Inflation? Ever heard of it?
It’s back. Or at least investors can smell the faint whiff of it amidst the seasonal tang of freshly cut Christmas trees.
And that’s actually a good thing.
On December 15 the Bureau of Labor Statistics announced that the Producer Price Index (PPI), which measures price increases at the wholesale level, had climbed 1.8% in November driven by rising prices for food and energy. The core PPI, which excludes those two categories on grounds that prices in those sectors are too volatile, rose 0.5%.
The next day the bureau reported that prices at the consumer level (the Consumer Price Index or CPI) had increased by 0.4% in November led by higher prices for energy and healthcare. That increase followed a 0.3% climb in the index in October. The core CPI, which excludes food and energy prices, was unchanged in November
I know that inflation hawks, on the outlook for any signs that the massive increase in government deficit spending as a result of the twin fiscal and economic crises has led to an increase in inflation, reacted negatively to this news. To them the increase in the headline PPI and CPI is a sign of that runaway inflation is just around the corner.
I’m worried about the long-term inflationary trend too. Anyone who looks at the deficits piled up in the United States (and in much of the rest of the developed world) has to worry about the possibility of runaway inflation at some point in the future.
But not yet. As Federal Reserve chairman Ben Bernanke told the U.S. Senate Banking Committee recently, the U.S. economy is operating with so much unused capacity—so many factories are running at 50% of full speed and so many workers are unemployed—that a rapid increase in inflation is unlikely any time soon.
(Of course, the definition of “anytime soon” isn’t very precise. But the term isn’t any more or less vague than the Fed’s promise to keep interest rates low for an “extended period.”)
In the short-term of “anytime soon” a bit of inflation is actually a good thing. It’s a sign that the U.S. economy is growing—prices should rise if the economy is recovering from the Great Recession—and that the United States will escape the prolonged period of deflation that has keep the Japanese economy trapped near zero growth for much of the last decade.
None of this means we—investors, Fed officials, our representatives in government—shouldn’t be worried about runaway inflation in the long run. Just that right now a little inflation is a positive signal of economic recovery.
Respectfully, I understand what you are getting at.
I think you are missing the point that you are making all these unrealistic fundamental assumptions such as gold standard, etc when it just wont happen any time soon in the real world, if ever. I cant think of any modern developed economy thats on the gold standard.
In a fantasy world, where we do have a gold standard, sure maybe your idea could work? But its a fantasy world none the less. Under today’s real world situations and circumstances, aka. reality, deflation will sink us back into recession if not depression.
For those of you who are proponents of deflation, you seem to assume that one of the benefits of deflation is lower prices.
However, considering that the US imports most of its goods, if the US currency is devalued, the cost of these imported goods will rise and therefore deflation will actually lead to higher prices for goods (until the point that US manufacturing starts making most of the goods that are sold in the US)
Terry, I think you’re missing a key piece of the puzzle. Deflation didn’t cause the Great Depression or mediocre growth in Japan. It was/is a symptom of excessive growth (i.e. bubble) caused by inflationary monetary policies…the bubble eventually bursts. Depressions are the cure, they get rid of all the mal-investment caused by the irresponsible monetary policy of the central bank. They’re brutal but, before the 1930s, they were over quickly. Now, the Fed/Congress/President is simply trying to prop back up a bubble economy via money printing and taking on incredible levels of debt. They’re trying to solve a problem caused by too much debt, with more debt. It’s insane, it won’t work and it will end in tears. A Gold standard restricts the ability of the government to inflate and cause these huge economic problems and that’s why people like myself & Ed are for it.
I’m just saying, in a realistic world, if you want to see what deflation does to our economy or your lifestyle, all you need to do is look at the last time in U.S. history we had a stretch of few years of deflation. Hint: Great Depression, or check out “the lost decade” or 2 in Japan.
Ok, lets be realistic,
If the Fed did not exist:
Politicians, we are talking about congress, the president have huge incentive to want the economy to be stimulated as much as possible. Im not saying Greenspan is a saint or anything, but he had to make many unpopular moves against the presidents wishes to raise interest rates to keep inflation under control much to the dismay of Reagon, Clinton and the Bushes during the booming years.
