The era of aggressive monetary policies over the past eight years raises a compelling question regarding consumer price inflation. Although the expansion of the money supply inherently suggests inflation, the striking reality is that after a quadrupling of the monetary base, consumer prices have remained surprisingly stable.
The latest Consumer Price Index (CPI) figures indicated a mere 0.2 percent increase in March. This figure hardly reflects a significant devaluation of the dollar, which has actually appreciated by 20 percent over the past year.
While consumer prices remain steady, we have witnessed substantial asset price inflation. Since the market bottom on March 9, 2009, the S&P 500 has surged over 217 percent, indicating that the primary market index now commands more than three times its value from just six years ago.
In contrast, treasury yields remain at historical lows, with the 10-year note yielding a mere 2 percent, reflecting a minimal risk premium on dollar-denominated government debt.
Anecdotally, certain prices seem exorbitant. The escalating costs of college tuition are a prime example, and hotel room rates in San Francisco have reached eye-watering levels. Conversely, items such as blue jeans and laptops are surprisingly affordable. Given the substantial monetary maneuverings, shouldn’t we expect widespread price hikes?
Additional Insights
Interestingly, the supply of consumer goods appears to have dramatically outpaced demand. Affordable foreign labor has facilitated a flood of inexpensive products flooding the market, yet consumers are not buying them at the anticipated rate.
The most plausible explanation for the disparity between the significant increase in the money supply and the modest increase in consumer prices is the sluggish velocity of money. The federal funds rate has lingered near zero for over six years, while the Fed has more than tripled the monetary base. Yet, this influx of credit remains largely stagnant within bank balance sheets and the stock market, trickling into the real economy at a crawl.
One reason lenders may remain hesitant to extend credit is the scarcity of creditworthy borrowers. It’s possible the economy has reached a saturation point where further debt expansion isn’t feasible. While the reasons remain murky, economist Martin Feldstein offered some insights on this subject recently.
“The overall unemployment rate has dropped to just 5.5 percent, with the unemployment rate for college graduates at a remarkable 2.5 percent. The inflation typically seen at such employment levels has been temporarily delayed due to the decline in oil prices and the 20 percent appreciation of the dollar. A stronger dollar not only reduces import costs but also puts downward pressure on domestic products that face competition from imports.”
“Inflation is likely to start rising in the coming year.”
If Feldstein’s projections hold true, and inflation does begin to rise, it would imply a weakening dollar and an uptick in oil prices. While we may not share his belief that this shift will occur imminently, we acknowledge his expertise and recognize that anything is possible.
Connecting the Dots on Employment and Inflation
Simultaneously, the economy seems to be struggling for breath, akin to a fish out of water. According to preliminary estimates from the Commerce Department, the GDP grew at an adjusted annual rate of just 0.2 percent in the first quarter. Unsurprisingly, they attributed this slowdown to the weather. More clarity will emerge with the next employment report.
As we connect these dots, several possibilities intertwine: a slowing economy coupled with the prospect of rising inflation. This combination presents a scenario of stagflation.
Typically, stagflation arises when both unemployment and price inflation trend upward simultaneously. To assess the current situation, one could calculate the misery index by adding unemployment and inflation rates. Presently, this index is low, but it could change rapidly. What does this signify?
The Phillips curve suggests an inverse relationship between inflation and unemployment. When unemployment rises, inflation typically falls, and vice versa. However, how can both indicators rise concurrently?
This phenomenon can occur only through significant government intervention in the economy and credit markets, creating another distortion akin to the Dow reaching 18,000 or escalating wealth disparities.
In conclusion, the current economic landscape presents a complex interplay of stagnation and inflation. While theories abound, the outcomes remain uncertain, underscoring the importance of vigilant observation in the months ahead.
Sincerely,
MN Gordon
for Economic Prism
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