The Case for Inflation from a Plateauing Supply
Posted by Prof. Goose on April 12, 2007 - 10:20am
Topic: Economics/Finance
Tags: conservation, inflation, oil, peak oil [list all tags]
This is a guest post from Jeff Vail.
Will Peak Oil lead to inflation, deflation, or some variant thereof? I don’t claim to know the answer—in fact, I’d argue that anyone who "knows" the answer is discussing theology, not economics. My hope here is to present a case for Peak Oil resulting in inflation, and to spark a centralized debate on the topic. Allow me one courtesy: for the purposes of this discussion, assume that we are not able to sufficiently mitigate the effects of Peak Oil through conservation, efficiency, or alternative energy sources. Assume that Peak Oil will have significant, negative economic effects—the issue that we are discussing here is whether those negative effects will be inflationary or deflationary. I will focus my discussion on effects on the United States, but thoughts on the inflation/deflation debate outside the US are certainly welcome.
A quick review, so that we are all comparing apples to apples.
Inflation is the decrease in purchasing power of a currency due to an expansion in the supply of that currency ('printing money') and the interest rate offered by that currency's central bank. Personally, I subscribe to the Austrian theory that interest rates are a function of global economic growth and currency-specific money supply, allowing markets, not central bankers, to play the key role in rate setting.
Deflation is the opposite of inflation and is an increase in the purchasing power of a currency. There are several theories about the cause of deflation, but there is general agreement that it is caused by the combination of a reduction in money supply and a slowing of consumer spending (because this reduces the velocity of money in the economy).
Central Banking, and Measures of Money Supply
To what extent do central bankersin the US, the Federal Reserve Bankhave the power to decide between inflation and deflation? This balancing act is the central problem of central banking. Central bankers have three critical tools in their tool belt: interest rate setting, and setting of reserve requirements, and open market operations.
Interest Rate Setting: The Fed sets the benchmark Fed Funds Rate, which governs the rate at which banks lend—via balances with the Fed—to other banks overnight. While this is the most visible of the Fed’s functions, it is possibly the least important. Ultimately, the price of money (the interest rate) is set on the markets, such as through bond trading at the CBOT, and is based on supply and demand. If the Fed sets a rate that is too far off the market rate, it is essentially subsidizing lenders (though, as explained below, they can set that market rate through open market operations).
Reserve Requirements: The Fed also sets reserve requirements for banks—how much they must keep in liquid assets to cover loans that they have made. For example, if a bank has $100 million dollars, and the Fed has a 10% reserve requirement, then that bank can (via fractional reserve banking covered by overnight loans at the Fed Funds Rate) generate loans of $1 billion dollars. If the Fed changes the reserve requirement to 5%, then that same bank can now make $2 billion in loans—this increases the money supply, and represents an inflationary pressure.
Open Market Operations: This is, in my opinion, the most important and most hidden tool in the central banker’s tool belt. The Fed engages in open market operations by buying and selling their own securities (T-Bills, T-Notes, etc.). When the Fed sells these securities, they are decreasing the money supply because the private party purchasing the security must give the Fed money now in exchange for a note that will pay them money at some future date. Conversely, when they buy back their own securities, they are increasing the money supply because they are providing money today to buy back a note that only obligated them to future payment. This is the actual mechanism by which the Fed "prints money." There is virtually no limit to the amount the fed can increase or decrease the money supply (there is a theoretical limit to their ability to increase the money supply because they can only buy back all securities currently in circulation, but this isn’t much of a limitation), but significant buying or selling of securities will also have a significant impact on their price—essentially the rate of return that the Fed must pay on these debt instruments. Finally, the Fed can get around the theoretical limit of how much they can increase the money supply buy selling higher numbers of very short term T-bills, for which the market will only absorb at an increase in the rate of return—even though this decreases the money supply until the maturity of the T-bills, it has the ultimate effect of increasing the money supply after their maturity.
In addition, central banks such as the Federal Reserve often decide how to report issues related to central banking. Money supply is, in the US, measured by the Federal Reserve. Historically, they provided three measurements of money supply: M1, M2, and M3 (definitions of these measures here). They recently discontinued reporting the M3—something that I see as an ominous portent signaling the intention to discretely "inflate away our problems."
