Tag Archives: inflation

What are the limitations of the Fed’s power? It’s neither impotent nor omnipotent!

Summary:  Although one of the most power agencies of the US government, obsessively discussed in the financial news, it remains one of the least well understood. Here we examine the limitations on its power.  Readers can decide for themselves if these limitations are too tight, or too loose. Next in a series about Central Banks, the giants of State power.

From The Independent Word

Contents

  1. The power of Central Banks
  2. Inflation
  3. Hyperinflation, the quick killer
  4. Deflation, the quiet killer
  5. Legitimacy — the ultimate limit
  6. For More Information

(1)  The power of central banks

The development of central banking in the century before WWI was one of the last few innovations necessary to produce the nearly omnipotent  modern State.  Central banks provided the mechanism to not only easily finance large projects, such as wars and great societies, but also harness large banks to the State’s needs (for their mutual gain).

The ability to print money, set interest rates, and harness banks’ power to lend gives the illusion of omnipotence. But life means limits.  Central banks have both hard boundaries to their abilities — and a hidden weakness.

Central banks have well known limits to their powers of monetary stimulus, no matter how exercised.

Posts about the Federal Reserve:

(2) Inflation

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
— Milton Friedman, The Counter-Revolution in Monetary Theory (1970)

Central banks can stop and start inflation by controlling the nation’s money supply.  Stopping inflation requires painful measures, but with the certainty of success.  Starting and managing useful inflation requires more skill.

Why create inflation?  Unanticipated inflation acts as the magic sauce of monetary policy. Quiet, mild, relentless. It lowers the real interest rates. If we also have wage growth slightly above inflation, then our crushing debts evaporate painlessly (as we erased aprox 1/3 of our WWII debt). Bernanke literally wrote the book on this, Inflation Targeting (1998).

There are two limits to central bank’s ability to manage inflation.  First, the nation’s currency.  The central bank can expand the money supply without limit — with effects varying depending on its internal circumstances. But it will depress the value of the currency.  A weak currency can boost exports, beneficial if not offset by the increased cost of exports (eg, China and Germany have done this successfully). At some point, however, a currency collapse comes — with horrific consequences.

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It’s the end of the world we’ve known since WWII (updated status report)

Summary:  This is an updated status report about the end of the post-WWII world.  The global recession has accelerated the transition, revealing the current order’s weaknesses, and showing the people in the emerging nations that they have outgrown it.  The major nations continue to defend the current systems, a futile effort wasting time and resources that could be better spent adjusting to the new world now evolving.  This post updates previous posts in this series; links appear at the end.

By S. D. Siegel

Contents

  1. Decline follows the peak, as night follows day
  2. What happens next?
  3. Can we predict the form of the new world order?
  4. For more information

(1)  Decline follows the peak, as night follows day

Thou know’st it’s common; all that lives must die,
Passing through nature to eternity.
— Queen Gertrude to Hamlet (Act I, scene 2)

The post-WWII era peaked in the 1990s, with the end of the Soviet Union in 1991, the crushing of the emerging nations in 1997-98 (leading to their search for new systems), and the trough of WTI crude oil at $12 in 1998.

Decline started soon after, resulting from structural flaws in the major nation’s political processes.  Symptoms include:

  • growing domination of the financial sector in the politics of US and Europe (eg, the failure of regulators to rein in the technology and housing bubbles before they burst),
  • the ill-designed stage 3 of the European Monetary Union started in 1999,
  • Bush Jr’s tax cuts in 2001 and 2003 undercut the solvency of the US government,
  • the US reaction to 9-11: the War on Terror’s massive changes to America’s internal political regime and external grand strategy, and
  • the major nation’s inability to craft effective energy policy in response to the first signs of global oil production peaking (eg, rising oil prices).

The decline so far consists of two sets of interrelated dynamics.  First, a reversion to the mean of history:  the center of economic power returns to the East, ending a few hundred year long aberration.

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Update on the inflation hysteria, the invisible monster about to devour us!

Summary:  The boomers lust for inflation.   Conservatives fan this fear for political gain.  The government hopes for gentle inflation to deleverage the US economy.  Evidence suggests that disappointment lies ahead for all.  Here we review the evidence.

Most were too young, too poor, too inexperienced to get rich during the Great Inflation of the 1970’s.  Some benefited by inheriting their parents’ gains.  But for most boomers this is their last chance to win the life lottery.  Loaded with debt but able to borrow, ignorant of economic theory and history but eager to speculate, they hysterically warn of the Big Bad Ben causing inflation.  Please don’t throw us in that inflation patch they cry, while buying gold and silver — holding short-term debt, buying that third rental property with 10% down, and investing in foreign debt.  Most of all, the magic of inflation is their only way to shed debt without drastic cuts to their standard of living in retirement.

Governments use unanticipated inflation as their magic sauce for policy.  Slowly accelerating inflation played a big role in evaporating the massive US WWII debt, reducing it from 108% of GDP in 1946 to 25% in 1975.

Now we’re primed and ready for it.  Probably to be disappointed, since anticipated inflation has none of the magic we and the government hope for.  See this post for an explanation why.