If the Feds did not exist, you think the politicians would ever consider raising interest rates? You would leave it to congress? to the president’s office where they have every incentive to print more money?
I dont think talking about a static money supply or golds tandard is even relevant in this discussion when its just not the way things are set up. These assumptions are not realistic.
I mean in a unrealistic world, If deflation does not cause demand to dry up, and company revenues, earnings, to fall, and my 401k wouldnt crash, and unemployement dosnt increase and economy GDP does not decrease.
If the above is all true, and my money has more and more buying power?! SIGN ME UP! GIVE ME SOME DEFLATION 🙂
Terry, Since the Fed causes inflation (along with fractional reserve banking), how would inflation be worse without the Fed (assuming the other alternative was a gold standard like we used to have)?
Actually Terry, if the Fed did not exist, and the U.S. had a static money supply, there could only be inflation or deflation if the population increased (deflation) or decreased (inflation). Prices would only be effected by supply and demand.
I agree with what you said Purewater, if and only your requirement of ALL OTHER THINGS BEING EQUAL is true. But its a capitalistic economy, and when you change something, everything else changes too to adjust. All other things being equal is a dream scenario, not reality.
If you think 97% inflation since 1913 is bad, Id hate to imagine how many times worse iinflation would have been if the Feds did not exist. 🙂
I understand where you guys are coming from in the current fiscal situation, which has debt at alarming levels. You can make a fair argument that inflation is the least bad option, and then you hope to God it works (I think that plan is doomed, but that’s not relelvant).
My point is, all other things being equal, why or how would increasing the money supply make your economy better than keeping the money supply flat and letting productivity gains decrease prices? Say you were starting a new country with a new fiat currency…how does an inflation policy make things better for the long run? All your doing is devaluing every other currency unit by adding new ones. That’s why the US Dollar has lost something like 97% of its value since 1913, when the Fed came into existence. An inflationary policy is good for one group and that’s bankers. If you know prices are going up, you spend money and take on debt to do it and the policy drives bank profits. If you know prices are gently falling you’ll be induced to save your money. I think most people have heard the inflation propaganda so much they don’t even think about it, they just take it as a given that deflation is bad.
To Ed, and you should be happy that they are doing whatever they can to avoid it. The impact of deflation is a lot more far reaching on a country’s economy and your lifestyle than just the relative value of your savings account.
Lets not forget that a 0.4% monthly increase in the CPI for November is a monthly, not annual rate of increase in the CPI. This translates into an annual rate of inflation of about 5% if continued for one year at that 0.4% rate. Similarly a 1.8% rise in the non-core PPI is an annual rate of about 24% inflation.
Terry, I would call that the Fed’s #2 duty, since Bernanke seems more intent on fighting deflation at any cost. 🙂
Terry is on the money. If we don’t have some inflation we are looking at implosion of banks and more problems that we can even think of.
I don’t argue that housing prices need to come down to reflect true values, but a deflationary cycle in all assets would be ugly
also I am not sure if anyone argued that inflation drives economic growth, its only proven that slight inflation is best for sustained economic growth, Everyone knows too much inflation is bad, in fact the Feds #1 duty is to keep inflation in check.
^^where did you get this data from? care to cite some sources?
Nice to read some positive thoughts on deflation, which I totally agree with it. Deflation gets a bad rap…I won’t write an essay on this, but just say that deflation promotes savings, rather than inflation promoting spending. In response to the tired and erroneous argument that inflation drives economic growth, pray tell how the US economy went from an agrarian society at the start of the 19th century to the greatest economic power in the history of the world by 1900? Besides the Civil War blip, that entire century was deflationary. Economies grow via productivity gains and investment, not creating money with the push of a button.
I can tell you deinflation would certainly make my retirement planning easier, I could just sit back with everything in cash and know that each year the same amount would buy me more food and other things.