Before I lay out my argument for why the Federal Reserve will choose to pursue an inflationary policy in response to Peak Oil, I’d like to outline three specific areas in which the inflation vs. deflation decision will have significant ramifications:
1. The Elephant in the Room: Entitlements
What "environmental" factors will influence the central bank’s decision to pursue either inflationary or deflationary policies? In my opinion, the elephant in the room—in both the US and internationally—is our huge set of entitlement commitments and debt obligations. Our entitlement commitments include corporate commitments to pensions (and their government backing when corporations default), and government commitments to social security payments—both especially salient given the wave of "Baby-Boomers" expecting to be able to retire in the near future. In 2004, $492 Billion was paid in Social Security benefits. In 2010, the first of the 'baby boom' generation, 76 million Americans, will turn 65, and that number will likely skyrocket. Corporate pension obligations will similarly go through the roof—they are already bankrupting America’s car companies, for example—and the likely defaults will increase the burden on the government to pay pensions thanks to our Pension Benefit Guarantee Corporation.
2. Debt Obligations
Our debt obligations are massive, and are held in significant quantities by both domestic and international investors (including nation-states such as China). The U.S. Federal Debt is currently about $8.5 trillion dollars, 44% of which is held by foreign entities, mostly (64% of that 44%) foreign states. Inflationary policies will have the impact of reducing the value of our debt obligations, whereas deflationary policies will increase the value of these debts.
3. The Petrodollar System
In addition, inflationary or deflationary policies may have significant impacts on the durability of the existing petrodollar system. If the US petrodollar system stays in effect through the effects of Peak Oil, it may mitigate the financial impact with regards to the United States to some degree by passing this burden to other, oil consuming nations. However, for exactly that reason, I see it as likely that the petrodollar system will gradually erode over the next decade or so. I’m no expert in this area, and a huge amount has already been written on this topic. The erosion of the petrodollar system, though, would likely exacerbate the tendency towards inflation of the US Dollar. The reason for this is that, if the value of a currency is the result of the supply and demand of that currency, then the erosion of the petrodollar system would reduce the demand for dollars, reducing the relative price (value) of those dollars.
The Argument for Inflation
In my opinion, it seems most likely that the US Federal Reserve will pursue a policy of inflation in response to Peak Oil. It is my opinion that central banks can choose between inflation or deflation—though not necessarily the relative magnitude of their choice. That is, the central bank may only be able to choose to create either hyper-inflation or mild deflation. The reason that the Fed has the power to choose either inflation or deflation is because they have theoretically unlimited power to increase or decrease the money supply through open market operations—no matter which way the economy is naturally trending, the Fed can force an inflationary or deflationary environment, though at the extremes these actions will have severe, long-term drawbacks. Given this power to choose, it is my opinion that the US will choose inflation, even hyper-inflation, over deflation, even if that deflation would be relatively mild. There are five reasons why I think that this will be the case:
First, the Federal Reserve will want to maintain at least a modicum of control, and most monetary policy tools at their disposal do not function well, if at all, in a deflationary environment. For example, the bank cannot set interest rates below 0% (well, without giving away money...), and yet a 0% interest rate may not be sufficiently low to expand the money supply to slow or reverse a deflationary spiral.
Second, it is my opinion that our massive entitlement and debt obligations make inflation more attractive than deflation, as they have the effect of diminishing those obligations.
Third, and closely related, is the psychological impact. Inflation can easily be masked by a non-representative Consumer Price Index (CPI), as I think is currently occurring—the CPI does not include many housing, health care, education, or energy costs. As real inflation gradually erodes the purchasing power of fixed wages and incomes, people will only slowly perceive the damage.
Fourth, and also related, is the short-term nature of our political decision making process. During the relatively benign economic conditions in the US over the past 20 years, with only mild recessions, it has been possible for the Federal Reserve to act with a high degree of independence from politicians. However, I think that under more severe economic hardship, political forces will exert a great deal of influence over the Fed. With that said, I think that the very short term nature of our political system—with a two to four year time horizon—we will opt for the short term relief of inflation from our debt and entitlement obligations despite the long term pain that inflation will cause.
