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Thoughts from the Frontline

The Theology of Inflation

April 6, 2013

We begin this week with a simple pop quiz. Is inflation good or bad? Answer quickly.  I’m sorry – your answer is wrong. Or rather, we can’t know if your answer is right or wrong because we are not sure what is meant by the question. We may think we know – and we may be right – but we can’t be sure, because the word inflation has different meanings for different people in different places and different times. In fact, even the same people in the same place and time can’t agree on a precise definition.

This is in part because most of us still think of economics as a science akin to physics or mathematics. Inflation is one way economists attempt to measure things. But unlike the distances between stars or atoms, or the certainty implicit in even very abstract mathematical models, our measurement of inflation is limited by and entirely dependent upon the tools we choose. In fact, the methodology we use has as much ability to determine the outcome as the actual data does. This week we begin a series on economic data with a look at inflation, but we’ll preface the series with a discussion of how economics may be more akin to philosophy or theology than the hard sciences. If you are an academic economist, you may want to move on to the next letter, unless you are capable of not taking yourself too seriously.

First, a little housekeeping. You are getting this letter this week on Friday night or Saturday morning, depending on what part of the globe you inhabit. When Thoughts from the Frontline first started (in August of 2000), I wrote on Friday during the day and hit the send button in the afternoon. The list was smallish and delivery was quick. Over the years, it has taken me longer to research and write. My business life is now focused around thinking about and writing this letter, which suits me just fine.

But now “writing day” often stretches late into the night and beyond, into the following morning. Friday nights became Saturday mornings and I ended up sleeping too late on Saturday to really enjoy the day. I should note that since I quit drinking about 19 months, 26 days, and 4 hours ago (but who’s counting?) it is taking me about twice as long to write the letter. Seriously.  I suspect that, like many writers far more productive and interesting than I am, I was self-medicating my ADD with a little wine and scotch on writing nights. Not a lot, mind you; just enough. Whatever enough is, which is another data point that can be, well, fluid.

So I decided to try writing Sunday night, and then moved to Tuesday night due to the publishing schedule of other Mauldin Economics publications. However, readers told me they prefer to read me on the weekend. It finally dawned on me (skilled analyst that I am) that there is little difference between Tuesday and Thursday nights. So the new schedule will be that I will write on Thursday night, reflect and edit on Friday, and make sure the letter gets to you overnight for your weekend reading pleasure. Thanks for your patience as I wandered through the week in order to get back to sending the letter on the weekend when you always wanted it anyway.

The Theology of Inflation

Long-time readers may know that for sins committed in my past lives I matriculated to Southwestern Baptist Theological Seminary in Fort Worth after graduating from Rice in 1972 (just as slide rules were starting to slip from the pantheon of must-wear gear for the respectable nerd). I decided not to pursue the religious endeavor beyond that point, which was a positive choice both for me and for the…

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April 11, 2013, 11:36 a.m.

John I am enamored with your style and substance of writing. In comparing economics to religion you left a few metaphors out. First there is the “unseen hand” controlling the economy per Adam Smith. Secondly the “Keynesian crosses” and the ones on Golgotha. Thirdly dividends and the blood of Jesus. Dividends cover a multitude of sins in the underlying stock.Forthly Finance guys love to talk about their return on equity, preachers love to talk about their return on souls saved. Some of these are a stretch but are off the top of ny head. Keep up the good work.

Joseph Moffa

April 9, 2013, 9:10 a.m.

RE: Ronald Nimmo In Comments Section:
There are two terms but there really is only one that clearly defines inflation. Let me explain.
While increases in money supply ( i.e., inflation) are likely to be revealed in general price increases, this need not always be the case. Prices are determined by real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place. In other words, while money growth is buoyant—i.e., inflation is high—prices might display low increases. Clearly, if we were to regard inflation as a general rise in prices, we would reach misleading conclusions regarding the state of the economy. This is what happened during the 20’s.
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. 
The essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services.
The U.S. government’s plan to introduce an improved Consumer Price Index in order to more accurately measure inflation is an exercise in futility. Inflation is not about a general increase in prices; it is about increases in the money supply. Hence, whatever the improved index would measure has nothing to do with true inflation, which is always increases in the money supply. Consequently, to find out the status of inflation, there is no need for various sophisticated price indices; all that is required is to pay attention to the money supply’s rate of growth.

Mark Terry

April 8, 2013, 2:33 a.m.

One of the most insidious side effects of keeping track of inflation - through an index, as in the CPI - is the use of that index to “adjust”  wages or other benefits. Regardless of your economic theology, one of the basic tenets of the free market holds that reduced demand will reduce prices, and vice-versa. If you give people more money when prices rise, you effectively neuter that tool, and “fan the flames” of inflation. It’s even worse when the index is so dysfunctional. Were we ever to experience true deflation, where a drop in the CPI might call for a reduction in benefits, I wonder what economists would say about that prospect as a tonic for the economy!

CPI-based wage and benefit adjustments should be banned.

Ronald Nimmo

April 7, 2013, 3:21 p.m.

RE: Joseph Moffa in Comments Section:

  There are terms to distinguish one meaning from the other, though they are not one-word terms.“Monetary inflation”  refers to an increase in money supply and “price inflation” refers to the increase in the level of actual prices paid for goods and services. But I too was confused by this ambiguity until I read some materials that enabled me to understand that there were 2 different definitions. We see this happening every time we open up a dictionary and see multiple denotative and connotative meanings for the same word, usually in a numbered sequence.
  But a lot of confusion arises from the fact that writers and commentators often do not make it clear which meaning of the word “inflation” they are invoking, monetary inflation or price inflation.

