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The government wants us to think that inflation is a potential problem, but it's not



May 15, 2009 – Comments (6)

I just came across the following article on the April CPI numbers that were published today in this morning's Wall Street Journal: Prices Suggest Little Deflation Risk .  I think that this headline is very misleading and is drawing incorrect conclusions from the data.

Despite what the title says, my interpretation of the recently published CPI data leads me to believe that if not deflation then dis-inflation is very much here right now.  The April CPI was flat after falling 0.1% in March.  Over the past year, consumer prices have fallen at the fastest price in nearly 50 years (June 1955).

The author cites the fact that the fact that most of the drop in prices came from a decline in the price of energy and food as a reason that deflation remains "remote."  First, this conclusion is incorrect.  While the often cited but fairly irrevalant "core" CPI which excludes food and energy (I'd like to meet the person who doesn't actually have to pay for these things in real life) did increase 0.3% (actually 0.253% which was rounded up) in April, a whopping 40% of that increase was a result of a dramatic (9.3%) increase in the price of tobacco products in response to the government raising taxes on companies in the industry.  This increase was artificially created by the government and it is not sustainable.  The core CPI ex-tobacco, only rose 0.16% in April and 0.06% in March.

Another questionable part of the core number is the fact that according to the government, housing...which accounts for a whopping 40% of the CPI...only fell 0.1% in April.  Really?  I'd love to see the data that this number is based upon.  In fact, the "owners' equivalent rent" portion of the CPI actually rose 0.1% for the month.  These numbers seem completely off the wall to me.  Ask any person in America is the price of housing is increasing or decreasing.  I'm pretty sure that they'd say that it is falling fairly rapidly.

To me dis-inflation is very much here right now.  Yes, the Fed and Treasury are pumping money into the system fast and furiously.  However, the destruction of the shadow banking system, the reduction in leverage, and many other factors have caused the velocity of money to drop dramatically.  The drop in velocity has been greater than the increase in money supply.

The government wants us to believe that inflation is a major potential problem because they don't want everyone to get sucked into a terrible deflationary vortex where everyone believes that prices are falling so they wait to buy stuff, which causes prices to actually fall, and so on, and so on.  But it's not.

To me, the only way that we see a real inflation problem in the United States any time soon is if the world begins to choke on all of the paper the government is printing to fuel its massive spending and budget deficit.  A dramatic drop in the value of the U.S. dollar, which is currently sitting near its lowest level of the year, would obviously cause the prices of everything to rise for Americans.  This may eventually happen, I just think that it is several years away.  Perhaps that conclusion is incorrect.

There are many people out there who believe that inflation is a very real, very immediate problem that I am sure will disagree with this post.  I welcome you to post your thoughts on this subject and try to change my mind.  I am trying to keep an open mind and see all of the angles here.  Let's just try to keep things civil :).  Remember it's Friday.  I'm looking forward to a cold beer and some poker after I put the kids to bed.


6 Comments – Post Your Own

#1) On May 15, 2009 at 11:56 AM, unvrsldeflation (66.94) wrote:

Sorry, I don't disagree with you. I too think that the amount of destruction wrought in the system, shutting down the rate of flow of money as well as the amount that can be stored both in real and comparative figures is too real to be passed over so easily. Higher unemployment can only exacerbate the crisis - reinforcing the lower equiibrium point we are coming to. As for people not spending because they think prices will come down, yes for some items (the ones people have now to save for), but mostly they won't spend because they won't have any marginal capacity to consume.

For prices it is a race to the bottom. For business it is about having the capital to survive and then to look and see if there is opportunity. CEO's who anticipated something like this are few, but some companies are cash rich and more than well positioned to survive. Their competition might not be, though. I am looking for a period of consolidation with bankruptcy as a new, far more widely used tool -  used to shed debt and acquire capacity towards the future. 

It remains to be seen how long this will last. It certainly will not be over as long as unemployment threatens to hover or is hovering at or about 10%. Pity the Mid-West.

