A Note On Inflation: It’s Here

In an interesting article in the Wall Street Journal’s “Numbers Guy” column, it was pointed out that maybe the government’s reporting of price inflation is skewed to favor the government. Shocking. He notes that the government keeps fiddling with its methodology:

According to one rogue economist, John Williams at Shadow Government Statistics, if we still calculated inflation the way we did when Jimmy Carter was president, the official inflation figures would look about as bad as they did when … Jimmy Carter was president. According to Mr. Williams’s calculations, if we counted inflation under the old system the official rate wouldn’t be 1.5%. It would be closer to 10%.

I follow Shadowstats for price inflation, though I rarely report it. He uses the same methodologies used by the BLS in 1980 and 1990, depending on which chart you select. According to Mr. Williams:

The SGS Alternative CPI-U measures are attempts at adjusting reported CPI-U inflation for the impact of methodological change of recent decades designed to move the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.

His latest numbers per the 1980 methodology:


Compare this to the latest official chart on CPI-U from the BLS and the GDP Price Index which the Fed follows:

This is an important topic because with an expanding money supply, one would expect to see price inflation, yet the official statistics reveal no substantial price increases. And that begs the question: Why not?

Austrian theory commentators, including me, have been saying: just wait and price inflation will happen. Yet it the official statistics were not revealing significant price increases. Austrians say that money expansion, either through the Fed (money base) or the banks (credit creation supported by the Fed) is inflation and that rising prices are an effect of inflation. This theory makes sense because, if the money supply were stable, then if prices rose in one sector of the economy it has to be because of greater demand for those goods relative to the supply. Accordingly, that would leave consumers with less money to spend on other goods, the prices of which would go down. Thus it is a factor of supply and demand for goods in a stable money supply system and not all prices rise, as it does during a price inflation.

On the other hand, assume that the money supply increases overnight by 20% (assume that magically everyone had 20% more dollars the next morning). There is no new wealth created, just more pieces of paper. If everyone goes to buy stuff  in the morning, they would bid for scarce resources and drive up all prices for goods, ultimately by 20%. It’s not magic; it’s simple math.

True inflation, an increase in the money supply, is occurring. This is no surprise to my readers. Here is the latest data on Austrian Money Supply from Michael Pollaro:

Mr. Pollaro states:

The U.S. money supply aggregates based on the Austrian definition of the money supply, what Austrians call the True Money Supply or TMS, continued their recent surge, in December posting an annualized rate of growth of 38.9% on narrow TMS1 and 24.6% on broad TMS2. That brought the annualized three-month rate of growth on TMS1 and TMS2 to 22.3% and 18.1%, respectively, 8.6 bps and 2.7 bps higher than those posted in the prior month. …

Turning to our longer-term twelve-month rate of change metrics – more indicative of the underlying trends – and focusing on our preferred TMS2 measure, we find that TMS2 saw another healthy increase, in December growing at an annualized rate of 9.9%.  Not only was this a tick up from November’s 9.8%, but we think close enough to 10% to mark December as the 23rd time in the last 24 months that TMS2 posted a twelve-month rate of growth in the double digits. For new readers of the Monetary Watch, the last time TMS2 saw this kind of string was during the run up to the now infamous housing boom turn credit implosion, a time during which TMS2 saw 36 consecutive months of double digit growth.

With QE2 underway there is no reason to doubt that this trend will continue.

That is why the ShadowStats data is intriguing. If we measure price inflation by historical methodologies, the rate would be over 8%. If you study the ShadowStats chart you can see that price inflation took off in 2009 about the same time as did QE1 (QE1 expanded dramatically in March 2009), then backed off with the decline in QE and now is moving up again after the announcement of QE2 in September, 2010. This conclusion could, of course, just be confirmation bias or a logical fallacy on my part (post hoc ergo propter hoc), but it does fit into the general Austrian monetary theory: we would expect to see this occur.

I believe we are just starting to see the beginning of price inflation. The data reveals that the main drivers of the CPI at this point are food and oil, and part of those increases are related to supply and demand issues. We all understand the role of OPEC in oil and how they can let short supply chain issues drive up the price of oil. That is occurring now. The same thing is occurring with food where disruptions in production in a short supply chain world (we are just discovering this issue with regard to food) can drive up food prices worldwide.

Supply and demand issues don’t account for all of these price increases, but there is no practical way to measure that versus money supply-driven price inflation. The only way to determine it is to look at money supply itself: if money supply expands, we should see other secondary effects besides price inflation.

We should see a rise in the stock market. Since QE goes directly into the pockets of the Fed’s primary dealers (the big banks and financial institutions on Wall Street), those companies do what they do best, which is to invest the new money into financial media. Such as the stock market. Since the supply of stocks hasn’t grown, it may be that this new money is chasing the stock market and driving it higher. For a discussion of this, please see this article.

We should see a modest increase in consumer spending. While consumer spending as measured by retail sales has been modest (see this chart), I believe much of such spending is coming from upper income folks as a result of the wealth effect of the stock market boom. It isn’t coming from middle America since wage growth has been relatively flat, unemployment is still high, and the spending source from this sector has been from savings.