Fifth, I think that the popular view of history favors inflation over deflation. The Great Depression was a deflationary spiral, and is the benchmark within the American experience for true economic hard times. In comparison, the inflation of the '70s and '80s seems mild. While that comparison may not be valid in reality, I think that it carries great weight in our national psyche. Given the choice, I think that the Fed (especially under increasing political pressure) will do anything to avoid comparisons with the deflationary events surrounding the Great Depression.
Of course, given that I think the negative economic effect of Peak Oil will be severe, it might be more accurate to characterize this inflation as "stagflation", which is inflation combined with recession (or depression).
Finally, what will about the timing of inflation in response to Peak Oil? This, I think, is one question that is simply to complex to answer satisfactorily. The timing of the decline of the petrodollar system, the timing and speed of the decline in global oil production, and countless other economic factors all come into play. In the end, though, I do not think that the timing issue prevents forming an opinion on the general direction: inflation or deflation? I think that the evidence weighs clearly in favor of an inflationary future.
As a final disclaimer: I am not a central banker. I studied economics and finance in my undergraduate education, as a component of a doctoral program, and as a student at the American Institute for Political and Economic Systems in Europe. I think this debate is incredibly important and interesting, both from a financial mitigation perspective as well as for personal preparations. That said, my goal here is to learn about this issue, not to prove that I am right. Let the debate begin!
The tanker rates in the Persian Gulf have been falling for eleven days with an adequate supply of tankers for the amount of oil that must be loaded. That is deflationary.
On the other hand the price of crude was up a dollar this morning. That is inflationary.
Part of inflation is by will of government decision. Whether or not a government can balance its budget. The cost of borrowing money. The amount of money in circulation. The amount of money the Fed requires banks to keep on deposit to cover for bad loans, private depositors needs to withdraw funds, etc.
Shortages of gasoline resulting in price spikes in gasoline might cause the price index to rise, even though the price of tanker transport might be falling.
Typically nations experienced more inflation during times of war than times of peace.
Remember: Price increases are not inflation. An increase in the money supply is inflation. When there is no increase in the money supply and the price for oil increases, the price of something else (say, SUV's) will fall. We have never experienced a constant money supply so we do not know deflation. But deflation was present thorughout the 18th and 19th centuries, in those periods when the money supply (ie gold) was not increasing faster than the world population and economy. South Africa, California, and Australia all sparked some bouts of "inflation" separate from the wars.
You beat me to it. The price of oil going up in not in itself inflation. The price of computers going down is not deflation.
That said, I agree with JV's conclusion though maybe not for the all of the same reasons. The elite can escape the devastation of inflation through posession of hard assets, though they may be threatened ultimately by the ensuing consequences. The accumulated debts to pensioners cannot be openly repudiated on a sufficient scale: they must be inflated away.
It's hard to see any power bloc benefitting from deflation. Theoretically, deflation benefits bondholders. But deflation would render debts owed uncollectible. The housing meltdown is already showing that, and we see this in already mildly inflationary times (compared with what's to be). Deflation here would cause revolution in China whose factories would idle.
The biggest thing, of course, is the military and intelligence machine. This is what undergirds tha value of the dollar now. This is what allows one to hope that the dollar, which is not backed by anything else, is at least backed by oil, theirs, oops, I mean ours. It must be fed, and can only be fed with inflated dollars. And if it isn't fed, then the sole backing disappears and we are back to the Weimar days. The elites all over the world fear the dam's breaking which is why they all appease a regime they detest. These guys have the world by the pashwingi -- for now.
Actually I see inflation as more harmful to the "elite" than to ordinary people. Inflation primarily benefits debtors, by allowing them to repay their debts with cheaper money than they borrowed. As a general rule, the wealthy loan money to the poor, rather than the other way around. Therefore inflation will benefit the proletariat at the expense of the elite.
"Theoretically" you are right. They lend. But with an implosion they don't get paid back at all. People are already going into default. Deflation would mean economic implosion -- far more would default.
Next, the elite lends, but not their own money. They lend the middle class's money, their pensions, college savings, etc. You don't get into the elite lending your own money -- no, no, no.
Therefore the elite borrows, borrows from us. Now I said the proletariat goes into default. But not like the elite goes into default. The elite goes into default by eliminating our pensions, by running up massive govrnmental debts that will be the excuse for tearing up all contracts with the common folk. The only contracts that aren't torn up are the tax reductions for the very wealthy. The military-industrial complex doesn't need a contract -- it's implied.
