One principal conundrum of the extreme monetary policies of the last eight years is on the subject of consumer price inflation. Expansion of the money supply is, by definition, inflation. Yet how come, following a quadrupling of the monetary base, consumer prices are flat?
The last we checked the CPI weighed in at just 0.2 percent in March. This certainly doesn’t seem like the great currency devaluation is under weigh. In fact, the dollar index is up 20 percent over the last year.
Obviously, there’s been massive asset price inflation. Since the market bottom on March 9, 2009, the S&P 500 is up over 217 percent. In other words, the market price of the primary index costs more than triple what it did just 6-years ago.
Similarly, treasury yields stumble along at historic lows. The 10 year note’s yielding just 2 percent. The risk premium for dollar based government debt’s practically nonexistent.
Anecdotally, certain prices are off the charts. College tuition’s become a disgraceful rip off. Hotel rooms in San Francisco are very steep. Conversely, blue jeans and laptop computers are cheap. Given the monetary shenanigans that have gone on, shouldn’t everything cost a fortune?
Additional Insights
Somehow, the supply of consumer goods has raced far ahead of demand. Cheap foreign labor produces a profusion of cheap products for practically nothing. But even at everyday low prices people aren’t buying them all up.
The most reasonable explanation for the disconnect between the dramatic increase in the money supply and the minor increase in consumer prices that we’ve come across is the lethargic velocity of money. The federal funds rate’s been set at practically zero for over 6-years and the Federal Reserve’s more than tripled the monetary base, yet the abundance of credit is holed up within bank balance sheets and the stock market. The money drips into the real economy like cold molasses in February.
Perhaps lenders aren’t lending because credit worthy borrowers are scarce. Maybe the economy’s reached total debt saturation and cannot support any additional debt. We don’t know. But we did come across some additional insights on the subject from economist Martin Feldstein earlier this week…
“The overall unemployment rate is down to just 5.5 percent, and the unemployment rate among college graduates is just 2.5 percent. The increase in inflation that usually occurs when the economy reaches such employment levels has been temporarily postponed by the decline in the price of oil and by the 20 percent rise in the value of the dollar. The stronger dollar not only lowers the cost of imports, but also puts downward pressure on the prices of domestic products that compete with imports.
“Inflation is likely to begin rising in the year ahead.”
If Feldstein is right, and inflation does begin to rise in the year ahead, it means the dollar is weakening and the price of oil is rising. We don’t necessarily agree with Feldstein that this will occur in the year ahead. But he is much smarter than we are and anything’s possible.
Connecting the Dots on Employment and Inflation
At the same time, the economy looks to be gasping for air like a fish out of water. According to the Commerce Department’s preliminary estimate released on Wednesday, first quarter GDP grew at a seasonally adjusted annual rate of 0.2 percent. Naturally, they blamed it on the weather. We’ll know more when the next employment report comes out.
Connecting the dots we see several possibilities coming together. There’s the prospect of a slowing economy. And there’s the prospect Feldstein points out of rising inflation. The simultaneous occurrence of these is known as stagflation.
Typically, stagflation occurs when unemployment and price inflation rise in tandem. To calculate the misery index just add unemployment and inflation together. Right now the misery index is low. This could quickly change. What to make of it?
According to the Philips curve there’s supposed to be an inverse relationship between inflation and unemployment. When the unemployment rate increases, the inflation rate decreases. Conversely, when the unemployment rate decreases, the inflation rate increases.
How could it be that both go up at once?
Only massive government intervention into the economy and credit markets can pull off such a feat. Consider it another deformity, like DOW 18,000 or the wealth gap…
…the kibitzers will the impossible to life then pant and gasp about for votes.
Sincerely,
MN Gordon
for Economic Prism
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