US Treasury debt and paper issued by GSE’s such as Fannie, Freddie, plus various privately issued mortgage backed securities. This has shown up in all indices of money supply measurement (M1, M2, and True (Austrian) Money Supply). For example this chart measures the CPI against the implementation of QE1 and QE2 (ongoing):

As you can see, the blue line, CPI, correlates well with the injection of money into the economy starting in November, 2008 for QE1 and in August, 2010 for QE2 (orange vertical lines). M2 (red) and M1 (black) rise and fall in tandem in relation to quantitative easing. Lest I am accused of confirmation bias or logical or empirical fallacies, the essence of Austrian theory is that an increase in money supply is in itself “inflation,” and price inflation is one of its many negative results. There is an historical correlation between money supply and prices. The time lag varies, but the correlation is positive. And, as Dr. Shostak put it, it is easy to understand why.

The big question as I discussed in my last article is whether or not there is sufficient money expansion from QE to cause price inflation. That is a money supply question. The Fed injected about $2.1 trillion up to June, 2010. Since then it has injected another $300 billion. The way to see this is through the Fed’s balance sheet. They inject money into the system by buying assets on the open market. Lately they have been allowing certain mortgage-backed asset purchased in QE1 to expire on maturity and have been using that money and QE2 to buy US Treasury paper freshly issued by the government (monetization of federal debt). Here is a chart illustrating this:

To illustrate the emphasis the Fed has placed on Treasurys, these two charts show what is happening. The first chart shows the GSEs, etc, debt declining, and the second chart shows the increase in purchases of Treasurys.

These charts are from the Cleveland Fed

I think the answer to my question, is that there is enough new money being pumped into the system to cause price inflation and the money supply indices demonstrate that. That is why we are seeing the CPI trend upward. The impact has been modest at present. This is one reason for the spike in food and oil prices (but not the sole reason).

The reason we are not seeing higher inflation here¹ is that while the money supply has been expanding somewhat modestly as a result of QE, QE lacks the multiplier effect of bank credit expansion. M2 has increased only 4.1% in the past 12 months, and True Money Supply 2 has increased 10.3%. Look at the last 12 months of the Fed balance sheet, above. Bank lending is still in a funk:

The Fed’s language may sound more cautious on inflation lately, but their goals are unchanged. The Fed would love to see more inflation because they confuse price inflation with economic expansion. This is of course a serious error that they make. They will continue to pump money into the system through quantitative easing. They believe that as long as wages remain subdued (they declined 0.5% in February, reflecting a trend of declining wages since June, 2010) and as long as capacity utilization remains low, they can print money without fearing significant price inflation. But that is about to change.

But there is more to the story than just the Fed: the rest of the world (that counts) is inflating too.

Eurostat (Europe’s official statistical service) just announced that price inflation for the eurozone in February was up 2.4%, the highest since October, 2008. For the EU itself, it was up 2.8%. Germany had the highest increase in two years in February (0.5%) and 2.1% for the year. Output prices (at the factory gate; similar to our Producer Price Index) were up 5.3% for the eurozone. Most of these increases, according to the ECB, were driven by oil prices.

ECB President Jean-Claude Trichet said, ”The governing council remains prepared to act in a firm and timely manner to ensure that upside risks to price stability over the medium term do not materialize.” I am sure he means well, but he should look at his own house to discover the reason for price inflation. If prices are going up because of supply/demand issues, what, pray tell, is the “proper price” for goods? If it is due to monetary inflation, then he needs to look in the mirror for the cause.

China is having an even greater problem as their price inflation index rose 4.9% each in January and February. The last National People’s Congress said the official price inflation rate should be 4% (up from 3% last year) which is a tacit admission that they have a problem controlling it. The People’s Bank of China raised bank reserve requirements to 20% (10% here), the sixth rise in a year. They have also raised the lending and deposit rates three times since October. Housing prices are still rising. Of course, they flooded the economy with money and credit after their last housing bust. You’ve got to appreciate the naiveté of the Mandarins as they believe they can dictate the economic efforts of 1.5 (?) billion people.

The point is that major economies of the world have been substantially pumping new money into their economies and it is having an impact on world prices, especially commodities, including oil and food. Too many pieces of paper chasing the same amount of goods. They are poised to step on the monetary brakes as China is doing now.

We are seeing the impact of worldwide inflation on commodities and food here. Spillover, if you will, as a result of a coordinated international effort to revive national economies with monetary stimulus. So, while we can’t get price inflation off the ground here, the world’s inflation is creeping into our prices.

Worldwide inflation will continue to put pressure on prices and impact our economy. At the same time money supply will continue to grow from QE input (true inflation). Both factors are contributing to price inflation. Inflation in turn is putting greater negative pressure on real savings (savings resulting from organic production, not from money printing) which is the reason why employment growth remains sluggish.

Worldwide inflation is currently helping US exporters. As these inflating economies appear to grow they have been buying what appear to be cheap US products as a result of a cheap dollar (another impact of monetary inflation).

One wonders what will happen to exporters as other nations tighten money supply to combat inflation; it can’t be good. Since manufacturers, especially exporters, have been leading our economy, a combination of factors seems to be working against them. The prospect of eventual reduced foreign demand from slowing foreign economies will hit exporters hard, despite a declining dollar. And a shrinking pool of real savings at home sets limits to economic growth here.

I believe the Fed and the government will respond to this with more fiscal and monetary stimulus. The result will be more inflation and economic stagnation.

^1. Other statistics show that the CPI is actually much higher than the official BLS report; see “A Note On Inflation: It’s Here.”