The elite can play the world's assets, unlike you and me. That's what globalization is really all about -- not trade so much as free movement of capital. That, by the way, is why the Soviet empire crumbled peacefully. The Soviet elite could not walk away from their rust belt -- it wasn't capital. They envied the Western elites. They thought they would be better off with capital. That they were outmaneuvered is another story.
This is a fascinating thread, but perhaps we should simplify it and take it a step further?
Since there is wisdom in the collective, why not do a simple poll?
"Do you think PO will result in"
a) high inflation/stagflation
b) little meaningful change
c) deflation
d) total chaos
Hal,
I don't quite see it as debtors vs creditors, but more as the prudent vs imprudent. For example, the creditors and debtors in the New Century collapse are very much on the same team when it comes to pressure for a Federal bailout.
The irony of all this is that that the majority of TOD members seem to believe that an inflationary scenario is the most likely outcome. Well, that means that when the credit meltdown comes, those with debt are going to be bailed out by those without debt.
...in which case all those following Westexas' ELP maxim are going to get a big fat bill demanding that they pay for the financial recklessness and profligacy of others.
Not a comforting thought.
But...but... then the already slave-level wages of the poor person become worth even less. Wages of the lower percentages of the working poor have declined in recent decades. The rungs keep coming off the ladder.
Yours is the most common, and in my opinion, the most erroneous view of inflation. A change in the price of a good due to scarcity is NOT inflation. It is simply the market adjusting to the supply of the commodity on hand at a given time. The only thing that can cause inflation is the printing of more money than there are goods and services for that. Then there are more dollars chasing the same amounts of goods and services.
Personally, I do not accept your definition of inflation at all. I doubt that Jeff will either based upon his article.
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
I second what GreyZone pointed out: increase in the relative price of oil due to a new supply/demand equillibrium is a change in price. Decrease in the overall purchasing power of a dollar because the money supply is increasing faster than the quantity of goods and services being purchased is inflation. The issue here is not whether or not the relative price of oil will increase, but rather how central banks will react to the resultant negative economic effects by implementing a broader inflationary policy.
Jeff, I really wish you had described the two definitions of inflation in common use in your post. We're bound to have dozens of posts simply arguing about the definition of inflation. I know it ticks off Austrian school followers, but most people do not agree with the Austrian school definition of inflation. This almost always devolves into a shouting match between the two definitions because people don't specify which definition they're using.
The Austrian school definition isn't "right" and the general level of price definition isn't "right". They are two definitions that are considered equally valid by their different adherents.
Did you bother to read Jeff's article? He stated his definition of inflation and his classical leanings at the very beginning! He doesn't have to repeat it 55 times because someone refused to read.
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
Of course I did. He didn't acknowledge that there are two definitions of inflation and that he was using the less common, but maybe more rigorous, definition. His statement was also a bit ambiguous as to whether he was using the Austrian School definition of inflation or the Austrian School theory of interest rates. If *you* read his statement, you'll see that he referred to the Austrian School WRT interest rates, but didn't indicate that WRT his definition of inflation.
You have to realize that the Austrian definition of inflation is *not* the common accepted definition. Look up the Wikipedia definition of inflation and you'll see this. That *certainly* doesn't mean that the Austrian School definition is wrong, but when you're using an uncommon definition of a commonly understood word, you're better off acknowledging the discrepancy up front and making it clear you're using the less common version.
Whether he labeled it or not, he clearly stated his definition.
How much clearer does he need to be? Is this like "depletion", which many around here confuse with "decline" but which is actually what happens from the time the first drop comes out of an oil well? Do we expect the readers of this site to be conversant with the word depletion and what it really means or the commonly accepted (and incorrect) version?
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
(Comment deleted, I was confused.)
I think it's a little more complicated.
It is sort of an axiom of accounting that this kind of 'inflation' has to occur by printing of money and therefore there is some kind of "conservation of inflation" if money supply (and money velocity) is held fixed.
But let's look specifically at the actors involved. What happens when the price of oil goes up and the money stays fixed.
People who have to buy things made or transported with oil (i.e. nearly everybody) have less buying power, simulating "pure" monetary inflation.
