According to Oxford,
Inflation, the general increase of prices and fall in
purchasing value of money.
Deflation, reverse or reversal of inflation.
Stagflation, state of inflation without the corresponding
increase of demand and employment.
A situation arises where the quantity of money is
not as important as how far its circulation reaches. It slowly becomes
insufficient to buy the needs and wants of the population at the periphery of
the economy.
For instance in stagflation, there may be money
around but it’s not producing the economic flows that it should. This
can also be tied to the extent of the circulation and the velocity of money
itself. There may be sufficient money around but is becomes locked up in
Treasury bonds and not lent into the economy to stimulate economic activity
(such is the case now). Asset prices rise in this environment and further
make inadequate the money for purchasing such assets.
Alternatively, the reduction of money can happen in
situations, like today, when mortgages are at an all-time low of 3.94%, but
through fear of falling house prices (reducing creditworthiness) potential
job losses and the consequential need to save for the rainy day, house buying
drops off. Every situation produces a reduction in the available supply of
money and precipitates liquidity crises. This is from where the major threat
to monetary stability comes. In our global world, with its plethora of
national currencies, a non-national
asset becomes protection against inflation, deflation, and stagflation across
the globe.
Why should this be good for gold? Gold is both an
international asset and international cash. It’s the combination of
these qualities (and the liquid nature of gold, in the most difficult of
situations) that set it apart from paper money and other assets. It’s
these qualities that will force the monetary system to bring gold back into
the global, monetary system in one way or another.
“Normal”
Inflation
Today in every country across the world, there is
inflation –even when a country is in recession. When we hear the
reports on inflation changes, we usually hear just one rate affecting the
currency zone we live in. In reality there are several types of inflation,
each driven by a different set of forces.
The serious food inflation being suffered by much of
the world has reached 70% in some parts of the world. This is a result of
demand and supply pressures. The pressures on the poor are the most worrying
from this source of inflation. Some households spend a large percentage of
their income on food, so such rises have a serious impoverishing impact on
their lives. In the developed world, where a much smaller percentage of
disposable income is spent on food, such inflation is not as pernicious. To
the investment world, the differences show the impact on the ability to
invest, the shortage of liquidity for citizen’s everyday lives. Where
it’s possible, this type of inflation can be managed by increasing the
amount of food grown –so increasing supply and lowering local prices.
Take a look at oil and other energy inflation. The
fact that the oil price is easily managed by oil producers makes any
inflation from this source manufactured to suit the needs of those people. As
the world runs on oil, price rises affect everyone to a greater degree. Oil
prices reflect the sum total of global demand. China, where economic growth
is bringing the poor (i.e. low oil-utilizing population) into a world where
oil takes a growing part of their lives, is seeing rapidly increasing demand.
As half the world falls into this category, we foresee demand from that
source growing almost exponentially. The developed world may be going through
a falling demand phase, but this could fail to lower prices as the emerging
world is more than compensating for such falls.
Energy Inflation
Worse still, in the majority of nation’s oil,
demand represents a major import to every nation. The foreign exchange needed
to pay for this has to come from the income from exports (except in the case
of the U.S., where they have run a trade deficit for several decades through
the printing of new money, which is a leading U.S. export). Oil price
inflation is of a different nature as it affects profitability of business
and therefore the economic performance of nations themselves. Falling oil
prices have a stimulatory impact on nations as money rises in oil purchasing
power, when oil prices fall. Again, we see an impact on general liquidity.
Oil price inflation is considerably more pernicious,
for oil payments represent a draining of money from a nation because oil
payments leave the developed world and arrive on the shores of oil producers,
sucking wealth out of those oil importing nations. The same happens with
cheap imports. Consequently, we’re seeing a draining of wealth from the
West to the East. The only way to stop this is to lower oil demand and raise
the prices of imports (i.e. Protectionism). In today’s global economy,
this is proving no alternative.
The burden on smoothing out the three liquidity
problem makers –inflation, deflation and stagflation—falls upon
the shoulders of the country’s central bank.
Central Bank
Money Management
In terms of ensuring price stability, central banks have
to balance the needs of their economy with the money supply available to it.
Price stability is achieved when they succeed in balancing the two; however,
with governments adding to their burdens by passing some of the
responsibility for growth and economic stimulation onto them, they find that
they’re forced to bend the rules of price stability, and often.
In the present economic climate, with a recession
impending or underway, central banks across the developed world have turned
to quantitative easing (significantly increasing money supply through money
market and Treasury market operations) to increase money supply and overall
liquidity to encourage the banks to find it easy to lend and give the economy
the liquidity it needs to grow. This hasn’t worked nearly as well as
had been hoped, for the deflationary forces and slowing growth have
discouraged bank lending –businesses and consumers have not sought this
extra money. As a result, it has found its way into government bonds and
bills against central banks using somewhat toxic assets as collateral.
There are two possible solutions:
- The first is to allow the very painful,
politically unpopular, recessionary/depressionary
forces to shrink the economy, forcing growth in economic activity, to be
followed by greater monetary demand from that growth to bring about a
growing economy. Today that would not be politically workable.
- The second is to rapidly increase the money
supply to stop any stagflationary or
deflationary shrinkage of the economy.
A Different
Type of Inflation
There is an analogy that may be useful to the
reader. The human body needs blood to feed and nurture it. The body requires
a certain volume of blood, going at a certain speed and circulation to the
outer reaches and capillaries of the body. Interfere with these processes and
the body loses its health. The Fed is the supplier of money and can to some
extent influence the speed at which it travels. When the circulation slows,
the Fed can add quantities of money to speed it up (i.e. quantitative
easing). By lowering interest rates, it’s hoped that the circulation is
improved, and the speed at which the money travels regulates the nurturing
ability of that money. But it takes government to exercise the body so that
it makes its blood system healthy. When government fails to exercise, the
blood systems come under pressure.
Today we find central banks in a very difficult
position because the additional money supply has simply expanded the volume
of money without forcing its circulation to reach consumer levels
effectively. It has found its way into unutilized ‘pools’
–banks and Treasury bonds where it’s of little use to the economy
overall. So, economic activity continues to shrink alongside dropping demand
and employment.
That’s why the Fed, in a cleft stick, issued
this statement,
“The Fed “will continue to closely
monitor economic developments and is prepared to take further action as appropriate
to promote a stronger economic recovery in a context of price stability.”
Bernanke may not be finished after attempts in
August, September to strengthen record monetary stimulus with unconventional
tools. The central bank’s near-zero benchmark interest rate and $2.3
trillion of housing and government-debt purchases since 2008 have failed to
produce self-sustaining growth in the economy and employment. The Fed is
scared of deflation; they’re more concerned with preventing deflation
rather than containing inflation. Deflation destroys businesses and wounds
the economy, long-term. Inflation just drops the value of money.
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