We should see a rather sluggish overall economy because monetary inflation causes the further destruction of real capital (i.e., savings derived from the actual production or services; not dollars from fiat money expansion). Monetary inflation distorts the business cycle, sends the wrong signals to business people, and they embark on projects that will ultimately amount to bad investments based on paper rather than wealth. Real capital is necessary for new economic expansion. Evidence of this lack of real capital is high unemployment, stagnant-to-modest growth, further liquidation of an oversupply of homes and commercial real estate from the last cycle, flat wage growth, lack of credit, and price inflation. All this is occurring now.

I believe this will drive our economy into stagflation: sluggish economic growth and price inflation.

The last time we had stagflation was in the Jimmy Carter/Arthur Burns era. The difference between monetary inflation now and, say the late 1970s and early 1980s as shown in the ShadowStats chart, is that bank credit isn’t expanding significantly now, but it was back then. The main source of monetary growth now is from quantitative easing, a rather poor inflationary tool versus fractional reserve bank credit expansion where you have a 10:1 advantage. The Fed is resorting to QE (direct injections of fiat money into the economy by the Fed) only because nothing else has worked for them. While QE does not have as great an impact as bank credit expansion, it does have some impact. It is not possible to inject $2.2 trillion of new money into the economy and not have an impact. Pollaro’s calculation of money supply reveals that is does. Even now we are seeing the Fed’s measure of M2 money supply expanding, finally.

Price inflation is here.


19 comments to A Note On Inflation: It’s Here

  • ohioralph

    It would appear that QE2 is offsetting any decline in credit due to defaults and writeoffs with any excess going into the stock market. Accordingly, QE2 must continue indefinitely unless the savings rate increases which seems unlikely given the extremely low rates being offered. With the FED’s balance sheet continually expanding, there is no way any exit strategy can be implemented here. I believe this describes stagflation which is a standoff that must give sometime in the future. Any resolve of this standoff will be undesirable from a political viewpoint. Truly this is the definition of being between a rock and a hard place.

  • Buck


    I truly struggle to put your words into proper context…

    “Even now we are seeing the Fed’s measure of M2 money supply expanding, finally.”

    What in God’s name do you mean by “finally”? Fed M2 has been expanding every single year, for the past 50 years!

    “Price inflation is here.”

    First of all, and commensurate with the M2 data above, price inflation has always been here, but for a brief respite in 2009.

    I find it odd that all through 2008 (and even still), you were warning “just wait and price inflation will happen when per SGS-CPI, which you “follow” for price-inflation, we were already sitting at the peak of a wave of price-inflation that had been building for 20+ years! Why were you not talking about how bad the inflation was, instead of how bad it will be?

    The only way your comments/prognostication can make any sense is if you believe future price-inflation levels will exceed those of 2008, which at the time were not worth comment relative to what lies in store. I just want to be clear in order to reconcile your ‘stagflation’ thesis; is this what you believe?

    Similarly, you state, “Austrian theory commentators, including me, have been saying: .”

    when SGS-CPI, which you “follow” for price-inflation, was cresting a peak that had been building for 20+ years

    • Come on, Buck, will you ever give me a break? Have you been following the news or actually reading what I say? Price inflation is low per CPI. The Fed has been deperate to foment price inflation and they haven’t been able to do so. Also, if you look at the monetary chart, M2 has been declining as well. Commentators in the MSM have finally noted that M2 is budging, and that was the context of my comment. Also, where is the 2008 inflation? And to prove you never read anything I write, I wasn’t writing about inflation during 2008 and in fact only wrote a few posts then. You should open your eyes before you open your mouth. But thanks for commenting.

      • Buck

        Wow Jeff, where to start with you?

        “Also, where is the 2008 inflation? Gee, I don’t know Jeff, how about try the SGS-CPI, since you claim to “follow Shadowstats for price inflation”. In mid-’08 it is peaking at ~13.5%. Good enough?

        “I wasn’t writing about inflation during 2008 and in fact only wrote a few posts then.” In the 5th post you ever penned, March 23, 2008, The Chairman’s Report Card, you are already warning of future inflation due to emergency actions taken by the Fed during the crisis. You gave Bernanke an “F” for Fed bailouts and rate cuts, claiming it would cause “more inflation”. More than the 26 year high that we were sitting on at the time?

        This is what I am asking. This you refuse to answer.

        “Also, if you look at the monetary chart, M2 has been declining as well.” Hey Jeff, you see that fat horizontal line with a ’0′ to the right of it? When the pretty blue line dips below this line, that is when, and only when, M2 can be said to be ‘declining’. Learn how to read a chart (already).

  • [...] then, the Daily Capitalist quoted Shadow Stats – saying that inflation might be closer to 8% than 1%.  Fortunately, we have some market [...]

  • gabriel halevy

    An excellent article.

  • ChuckB

    Our government is obviously lieing through it’s teeth about inflation –what else is it lieing about?

  • What isn’t it lying about?

    A nation of liars deserve such a gubermint. And we ARE liars, being lied to. Because we can’t face the truth about the world we live in, about ourselves, our own natures. Our problem is rooted in what we believe.