AND
The people who produce oil (Mideast Potenates) have a massive increase in their buying power, simulating monetary deflation.
Of course you can say that this applies to many other goods and services and it is certainly true, but in almost everything else, there is a complex web of interdependencies and we don't see the internal price and income fluctuations as 'inflation', just fluctuations.
It is the specific physical nature of oil that results in such a low-order "collective" effect on nearly all of the non-oil-producing economy that it simulates, for all useful purposes, something that is almost like true inflation from all observable quantities except Dubai bank accounts.
The effect of oil scarcity is simple: transfer of wealth and capital from oil consuming people and nations to oil owning nations. If these oil producers are predominantly out of the country then the effect on your own country is nothing but a broad decline of purchasing power, simulating inflation (in prices) but without concomitant inflation in income.
Hi Greyzone,
I haven't thought this through completely yet but...
While scarcity of a good is not the same as 'printing ' more dollars, with a good like oil and natural gas, the number of dollars chasing this product would increase producing a deflationary reaction in other parts of the economy, but only on a temporary basis. If the money supply remained constant the economy would re-balance but on a lower level.
Imagine taking a sip from a glass of wine -- the gradient would gradually, if no other action taken, return to normal when the glass returned to the table, but at a lower level, this in what might be considered organic bottoms up induced inflation rather than Treasury top down.
I won't labour this further other than to say that I don't think we can view oil as other products. Other products are seeming in this discussion being considered as replaceable, oil isn't.
BTW thanks for the welcomed and appropriate follow up on mine of yesterday.
In the last few weeks a word that I haven't seen for decades: "Stagflation" has been cropping up in the press. Originally coined in the 1970's in response to the oil shocks of that time, the symptoms were economies showing little or no growth, but high inflation and high interest rates.
Probably the underlying cause was the impact of high oil prices working through economies (cost push inflation) leading to escalating prices. Money supply was under government control in many countries then; and governments in response tried to muddle their way through by allowing the money supply to grow in order to mainatain as much economic activity as possible.
Thatcher and Reagan then began "so called supply side" economics and the "miracle" of Thatcherism that supposedly corrected what were perceived as structural imbalances in the major economies.
Of course it was just then that Prudhoe Bay and the North Sea came on stream and the west was able to undo much of OPEC's power to control the oil price. Then we had years of $10 oil and the rest is history, so they say.
Now, oil as a proportion of the global economy is smaller, and thus the impact has been slower to manifest itself. However recent higher prices are working their way through economies. The corn ethanol fiasco in the US is driving up food prices even further. Add to that wall to wall debt in all sectors of the US economy and one begins to appreciate the tightrope the Fed is walking. Hence articles such as this debating whether infalation or deflation is the problem. Stagflation.
It is only a matter of time before the fundamentals take over. They cannot be helf off for much longer.....surely?
Stagflation won't be repeated due to the global economy that we have now, that we didn't have in the 1970's.Back then, wages grew quite abit even though the economy was sytematically hollowed out and turned from manufacturing based to services based. Now, we have a global economy that will only continue to accelerate and theferfore severely limit wage growth. And don't believe that it is all based on jet fuel. The internet has opened up vast frontiers for outsourcing.
So then without wage growth, prices will have to be limited or even collapse as we are starting to see in the housing market.
Nice post.
I just got off the phone with my girlfriend, and she mentioned that her friend at work showed her an article in the New York Times about stagflation today. She had never heard of it before. (We are both in our 30's)
I think it will be like the 70's. Stagnant wages. Inflation in energy and food. CAFE standards will be raised. Conservation will be preached. Wars will be abandoned. Eventually high interest rates will be imposed, and a new wave of cheaper energy will be unleashed on the world. If I had to guess I would say solar, nuclear, and wind will eventually drive down electricity costs, and transportation will go electric. This will probably take the better part of a decade.
So where do you put your money?
I think Energy companies will do well. I expect that earnings from high oil prices will be invested in alternatives. Other companies might just start paying a high dividend.
Gold and silver are a good hedge.
Real Estate probably needs a decade to wipe out the excesses of the last 6 years. That being said, you gotta live somewhere, so those people who have a 30 year fixed mortgage (and can continue to make the payments) will do well in the end.
Toyota seems like a good bet.