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#2) On May 15, 2009 at 12:40 PM, alstry (< 20) wrote:


It is great to see you are tracking what Alstrynomics has been saying since Alstry started blogging over a year ago.  This was a very competent blog. 

But be careful.....when the government is pushed back in a corner and has to choose between inflation and deflation....history is not in deflation's side.

We could see a reversal of current trends anytime.

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#3) On May 15, 2009 at 2:18 PM, Melaschasm (69.91) wrote:

This is a well written blog.  I for one have not been even slightly fearful of a deflationary sprial despite the many news stories.

One way to avoid a deflationary spiral is to print so much money that inflation is unavoidable.  Both the Federal Reserve and the US government has a preference for to much inflation, rather than to much deflation.  I am predicting a W recovery, because at some point the printing of money will generate nominal GDP growth.  This will kick start inflation, which will be followed by the Federal Reserve pulling liquidity out of the markets and increasing interest rates, which will slow down inflation, and either return the US to recession, or at least an extended period of stagnation.

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#4) On May 15, 2009 at 2:39 PM, portefeuille (98.91) wrote:

... that inflation is a potential problem, but it's not

Have a look at videos #3 and #4 here (the bottom two (!), the headlines are somewhat disarranged. There are 15 sec commercials at the beginning ... oh well, the videos that follow are well worth that!) on deflation, quantitative easing and all that ...

Hugh Hendry at his best ...



(side note: Have a look at the text as well. I very much agree with the following quote:

I watched a lot of CNBC Europe. It is like CNBC America except it's actually good. Segments are not broken into 2 minute shoutfests (apparently Europeans have longer attention spans) and the hosts have bright minds, wit, and challenge their guests. This is where I discovered Hugh Hendry, Chief Investment Manager, of Eclectica Asset Management. Quite frankly the difference between the Europe vs US versions are a direct parallel to how US Congress works versus UK Parliament: here, people give 2 minute speeches before voting to 90% empty Congressional hall with no challenges - there, even the Prime Minister stands in a room without prepared remarks, and has to answer critics/questions and think on his feet in an engaging atmosphere of direct confrontation. Ironic really. But I digress.)

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#5) On May 15, 2009 at 6:15 PM, CMFStan8331 (97.21) wrote:

I agree that inflation is not an immediate concern, but think it is a fairly serious long-term risk.  When the economy eventually begins improving, it's going to require both political courage and an extremely deft hand to start removing the excess liquidity at just the right time and in just the right proportion to prevent inflation from skyrocketing. 

 I don't see that the government had any other realistic option than to print money by the bushel-basket, though.  The possibility of a deflationary death-spiral is a vastly greater danger than the risk posed by the prospect of future inflation.  If they fail to cut the flow to the spigot at the right time we will eventually have a serious problem with inflation, but we were facing the real possibility of a new Great Depression.  All the folks who ranted and continue to rant about fiscal responsibility, in the face of such a potentially apocalyptic event, are beyond irresponsible.  

 The time for fiscal restraint will definitely come, but when your house is on fire, failing to call the fire department because you're worried about the big bill you're eventually going to receive won't get you anything other than a bunch of ashes.  

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#6) On May 24, 2009 at 7:10 PM, robstuck (< 20) wrote:

I also agree that we are in a period of disinflation. Not to be confused with deflation. For those that don't follow, disinflation is a slowing of of the rate in which prices increase while deflation is where prices actually drop. 

Due to the recent drop in the velocity of money as you mentioned, retailers are having trouble moving product at their current prices. This backs up inventory causing production to slow. Once the influx of money into the economy is realized, demand will surge requiring production levels that were slowed. This will result in inflation.

This is all on a micro level however. The macro level brings up new and interesting points. The US is currently experiencing debt levels that have never before been seen. Our debt is increasing while our GDP is decreasing. The only possible way for the United States to pay back this money is by debasing the dollar. 

read these!

I've also written a recent blog in relation to this topic.. 

Great Post!



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