Ralph Branca 22995

April 7, 2013, 4:25 a.m.

.....and… one seems to comment or think about the shrinking of food products while prices go up.  Look at the reduction of content in products like granola bar sizes, Starkist tuna can sizes over the years, candy bars, etc..  Why didn’t the Government consider freezing prices during such high unemployment to ease the impact on society?  We pay to get greater gas milage when buying a new auto.. but… gas then goes higher to bring us worse,  in total, where we started.
The CPI when introduced cause serious damage to our economy. No one considered the content of the number when giving increases(especially to unions,( ie. automotive).  For years the largest part of the content was medical and interest cost rates on borrowing. Most companies then were paying 100% for medical and those people who made their choices to upscale on housing were based on salaries increased. Yet no consideration was given to the number and portion of people the CPI really effected by other than their choice.

Emil Assentato

April 7, 2013, 3:01 a.m.

John, I’m surprised you would state, if there is inflation at higher levels why is the U.S. ten year note at 1.75%. Then later you recognize the extent governments (central banks) manipulate interest rates. The Feds balance sheet is over $3 trillion and they are buying $85 billion more securities each month, and arguably over 50% of our government’s exploding debt. We are a breathe away from being Argentina! 

You cannot have it both ways.

Joseph Moffa

April 6, 2013, 12:22 p.m.

When one reads about the Weimar Republic and the hyperinflation of that time it seems pretty clear to anyone reading about this episode that it was personal and definately an economic phenomenon.
To say that inflation is a rise in prices is wrong and it allows the perpetrator of inflation off the hook. You can’t heal any disease until you know the cause not the sympton. Ludwig von Mises clearly states the case.
To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflation” the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying “catch the thief.” The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices

April 6, 2013, 9:38 a.m.

E.G. Alexandersson (Prof of International Economics)

Inflation is a personal thing. It’s not an economical phenomenan. It is a statistical one.

It reflects the rise in prices of goods and services during a specific period in time for a specific basket of these things with arbitrary weights.

Each one of us has a specific consumption of goods and services whose variation in prices make the total spending of one month most probably slightly different for another month. This variation is what constitutes our inflation (or deflation). This should not include a one-off exceptional or extravagant spending item since this would constitute a high distortion in the computation of your personal price index.

Government stastistics should look at the typical basket of goods and services of different income segments of the population (say1 to 3 minimum wages, 4 to 5, etc.) and report these numbers independently (and maybe by State).

These numbers would have scant effects on bonds since these would be more related to the higher income brackets of the population, corporations, banks, financial institutions and goverment policies of different nations (Central Banks purchases).

In other words, aggregate demand and aggregate supply of bonds would determine their market prices and corresponding interes rates. Not your personal inflation nor the Government’s CPI which can be cooked in any way.

Jeff Martin

April 6, 2013, 6:55 a.m.

Couple of observations, John.
First, inflation is impossible without wage increases.  Rising prices are not the definition of inflation but rather the end result of inflation. Wage stagnation will keep inflation down for a long time to come. Sure, prices may rise, but only until demand wanes due to lack of purchasing power because wages aren’t rising.
Second, most of what you describe as inflation was actually part of the credit bubble that started in the late 1980’s and burst in 2007. With the Pacman style of capitalism that began under Reagan sending well paying middle class jobs overseas, the flatline of wage growth for most Americans was started.  In place of higher wages we were offered easy credit.  A myriad of cards and home equity loans; loans for college tuition and cars and boats replaced the “save and buy” mentality of the past. The price increases in all of those things was not inflation, it was a fundamental change in consumer behavior. Prices went up because money was artificially created by easy credit. Americans are still deleveraging and will be for maybe a generation. Without easy credit and with no wage growth, demand will hit a brick wall and prices will remain low.
Third, bond yields would be low even if the Fed was out of the market.  85 billion each month is not a big number.  If the market was truly out of value, even the Fed could not stop yields from rising. In fact, after QE1 ended, yields dropped on their own.
It’s clearly obvious to everyone except gold bugs that deflation is the greater threat in the coming decade in America and as long as we are the world’s largest consumer and wages are flat, it will remain so.

Jeff Martin

Lawrence Glickman

April 6, 2013, 5:55 a.m.

Once again you have missed the entire point of what is going on in the world. About 3-5 billion new workers in rapidly developing countries such as China and India are now dictating price and value of commodities and labor costs. Central banks like the USA’s Fed and Japan’s central bank believe that “inflation” is a desirable target as it prevents the downward cycle of “deflation” in jobs, goods, services and demand. This of course is absurd!! We are merely experiencing the “right sizing” of world markets dictated by the low cost manufacturers of goods and services and trying to prevent that with borrowed printed money is and has clearly been shown to be, a total and complete failure as shown by the recent numbers in the USA and Japan.

QE has produced what? 7.6% unemployment? Within a shrinking aging workforce and a debt burden that will come home to roost on future generations. A frozen manipulated real estate market with artificially inflated numbers based on withheld “shadow inventory” by banks allowed to mark their balance sheets to “Model” instead of “Market Reality”. A healthy DEFLATION to rational pricing of housing, medical services etc. based on world averages would be the only way to jump start new investment.

Until then all this talk of “inflation” being desirable is the just the last gasp of a dying group last century corrupt economies trying to protect special interest groups on the orders of “K” street lobbyists.

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