This is an update of the 22 February post More invisible signs of looming US inflation!  The situation remains unchanged.  Hysteria with little factual basis.  Before we start, some important notes about this complex subject:

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Inciting fear of inflation in our minds for political gain (we are easily led)

Summary:  Americans today are easily led by fear, as our leaders well know.  Commies and Islamo-whatevers under the bed.  Global warming.   Alar on apples (see Wikipedia).  Repetition makes it so, the secret to successful propaganda.  Today we look at at a favorite of conservatives seeking political advantage:   inflation (scary even if imaginary).  See the links at the end for more information.

We start with Michelle Obama doing the traditional First lady gig, speaking to reporters on the first anniversary of her “Let’s Move” anti-childhood obesity campaign:

We also want to focus on the important touch points in a child’s life. And what we’re learning now is that early intervention is key. Breastfeeding. Kids who are breastfed longer have a lower tendency to be obese.  {Source:  Politics Daily}

Sara Palin replied while speaking at a Long Island Association on 17 February.

It’s no wonder Michelle Obama is telling everybody you need to breast feed your babies.  The price of milk is so high!  (Source:  CBS)

For the truth we go to this graph from Understanding Dairy Markets website.  Note the scale does not start at zero, exaggerating the change.  The ten year change is 1.8%year. In the 2010 price was approximately the same as that of 2007.

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More invisible signs of looming US inflation!

Summary:  The inflationista’s are (again) hysterically sounding alarms about looming US inflation.  Or even hyperinflation.  Let’s review the data.  Can we see serious inflation?  No.  These fears are to a large extent fanned by conservatives for political purposes.  Left and Right both see that Americans are most easily herded by fear, like sheep.  The more graphic, even outlandish, the greater the effect.

Before we start, some important notes about this complex subject:

  • There are good reasons to worry about future inflation.  And future deflation.  That’s a difficult aspect of our situation.
  • No known metric reliably forecasts future inflation; data must be evaluated with respect to the overall context of macroeconomic conditions.  These things are complex.
  • Inflation is a monetary phenomenon.  Rising raw material prices are not inflation.  Also, raw materials are only a small fraction of end prices (e.g., raw food is only one-third of food costs, aprox).
  • Wages are a large fraction of end prices, and they’re flat.
  • The combination of rising sector prices, flat wages, and tight money is deflationary.  As it was in 2008 (remember the big inflation scare, ending in a bust.  We have the first two today; QE2 prevents the third).   Without wage growth, rising food and energy consume more of people’s budgets, expenditures on other things must drop.  Which looks like America today.  For more see this post and this post.  Update:  we see this in today’s response to rising oil prices — treasury yields have fallen.
  • Inflation is rising in the emerging world, becoming a serious problem.  That’s natural, as they’re growing rapidly (we wish we had such problems), and many act to keep their currencies undervalued (see this explanation by Dave Altig at the Fed) .  This divergence between the developed and emerging nations could force the long-expected decoupling, and perhaps a new world order.  For more see this post.

Some indicators that can warn of inflation

  1. Monetary measures
  2. Is the Fed printing money?
  3. Measures of the money multiplier and velocity
  4. Watch the dollar drop in value!
  5. Energy Prices
  6. Direct measures of inflation
  7. For more information

(1)  Monetary measures

In 1976 Milton Friedman was awarded the Nobel Prize for “for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy”.  Most importantly this, from The Counter-Revolution in Monetary Theory (1970):

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. … A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.

Friedman’s insight laid the foundation for modern analysis of inflation.  It’s widely ignored in laypeople’s analysis of inflation, of the sort now flooding the media.  Let’s look at some measures of the money supply.  First, a reminder of some vital details:

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A bad, likely, and seldom mentioned scenario for the US during the next few years

Summary:  Summary: Rising inflation would be bad. But there is something that might make inflation far worse, is more likely, and almost never mentioned: prices rising faster than wages..

About the past

The cost of living rose during the great inflation of the 1970’s.  But people got by because wages also increased, the value of their home rose, and their debts were inflated away.  Only in 1978 did things spiral out of control, with prices rising faster than wages.  Then the public turned against inflation, and President Carter appointed Paul Volcker as Fed Chairman in August 1979.  As seen in these graphs from the St. Louis FRED database about private industry hourly wages and the CPI {there are many measures of wages, each has measuring one aspect well; these are both BLS data series}.

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Inflation is coming! Or so we’re told. Instead look at the evidence.

Summary:  Not a day goes by that investment or political (conservative) writers don’t assure us that inflation is coming to the US — or even here.  Except when they’re warning of hyperinflation (for the right-wing its always Weimer-inflation, except when it’s NAZI-Munich).  This post shows the evidence that they’re wrong, and a possible source of this hysteria.

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Contents

  1. Warning signs of inflation?  No.
  2. There are signs of deflation.
  3. In fact we have low inflation
  4. What about rising food prices?
  5. The Boomers’ secret lust for inflation
  6. For more information about inflation

(1)  Warning signs of inflation?  No.

Monetary inflation from the Fed printing money!  Look at the line on that graph skyrocket!  Or not.  The slight increase since November results from QE2.

Monetary inflation show by the rapid increase in the US money supply!  Look at the line on that graph skyrocket!  Or not.  The YoY increase in M2 is 4.3%, roughly the increase in nominal GDP (the money supply should increase along with GDP).

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