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As compared to September last year, the growth momentum of price
indexes shows visible strengthening. Year on year, the rate of growth of the
consumer price index (CPI) rose to 1.6 percent in January from 1.5 percent in
the month before and 1.1 percent in September last year. Also the growth
momentum of the consumer price index less food and energy has strengthened in
recent months. The yearly rate of growth climbed to 1 percent from 0.8
percent in December and 0.6 percent in October.
Economists blamed the increase in price indexes on the higher prices
of apparel, airline fares, and shelter costs. Note that attempting to explain
general increases in prices in terms of the components of the price index is
not an explanation, because it doesn't address the key causes.
Is
Inflation about Price Rises?
The fundamental problem here is a failure to define the problem
properly. The essence of inflation is not a general rise in prices as such
but an increase in the supply of money, which in turns sets in motion a
general increase in the prices of goods and services.
As Mises explained in his essay "Inflation: An Unworkable Fiscal Policy,"
Inflation, as this term was always used everywhere and especially in
this country, means increasing the quantity of money and bank notes in
circulation and the quantity of bank deposits subject to check. But people
today use the term "inflation" to refer to the phenomenon that is
an inevitable consequence of inflation, that is, the tendency of all prices
and wage rates to rise. The result of this deplorable confusion is that there
is no term left to signify the cause of this rise in prices and wages. There
is no longer any word available to signify the phenomenon that has been, up
to now, called inflation. …
As you cannot talk about something that has no name, you cannot fight
it. Those who pretend to fight inflation are in fact only fighting what is
the inevitable consequence of inflation, rising prices. Their ventures are
doomed to failure because they do not attack the root of the evil. They try
to keep prices low while firmly committed to a policy of increasing the
quantity of money that must necessarily make them soar. As long as this
terminological confusion is not entirely wiped out, there cannot be any
question of stopping inflation.
Now a price of a good is the amount of money asked for the good. Hence
for a given amount of goods the more money is in the economy, the higher the
amount of money per good spent is going to be, all other things being equal.
This means that for a given amount of goods, an increase in the money supply,
i.e., the amount of dollars, all other things being equal, must lead to more
dollars spent per unit of a good, i.e., a general increase in prices of
goods.
When inflation is seen as a general rise in prices, then anything that
contributes to price increases is called inflationary. It is no longer the
central bank and fractional-reserve banking that are
the sources of inflation, but rather various other causes. In this framework,
not only does the central bank have nothing to do with inflation, but, on the
contrary, the bank is regarded as an inflation fighter.
Thus, a fall in unemployment or a rise in economic activity is seen as
a potential inflationary trigger which therefore must be restrained by
central-bank policies. Some other triggers, such as rises in commodity prices
or workers' wages, are also regarded as potential threats and therefore must
always be under the watchful eye of the central bank.
We suggest the Fed's massive pumping during 2008 to September 2009,
and the consequent increase in the growth momentum of the money supply (AMS), is the key factor behind the present strengthening
in price inflation. Observe that the yearly rate of growth of Fed's balance
sheet stood at 153 percent in December 2008 whilst the yearly rate of growth
of AMS jumped to 14.3 percent in August 2009.
The
Popular Definition Cannot Explain Why Inflation Is Bad
If inflation is just a general rise in prices, then why is it regarded
as bad news? What kind of damage does it do? Mainstream economists maintain
that inflation, which they label as general price increases, causes
speculative buying, which generates waste. Inflation, it is maintained, also
erodes the real incomes of pensioners and low-income earners and causes a
misallocation of resources.
Despite all these assertions regarding the side effects of inflation,
mainstream economics doesn't tell us how all these bad effects are caused.
Why should a general rise in prices hurt some groups of people and not
others? Why should a general rise in prices weaken real economic growth? Or,
how does inflation lead to the misallocation of resources? Moreover, if
inflation is just a rise in prices, surely it is possible to offset its
effects by adjusting everybody's incomes in the economy in accordance with
this general price increase.
However, if we accept that inflation is an increase in the money
supply, and not a rise in prices, all these assertions can be easily
explained. It is not the symptoms of a disease but rather the disease itself
that causes the physical damage. Likewise, it is not a general rise in prices
but increases in the money supply that inflict the physical damage on wealth
generators.
Increases in the money supply set in motion an exchange of nothing for
something. They divert real funding away from wealth generators toward the
holders of the newly created money. This, not price rises as such, is what
sets in motion the misallocation of resources. Moreover, the beneficiaries of
the newly created money — i.e., money created "out of thin
air" — are always the first recipients of money, who can divert a
greater portion of wealth to themselves. Obviously, those who either don't
receive any of the newly created money or get it last will find that what is
left for them is a diminished portion of the real pool of funding.
Furthermore, real incomes fall, not because of general rises in prices,
but because of increases in money supply; in other words, inflation depletes
the real pool of funding, thereby undermining the production of real wealth
— i.e., lowering real incomes. General increases in prices, which
follow increases in money supply, only point to the erosion of money's
purchasing power — although general rises in prices by themselves do
not undermine the formation of real wealth as such.
Contrary to popular thinking, the Fed's preoccupation with maintaining
price stability by keeping the CPI rate increases at a particular acceptable
range, such as 2 percent, can actually generate nasty surprises. For
instance, as a result of strong monetary expansion and a correspondingly
strong increase in the production of goods, prices remain stable.
Notwithstanding this stability, various nasty side effects are likely to
emanate from monetary expansion. Hence we suggest that Fed policy makers
should pay close attention to the sources of monetary inflation rather than
focusing on the symptoms of inflation.
On this Rothbard wrote,
The fact that general prices were more or less stable during the 1920s
told most economists that there was no inflationary threat, and therefore the
events of the Great Depression caught them completely unaware.[1]
Prospects
for Price Inflation
When money is injected into the economy, it never affects the prices
of goods instantly. Because money moves from one market to another market
there is a time lag. We have estimated that in the United States it takes
about 36 months before changes in money supply generate a visible effect on
the prices of goods in general. It must be emphasized that the lags are
variable, i.e., in some periods the time lag could be less than 36 months, in
some other times it could be more than 36 months.
Based on past massive monetary pumping and using the time lag of 36
months, we can suggest that the growth momentum of the full CPI and the CPI
less food and energy is likely to visibly strengthen in the months ahead. We
forecast that the yearly rate of growth of the CPI could rise to 2.4 percent
by September before jumping to 4.4 percent by December. Year on year, the
rate of growth of the CPI less food and energy is forecast to climb to 1.5
percent by September before climbing to 2.7 percent in December. The message
from our monetary analysis that there is a growing risk of acceleration in
price inflation in the months ahead.
Conclusion
Since September last year, the growth momentum of the US consumer
price index (CPI) has displayed visible strengthening.
We suggest that the Fed's massive monetary pumping during 2008 to
September 2009 is the key factor behind the strengthening in price inflation.
Based on past monetary pumping, we expect the growth momentum of the
CPI to strengthen further.
Notes
[1] Murray N. Rothbard. America's Great Depression, Sheed and Ward Inc., 1975, p. 153.
Frank Shostak
Frank Shostak is a former professor of economics and M. F. Global's chief economist.
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