Congrats to the Fed

My compliments go out to the Fed. I'm not sure how they did it but they have managed to cause nearly everyone on Main and Wall Street to fret over deflation. But just because we have one or two months of sequential declines in CPI and PPI, doesn't mean that deflation has become a secular trend.

Convincing Americans that we are about to "suffer" a protracted period of deflation is a pretty good trick considering the evidence of inflation that is all around us. And it is also pretty slick to have the investing public deathly afraid of deflation, while mistakenly seeking to embrace an optimal condition of moderate inflation.

How can we have allowed ourselves to be so easily duped? Thanks in most part to a monetary base that grew from $841 billion in August of 2008 to $2 trillion today; ten years ago the price of gold was trading below $300 per ounce, today it is above $1,200 per ounce. How is this evidence of deflation? The price of gold is the best arbiter for a currency's purchasing power. Therefore, gold is still telling us that inflation is eroding the value of our dollar.

Other commodities like crude oil are telling the same story. Ten years ago a barrel of oil was trading for $25. Today it is $77 per barrel.

Since 2001, the U.S. dollar has LOST over 30% of its value against our largest trading partners and has lost nearly 7% of its value since June alone. These facts have somehow caused the MSM to wring their hands about deflation.

More recently, the YOY increases in the CPI, PPI and Import Prices are 2%, 2.8% and 4.5% respectively. Even though these YOY increases aren't evidence for runaway inflation, they still can't be construed as deflation.

The truth is that prices should be falling. Aggregate hours worked are down 8% since their peak in March of 2008. Since the money supply should rise and fall along with the direction of the numberf of people in the work force, price levels should be falling as the money supply contracts. But that is not what we see today, as M2 is up 2.1% Year over Year.

Now I concur that If the monetary base continues to stagnate and banks stop lending to the government, then we could be headed for a deflationary environment in the future. However, at this time it is just conjecture.

But if that scenario does take hold it would not be something to fear. Lower prices are beneficial for those who have been thrown out of work and falling prices allow asset values to reach a level that can be sustained by the free market. The fact is that prices should be falling in order to reconcile the imbalances brought about by decades of profligate spending and borrowing.

Deflation...I say bring it on. But that is not what is occurring today. And because of the massive level of U.S. sovereign debt, inflation will be our most salient problem for the foreseeable future.

Could it be both.......... Mike, Could it be simply the entire economy is broken which we have differing effects causing inflation and deflation to the various sectors of the economy and markets. Submitted by Richard (not verified) on Thu, 2010/07/15 - 1:19pm » reply |

Yes. The Fed has vastly Yes. The Fed has vastly increased base money in an effort to get prices to rise. However, most of that money isn't being lent into the economy and therefore, you have some asset prices falling (e.g. housing). Yet, because the value of the dollar is in question, some asset prices are rising (e.g. energy, gold). Submitted by Michael Pento on Thu, 2010/07/15 - 3:24pm » reply |