Thursday, December 15, 2011

Inflation, Timeframes, and Semantics

So what the fuck is inflation?  it seems so obvious; it's when things cost more right?  Or is it when your currency is worth less?  Let's just google it.  OK so both definitions are right.  But when things cost more, how much of that is attributable to higher demand from those greedy emerging economies driving up my gas bill?  And how much is that Uncle Ben diluting the money supply? 

But regular folk don't care about money supply or equilibrium of supply and demand.  For regular Americans, inflation is simply when the increase in prices outstrip the increase in wages.  So this is why the average American shrugged when the dollar lost almost half its value from 2002 to 2006 according to the dollar index (DXY): everyone got paid more.  It was not until the Great Recession where prices continued to increase starting in 2009 that people began to notice.  It was then that prices increased yet people were getting paid less in aggregate.  It should not surprise anybody that that was also when gold became a household investment idea and shortly became parabolic.  Granted, gold started to rise a decade ago, but did not catch mainstream popularity until the last couple of years.

From 2009 on, we have been increasingly bombarded, now to an almost comical degree, about the ravages of inflation.  Some of these actually make sense, but others are your classic snake oil salesman and scaremongers (not to say any one of them will be more correct than the others as I have no predictive powers).  Of course, the backlash against these inflationistas has also been severe, as they point out the rate of inflation is relatively tame.  Look no further than the current Krugman-Wenzel fray where both sides claim the other is not only dead wrong but a huge clueless idiot. 

However, after looking at both arguments, their viewpoints are both backed by relevant data, but I think neither of them gets to the root of the inflation issue.  In a perfect world, we would have low unemployment and low inflation like we had under Bill.  Assuming that this does not happen in the near future, we face the old conundrum of the inverse relationship of employment and inflation.  The real issue is even though our economy sucks now, inflation is already running as if our economy is crushing it.  What we should be discussing is how high will inflation get when our economy finally starts to improve?  Will the Fed be able to land a Goldilocks scenario where we calm inflation without endangering the recovery?  The worst case scenario would be a Fed torn between its two mandates of low unemployment and low inflation as it continuously teeters to one camp before tottering to the other.  Meanwhile, the economy will experience even worse volatility and confusion as nobody wants to do anything in fear of getting trampled by an overactive Fed.

This leads me to Japan, which I'm alone in thinking perhaps those lost decades were a best case scenario considering the stubbornness of Japan's moneyed elite/politicians to never reform its financial sector.  By literally muddling through the last twenty years in a dazy malaise, it has prevented inflation by preventing recovery.  Sure the central bank purchased Lord knows how much random assets, but all that extra Yen is sitting as reserves and thus never hit the economy.  Is this a plausible scenario for America?  (If you answer yes or no and then give a longwinded answer using words like "firstly" and "perhaps" you might just be an economist).

Happy holidays!

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