Dividend producing stocks.
Land near Railroad stations.
Investment in conservation strategies in your own home (insulation and high efficiency systems) should pay off really well.
Whatever you invest in - just remember to diversify.
I was just a baby in the 70's, so I'm sure I have no idea just how bad it's going to be. Hopefully I can hang onto my job and ride it out.
Garth
Inflation is MONETARY phenomenon. Therefore, neither PO nor anything else must necessarily have any effect on monetary conditions.
Even if oil was $1000 a barrel, in "today's dollars", that would not be inflationary. It would merely be very expensive oil. House prices have also gone up 4x or so during the past ten years. Why isn't that inflationary? Or the cost of medical care?
Now, that said, there is some inflation here, as evidenced by the highest dollar/gold prices in 25 years, and it looks like it will become more intense. Thus, we will likely have inflation and higher real oil prices together.
I've written many thousands of words about this stuff at my site www.newworldeconomics.com.
Of course it is a monetary phenomenon but Jeff's scenario is actually asking what monetary policies will the fed take given the external stimulus of peak oil? And I still think inflation is going to be their primary and initial response.
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
I agree that peak oil is likely to be inflationary, particularly to the US.
The very last tool in the US tool box for maintaining our non-negotiable life style is our most valuable commodity: the trust that we will manage the world's reserve currency properly. No one wants to see the dollar collapse, and it looks to me like the Japanese, Europeans, and Chinese are all increasing their money supplies in step with the US.
The result of this initially is that the poorer countries, without exportable resources, cannot bid with us for the world's remaining reserves-- the first part of demand destruction.
The real test will be when exporters have to choose between taking Euros, Dollars, or Renmimbi for their oil. Right now, they can exchange dollars for everything. But when China says that you can only pay for Chinese products in Renmimbi, then the US is in trouble.
Jeff,
I happen to agree that the financial institutions will respond to any such crisis via inflationary policy. However, there are areas, such as those mentioned by Jeffrey Brown and others where deflation is occurring and will continue to occur. These areas are primarily areas where real property is actually losing value due to the changes in our society caused by peak oil, such as suburban real estate, vehicles, etc.
Also, as you note, the Great Depression was deflationary and the Fed has several times indicated that it wants to avoid that again at all costs. As for "stagflation", I believe we are already there. The CPI is not useful any longer for evaluating anything. As John Williams (author of shadowstats.com) has said previously, inflation is currently at least twice what is reported based on standards for reporting inflation as recent as the Clinton administration and even higher if we compare it back to the 1970s. Also, Mr. Williams says that the indicators, when unwound from government manipulation of the data, clearly show the economy is in a currently gentle contraction. So the recession is here and the inflation is here. Please note that multiple independent reconstructions of M3, which have been back tested against the existing M3 data and shown to be extraordinarily reliable, currently indicate the money supply is growing at close to 11%.
Finally, the petrodollar system demands inflation. Inflation is the imperial tax that the US levies on the rest of the world. So long as the tax rate is not too high, the rest of the world has appeared to largely accept this for their own benefit. However, in recent years the equation is changing with the imperial US now directly militarily intervening in multiple nations and heavily increasing the imperial global tax rate.
I don't see how anyone can argue that the Fed can do anything other than inflate given the choices available and the circumstances. The ultimate end may still be a deflationary crash but it won't occur til after the inflationary card has been played completely out.
Ghawar Is Dying
The greatest shortcoming of the human race is our inability to understand the exponential function. - Dr. Albert Bartlett
I concur - stagflation.
And perhaps something we have yet to envisage i.e. hyper-stagflation.
I agree, I think stagflation is the most likely. As GreyZone pointed out, the inflationary tools of a central bank may not work forever, and the ultimate result may be deflationary. However, so long as the global markets function and central banks can work within them, I think they will respond with inflation. At some point, if one assumes a hard crash scenario, I think that fiat money and the world markets in general fall apart, after which the resulting barter or commodity-backed currency could well be deflationary.
We really don't have to look much farther than the Fed minutes released yesterday:
The fed already knows they're in a bind. They've been increasing the money supply for quite a while now. The problem with the common definition of inflation is that, as you noted, it allows the Commerce Department to manipulate the definition of inflation to pretend it isn't happening. The problem they're going to have is that as the dollar devalues against other currencies and as the housing bubble bursts, sending more people into rentals, the homeowner imputed rent portion of the CPI is going to push the core price index up. People will figure out that we're experiencing inflation by any definition - we've been dealing with inflation using the Austrian school definition for so long that it's pretty much inevitable.
GreyZone,
This notion of systemically under-reported CPI over decades is very popular right now. It doesn't explain how over those decades the percentage of personal income devoted to discretionary spending (including entertainment, eating out, travel, etc) keeps rising. People simply have more to spend on stuff, and it shows. The CPI conspiracy seems to fall apart under this argument. Can you explain this?
P.S. I'm not intending to pick on you by my disagreeing on two different subjects in this thread. :-)
Here's my two cents on the matter:
1. People have more credit today. That doesn't mean that they're more creditworthy, but that new credit instruments have given people more access to credit for a given level of "creditworthyness." As long as this access to credit is accellerating, it diminishes the perception of inflation because there is, as you pointed out, more disposable income and thereby more discretionary spending--but it's a ponzi scheme, and when the credit expansion ends (as it may already have), the debt is still there--which will further drive the decision to inflate.
2. Over the past 50 years, it is my impression (no hard data at my fingertips...) that people have monetarized their free-time, among other things, trading it for more money by working longer. This has allowed discretionary spending to keep up with, roughly, inflation. But it can only go so far--most people with jobs already work more than 40 hours per week, unemployment is near the structural level, and there aren't many more "stay-at-home moms" who can enter the work force--they have already done so in the quest of increasing discretionary spending. We have met the point of diminishing marginal returns here some time ago, IMO, and inflation will now begin to outpace the increase in discretionary income within the narrow prespective of this factor.
The CPI doesn't include energy, housing, health care, education--these are things that globalization has done a very poor job of in terms of providing them more cheaply. CPI tends to include those thing which our modern economy has been efficient at providing for more and more efficiently (broad generalization). *IF* we temporarily define inflation as an index of consumer prices, why are are we ignoring half the prices that consumer pay??
#1 I think its fairly obvious that credit is going to be less and less available as the housing bubble unwinds. We have already begun to see the subprime market implode and this is very likely to spread to prime lending as well.
#2 I don't think that there are any "stay at home moms" today that can pull this off in most areas unless they are really making a sacrifice economically. Most families require 2+ incomes just to maintain lifestyles that they had in the past and much less quality of living than their parents had. Don't bother mentioning the trinkets like flat screens, I'm talking food, housing and medical care which have been and are at the limits of affordability lately.
#3 The CPI is just a governement number and is not reality based. I don't know anyone who takes it seriously unless they are in front of an MSM mic or camera.
#4 With all of this economic stress, do you expect it to just continue?
happy trails...
gunit
First, the CPI does include energy (part of transportation costs), housing, medical care, and education -- as well as, food, apparel, recreation, and services.
Second, people have increased their debt, but so far, the assets of the country have increased faster than the debt.
That being said, it seems to me that during our largely agrarian past, husband and wife worked very hard to make ends meet. Then during the US industrial boom there was a brief time when a single suburban male with little education could provide for a nuclear family with one job. Later, the wife was added back to the payroll to increase household disposable income.
Industrial productivity then improved to the point that lesser educated people cannot get high paying manufacturing jobs -- more education is needed to get increased income now. For instance companies frequent complaint these days is their widespread inability to find qualified people.
Economic observers seem to think that everything should be measured against that brief industrial period when the average Joe could get a high paying factory job and keep Suzie at home with the babies. I don't think the problem is really with the CPI so much. It a perception thing.
The June Cleaver fantasy was just that, a fantasy. Even in the '50s, many - perhaps most - women worked outside the home. My grandmothers both did.
But now, we really are working longer hours to maintain our lifestyles.
And not only are we more in debt, via credit cards and home equity loans...we are not saving as we used to.
I've even seen personal finance articles that recommend using credit cards as your emergency fallback, instead of saving up an emergency fund.
This book says "myth is rooted in fact" and "Affluence had become almost a right; the middle class was growing. In fact, writes Coontz, the 'traditional' family of the 1950s was a qualitatively new phenomenon.'" So it seems to argue in favor of what I have written.