Stone Pigs

Posted By Alan Partis on January 24, 2010

Inflation.  That word is one that strikes fear in the hearts of many by its mere mention.  It is axiomatic that the prevailing economic condition, whether good or bad, has a big impact on all our lives and influences everything from where we go for vacations (if we go anywhere at all), how we shop, how we vote, and, for many, even how well we sleep.  It was not so many years ago that our lives were very negatively impacted by inflation rates that topped 10%.¹  Even inflation rates above 5% have proven to be very disruptive.  More than one political career has been made or unmade by the ravages of inflation.

As a consequence of our experience with this beast, we, as a country, are highly sensitive to anything known to stimulate inflation … perhaps even hypersensitive.  Warnings about our pending doom at the hands of another looming inflationary cycle are becoming more and more common as of late.  More than one commentator, financial analyst, or economist has run the inflationary flag up the pole in recent weeks and months, warning of the consequences of actions taken by the Federal Reserve and President Obama and his economic team.

I’m here to make one simple request: please stop inflation.  Please stop talking about inflation.  Please stop worrying about inflation.

Inflation is not in our future.

Inflation is the result of an economic and monetary condition where there is “too much money chasing too few goods.”  Inflation is characterized by rising prices, not on individual goods or services, but in the economy on the whole when money supply growth outpaces real wealth creation (somewhat equivalent to GDP growth).  Looked at in terms of supply and demand, inflation happens when demand for goods and services exceeds money supply.  Inflation happens when there is too much money in circulation.

Possibly the biggest factor in inflation is consumer spending, and, at the risk of stating the obvious, that requires consumers who are spending.  Right now consumers are most decidedly not spending.  There are a variety of factors that have depressed consumer spending, but certainly the tightening of credit and a return to more responsible spending habits are chief among them.  Not only are consumers becoming more responsible while banks and credit card companies do the same, but the average consumer in this country, led by the baby boom generation, is growing older and entering a phase in their lives when they turn more to saving than spending.

Another of the driving forces behind inflation is high employment.  When nearly everyone is working and has money to spend, consumer demand naturally increases.  If productivity fails to keep pace, inflation results.  As long as we’re looking at unemployment north of 7%, consumer spending will remain depressed.

By definition, inflation requires the presence of so-called easy money.  Anyone who has a credit card, has obtained or refinanced a mortgage, or tried to purchase a car lately, knows that of all the things money is, easy is not one of them right now.  Lending rules have tightened even though they are quite probably still too loose to be responsible.  Even with interest rates at low levels (the Prime Rate currently sits at 3.25% where it has remained for over a year now), very little lending is taking place.  Given that raising interest rates is the prime weapon against inflation (as evidenced by former Fed Chairman Paul Volker’s action in the early 1980’s that finally killed the last great inflationary period that many of us recall from the 1970’s), should inflation begin to reappear now, there is plenty of room to raise interest rates and fend it off.

The great fear today is that many of our government’s actions of late would be hugely inflationary in ‘normal’ times, but these have proven not to be normal times.  In spite of what would appear to be the best efforts of the Obama administration and the Fed to do everything in their power that causes inflation and currency devaluation (printing money, massive deficit spending, and obscene debt loads), it remains squarely in the fantasy realm of bad dreams along with other evils such as Sasquatch and Osama bin Laden and occupies the minds of TV and radio pundits, but few others.

The fear of inflation is unfounded.  Given the aging of the baby boom generation, and the shear mountain of wealth that has been destroyed over the past year or so, Obama and his team simply can’t print enough money to keep up.  The absence of inflation today, in spite of all the supposedly inflationary activities and policies, is a testament of the power of the opposing forces already in place and of the misunderstanding of what is going on.

It is normally thought that government deficit spending is inflationary and given that our government is sailing so far into the red, we should be seeing double-digit inflation based on that alone.  Still, we don’t.  Why not?  Because the money the government is using to spend is being taken from the private sector to start with — they’re simply moving money from our pocket to theirs in order to spend it.  There’s no new money being injected into the system.  Some people will counter that it is the sale of treasury bonds that is funding the federal government’s spending, but a large number of those bonds are being purchased by our own Fed and again are not injecting new money into our system.

What about all the money creation that the Fed is doing as a result of low interest rates, etc.?  Those efforts too are being blunted by consumers and businesses who have voluntarily reduced spending and borrowing.  Consequently the velocity of money has slowed to a crawl and removed one of the crucial ingredients in the recipe for inflation.

Lastly, people will point to the rising cost of energy, specifically a barrel of oil, as evidence of inflation’s presence on our door step.  This too is a non-starter.  Probably the biggest component of the price of oil today is geopolitical instability, something that is largely a matter of world wide emotions.  While this is a real issue (at least until the aforementioned Osama bin Laden and his henchmen are eradicated), it is still just one item in our economic picture (albeit a foundational one).  Waning demand as a result of depressed consumer activity and increased pressures to adopt alternatives will keep downward forces on the price of oil for a while.

Inflation requires at least the feeling of a growing economy, if not the real thing.  Given the economic head winds being put in place by the Obama administration and a complicit Congress, it’s difficult to envision a return to euphoria and rampant spending along with easy money in the foreseeable future.

Until the Echo Boom generation ages a bit more and begins to reach its potential for wealth creation and spending, there’s no hope for inflation in our future — it’s much more likely that we’ll see real deflation.

So, can we all just stop talking, and worrying, about inflation now?

————

Category: Economics, Observations
Tags: