Wednesday, July 30, 2008

The Inflation Versus Deflation Argument - Part 1

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

One of the Federal Reserves two major purposes is to provide price stability for the American economy, a goal they chose to abandon in September 2007. While the Fed's interest rate policies after that time were highly inflationary, Fed officials excused their actions by denying that inflation was a problem, making rosy predictions that it would subside, and by assuring the public that they were capable of handling it and taking care of it in case it became a problem. None of this was true of course and the Fed's position increasingly lost credibility as gasoline and food prices skyrocketed in the U.S.

The Fed's biggest cover for its actions was the official inflation figures produced by the U.S. government statistical agency, the BLS (Bureau of Labor Statistics). The method of calculating the CPI (Consumer Price Index) was modified several times during the 1980s and the 1990s, with each modification producing a lower reported inflation number. Essentially these modifications involved reducing the importance in the CPI calculations of anything that was experiencing significant prices rises, thereby automatically lowering the final reported inflation numbers. It was hard for significant inflation to show up in the official government figures given this approach. By May of 2008, year over year CPI was only 4.2% in the U.S. despite rapidly rising energy and food prices during that period.

Recalculating CPI using the 1970s methodology indicated U.S. inflation was more likely around 12% (for more info:, almost as bad as it had been at its height in 1980. It became increasingly hard to convince the public otherwise, when the average U.S.consumer saw regular price increases at the gas pump and in the supermarket. Nevertheless, U.S. media continued to dutifully report the unrealistic official inflation figures as if they were true, helping the Federal Reserve perpetuate the fantasy on which it based its irresponsible monetary policy.

While the Federal government altered inflation calculations to produce the desired numbers in order to fool the general public about current inflation, lying about future inflation could not be done so easily. The augurs of where inflation was going, the money supply, are generally only looked at by the financially sophisticated. To solve this problem, the Federal Reserve simply stopped publishing the broad M3 money supply figures, the most telling number series of all, in 2006. Since many people realize that when a government hides information, its almost always information that would be particularly damaging if known, attempts to reconstruct M3 by private parties began immediately. By the spring of 2008, the reconstructed figures indicated that M3 was growing at approximately 20% (MZM, zero money, or cash and its equivalents was growing at an over 30% rate). The money supply figures indicated that U.S. consumer inflation was likely to peak at a minimum of 20% to 30% sometime around 2011. Depending on future readings, much higher inflation levels were possible.

The U.S. government's long-term misinformation campaign about inflation rates and its secrecy concerning money supply figures apparently didn't provide enough cover for the Federal Reserve. One group of apologists for the Fed (and the Fed had a legion of apologists who were feeding off the easy money gravy train that it was providing them at the expense of the American public) began publishing arguments about the risks of deflation in the U.S and how this justified an even easier money policy. Claiming that deflation actually existed in a period when inflation was getting out of control was by no means a new idea. It was in fact a prelude to some of the worse inflationary episodes in history.

NEXT: The Inflation Versus Deflation Argument - Part 2

For notes related to this talk, please see, 'Inflation vs Deflation Argument' at:

Daryl Montgomery,
Organizer, New York Investing meetup

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1 comment:


I will take deflation over inflation.