Thursday, March 15, 2012

Inflation: Hell to Pay

I have a problem with the methodology used to measure inflation. In business we segregate operating expenses, those costs that recur on a regular basis, and capital expenses, costs that are non recurring and are better understood as a longer term "investments," such as equipment purchases, real estate purchases etc. In our personal lives, rent, food, gasoline etc. might be considered operating expenses. Buying a house (not the mortgage payment,) a computer, television etc would be more like capital expenses, not rapidly recurring costs.

Last year we had had 10% food inflation in our home operating expenses, probably 30% energy inflation, health care and education inflation are still running at 6% or higher, and things like airline tickets have gone way up. But we are told by Bernake and company that inflation is running at around 2%. The reason is that he is combining reduced capital expenses with increased operating expenses, a methodology which would cause endless bankruptcies if used for decision making in business.

The value in your home went down the last few years, computers are cheaper, as are TVs and many other large ticket items. When those declines are combined with increases in day to day expenses, the net is about 2%. Well, I don't need the latest model computer or TV to survive, and I don't need a new car or home. But I do need food, energy and health care. And they take up the largest percentage of most household budgets. Cheaper houses, TVs and computers offset very little, and they certainly don't help pay household bills. The inflation rate is probably closer to 6% than 2%.

If you think that is bad, the following is far more depressing. BBB, aka Banana Ben Bernake (banana republics have been printing money excessively for decades,) has repeatedly told us that he sees no sign of inflation, and as soon as he does he will raise interest rates and tamp it right down. Nothing to worry about. Laurence Meyers, Federal Reserve Governor from 1996 until 2002, similarly said that controlling inflation is simple. We know how. If the inflation rate pushes above 3%, we will raise rates and it is easily controlled. The arrogance by both of these men is only exceeded by their blindness.

Below are excerpts from a Bloomberg piece by Amity Shlaes listing inflationary cycles and assigning causes. The speed with which they occured was like a fire spreading through a dried timber building. "When you see the flood, it is too late to build the arc." I make no claim to understand all the dynamics governing inflation, and neither do I know when the cycle will occur. It could be one, 3 or 5 years, but the seeds have been planted. This is all going to end very badly.

Consumer price index for urban areas, went from 1 percent in 1915 to 7 percent in 1916 to 17 percent in 1917. How did it happen? The Treasury spent like crazy on the war, creating money to pay for it, then pretended that its spending was offset by complex Liberty Bond sales and admonishments to citizens that they save more.

 In 1945, all seemed well: Inflation was 2 percent, at least officially. Within two years that level hit 14 percent.

All appeared calm in 1972 too, before inflation jumped to 11 percent by 1974, and stayed high for the rest of the decade, diminishing the quality of life for all Americans.  

The thing about inflation is that it accelerates. The acceleration hit storybook levels in the most sudden case of all, that of Germany in 1922. Many financial analysts thought the Weimar authorities weren’t producing enough money. “Tight Money in German Market: Causes of the Abnormally Rapid Currency Deflation at Year-End,” read a New York Times headline. The Germans didn’t know it, but they had already turned their money into wallpaper; the next year would see hyperinflation, when inflation races ahead at more than 50 percent a month. It moved so fast that prices changed in a single hour. Yet even as it did so, the country’s financial authorities failed to see inflation. They thought they were witnessing increased demand for money.

Germany in the 1920s is always the extreme example. But one form of denial then warrants comparison to the U.S. today. Bernanke talks about prices in one area - energy, for example -- as different from those in the rest of the economy. The Germans, in their denial, thought their problem was limited to exchange rates, and that their domestic economy had hope. Risibly, Chancellor Joseph Wirth tried to tie down prices by regulating foreign currency. The equivalent, and equivalently risible move today is the Ralph Nader effort to get the administration to push down oil prices.

Based on his study of the Great Depression, Bernake has justified printing vast amounts of money (The largest lender to the US government by far is the Federal Reserve) by pointing to that "evil" genius deflation. The currency did deflate then, but perhaps he should look at the period preceding the depression. Deflation also punctuated the Coolidge administration, arguably the most prosperous economic period in American history.

Mankind has been in search of perpetual motion machines, a loom to spin gold from straw, and many other impossible dreams. Bernake and company (liberal economists) hopes that they can boost the economy with currency manipulation is just another in a long line of  fools dreams. Their result will be the same as all the others.