  • [...] This post was mentioned on Twitter by R. D. Perez Llopis, Anthony Wes. Anthony Wes said: A Note On Inflation: It's Here | The Daily Capitalist: While consumer spending as measured by retail sales has b… http://bit.ly/g92o9R [...]

  • Correct me if I’m wrong but can’t the Fed act with Impunity above the Government?

  • Captiva

    Jeff–enjoyed your article. Thought provoking. The definition of money supply by the Austrian School is apparently difficult to apply in our current economic situation (especially, as you point out, when the numbers are impacted by political motives). My impression is that the Austrian School defines money supply in the broadest terms. Consequently, your definition would seem quite a bit too narrow in that increase in debt by all sectors would count as an increase in the money supply. I think the proper definition would be north of $50 trillion versus roughly $18 trillion by your count. IF I am using the correct definition then the money supply is shrinking and deflation is occurring as we speak. In fact, I believe we have at least another five years of deleveraging before we reach the next low in the money supply. Hold on to your Confederate Dollars boys, the South shall rise again.

    • Keith Weiner

      It’s controversial. I adhere to a branch of the Austrian school that does not believe one can add up liabilities of differing maturities to come up with a single monetary aggregate. The error is something like: 1/2 + 3/17 + 5/24 = 9/43. In this case, a debt instrument that will become money in 30 days + … a debt instrument that will become money in 30 years, etc. And let’s be clear, a bond or note or bill or CDO or whatever is not money. You cannot go and buy something and pay using that.

      Don’t get me wrong, it is important to understand the expansion of credit in the system via fractional reserve lending and other means, but while all “money” in our system is someone’s debt, not all debt is “money”.

  • baruch

    If you know anything about math, you know figures don’t lie, however our problem is liars know how to figure!

  • baruch

    If you know anything about math, you know figures don’t lie, however our problem is liars know how to figure!

  • [...] This post was mentioned on Twitter by Hal, Ray Barnhart. Ray Barnhart said: A Note On Inflation: It’s Here | The Daily Capitalist http://bit.ly/hHD0jk [...]

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  • Sage


    Good to see this debate. Seen others similar on Pragmatic Capitalism too! Can we have some conceptual reality check beyond the play of numbers? Recall the famous truism — Price inflation is always & everywhere a monetary phenomenon ( at least in the short run)! Money is a facilitator and not reflective of real goods & services at ny point in time — but also sometimes becomes a commodity in its own right as when highly leveraged instruments are created (futures or Madoffian pyramids). The ideal or required stock of money at any time relative to goods & services at that point in time is a highly speculative & relative term. Its growth is much more critical. Unless that keeps pace with real sector growth during normal times it will reflect in inflation — that is hardly the issue! No matter what measure of money supply you use, it only needs to be consistent & internally comparative — you cant compare the M2 with Austrian driven TMS 2 — these are just not apples to apples definitionally. Hence you cannot expect to see similar growth pegging either.

    In the current state of affairs in USofA as I see it there appears a severe slack in production capacity — therefore real supply can catch up in very quick time — if provided the correct growth impulses — which govt is attemting to do. If that happens then the ‘unusual’ trend of inflation will get absorbed thru both increasing supply as well as secondary demand cycles and so onwards. Hunky dory!

    Jeff appears to be spot on when he comments that QE working thru the FED system is unlikely to ripple into secondary expansion — as those will be used in existing financial instruments and drive up their prices — particularly where most of these instruments represent entities which are not expanding — or more rightly entities which already have surplus production capacities idle. That is why there are idle (unemployed) Americans!

    By the way — stagflation correctly means where ‘unusual’ inflation is seen not to generate expansion — as exemplified by depleting inventories, low unemployed stock of capital (real capital stock NOT monetary instruments). Any increase in DJIA is not necessarily an indicator of real growth. As in pre-2009 USofA the income-effect of growing wealth estimates alone fueled a large part of the growth in the “services” sector which in turn fueled our soaring banking profits — making them profligate and “unreal” in their investment strategies and contribute to bringing down the whole house of cards in the first place.

    Get away from seeking true directions from monetary ups & downs and get into the “real” world and monitor the “real sector” trends. By the way, your housing sector will continue to be laggard as in the pre-2009 state, housing investment had become a speculative commodity too — resulting in excessive supply relative to “real” demand. Check on % of more than 1 houseowners!! Then Vs now Vs in the future. This excess supply will take quite some time to get absorbed — meaning as I understand, quite some period of growth in “other” real sectors. In my view the technology driven sectors will become the leading indicators of growth — which is the real strength of USofA — not housing.

    USofA could however take a short cut — start another war or proxy war somewhere!! With Iraq winding down and maybe Afghanistan winding down too, there is further deflation contribution round the corner — although some fiscal space will be a positive contribution from the wind-downs. Pragmatically, that should get compensated by real investment into US infrastructure — if we want growth impulses to continue.


  • [...] Quien sabe? My point is that we will see stagflation regardless of oil. As I pointed out in “A Note on Inflation: It’s Here,” the forces of inflation are already in motion and its effects are starting to show up, one [...]