You’re correct in the context of people who are flipping houses will worry about that(or view their home as an investment). I don’t plan on selling anytime in the next decade or so. My house isn’t an investment, it’s a place for me to live(and a place for me to play with my power tools 😉 ).
I’m with Chris and Ed, deflation is not such a bad situation for the US economy. The real threat is runaway, self-reinforcing, ‘hyper’ deflation. But with so many US pesos sloshing around, I think that threat has been mitigated. We need deflation in housing prices in order to reflect true market values (supply and demand – what people can afford WITHOUT gov’t handouts), because housing prices under the reckless Greenspan and Bernanke Fed are not a reflection of market prices.
One other offshoot of deflation – people would be more encouraged to buy bonds (read: US Treasuries) because bonds GAIN value in periods of deflation. This demand for bonds could help offset some of oncoming avoidance of Treasuries by our foreign investors (China & Japan), which could help stem the interest rate increases in the future that most now fear.
The relative value of your house is the last thing you’ll be worrying about if there’s prolonged deflation. 🙂
In inflation your money is worth less, but your house(real estate) is worth more. It takes more dollars to buy it.
In deflation your money is worth more, but your house is worth less. Because money is worth more, it takes fewer dollars to buy.
(I’ve oversimplified that comparison a bit)
I’m more in the deflationary camp. As Ed pointed out savings actually increase, and we need a little more saving in the country. We’re behind in that area.
thats why economists track inflation adjusted prices….
As for deflation, it may sound good until you realize it seriously stunts economic growth (which is what raises living standards) as it makes our products and services more expensive relative to other countries. People who wants to buy things just says, “lf I wait, I can get this cheaper,” so companies sales drop sharply across the board and are forced to layoff people etc etc. Economy contracts even more.. Its a vicious cycle. Its a very very bad situation.
weaner21 is so right. The eventual fix in the housing market will occur when prices start to rise. This will be just illusion, however, because the gains will just be inflationary due to the massive increase in the money supply and the federal deficits. The fed will need to be brilliant to avoid much higher interest rates, very low growth and/or a much lower dollar. I am not optomistic. I can see a replay of the seventies coming.
One major flaw in your theory, is people’s mortgage payment.They don’t go down, as your wages will in a deflationary cycle. I would rather have increasing wages, and my mortgage would be less and less of a problem.
Here’s a simple question: Why is deflation a bad thing?
Consider: With deflation, the cost of goods and wages goes down. With inflation, the cost of goods and wages goes up. Either way, the VALUE of goods and wages remains the same. However, under a deflationary situation, your savings actually INCREASE in value, even assuming a zero return on investment. Under an inflationary situation, your investment returns are reduced by the inflation rate (i.e. if inflation is 1% over a period of time, and your investment return is only 1% over the same period, you’ve made nothing).
Deflation is a boogeyman the Fed uses to scare people from the Fed’s inherently inflationary tactics.
You know everyone always talks about Japan’s lost decade, but from what I can see they are still not out of their lost “decade” so I make it at about 20 years for them. After all they are still competing to be the currency for the carry trade. And we certainly don’t want that kind of trouble!
I agree, anything to avoid deflation is good news.
For now, the worst case scenario is experiencing the lost decade Japan went through. I don’t think the FEDs will say anything different today than last time, especially when options are about to expire. I guess the dollar carry trade still has some legs under it… for now
Please disregard my previous comment:
I thought food and energy prices are too volatile, not the core PPI.
I apologize.
I agree with Jim right now we don’t have to worry about run away inflation, but I certainly would have liked to see a bit of the deflation/no inflation all these numbers keep talking about. Because except for electronic stuff, everything I pay money for kept going up while they were throwing those negative numbers around.
So even when they talk about deflation I have to worry about making sure my investment keep up with inflation, so that is why I’m here! 🙂
It is generally accepted that an inflation rate of consistent 1 to 2% is a sign of healthy economy. Whether 1.8% inflation reading will be consistent remains to be seen.
“The core PPI, which excludes those two categories on grounds that prices in those sectors are too volatile, rose 0.5%.”
I thought food and energy prices are too volatile, not the core PPI.