Inflation;
Rotten to the Core
By
Paul Mladjenovic
(8/2/07)
© August
2007. Paul Mladjenovic. All rights
reserved.
Recently, a
venerable financial news website ran a recent headline (July 31, 2007) about the
core rate of inflation;
“U.S. core rate of inflation falls to
three-year low of 1.9%”. It is pronounced as a positive development for our
economy and therefore treated as if it were an
important piece of news. Before we get to the “hard-core” analysis, I think it
would be helpful to do a brief primer on inflation. In the general
financial media, there is a surprising amount of misunderstanding and
misinformation on inflation in general and on the “core rate” in particular.
Let’s get some perspective on the terms and
principles (just in case a politician, bureaucrat or financial reporter is
reading this):
What is
inflation?
Let’s first
break this question down into the two types of inflation; monetary inflation and
price inflation. Price inflation is the general rise in prices of goods and
services. This is the one everyone talks about. You here the complaint “Gee…how expensive “fill in
the blank” has gotten!” It is important to point out that price inflation is
not a problem; it is a symptom. This is a very crucial difference. If
price inflation is a symptom, then what is the problem? The problem
is monetary inflation. “Monetary inflation” is a fancy phrase meaning the
creation (really “excessive” creation) of a particular currency. In our case, it
is the excessive creation of dollars. Those dollars can be infused into the
economy either through the actual printing (or
electronic creation) of dollars or through credit ultimately issued by a central
bank. In any case, monetary inflation is
the cause of price inflation.
Stated
another way, monetary inflation is the problem and price inflation is the
symptom. Monetary inflation means increasing
the money supply. Keep in mind that when we talk about “price inflation”, it
doesn’t always mean rising prices of goods and services; it can also mean that
assets can experience price inflation as well. Whenever we hear about an “asset
bubble” it is a reference to how an asset has risen in price far above its
realistic market price (the effects of supply-and-demand) due to an excessive
influx of monetary inflation. Some recent examples of asset bubbles
(excessive price inflation of assets due to the problem of monetary inflation)
are the Internet/ Tech stock bubble of the late 1990s and the real estate bubble
of 2002-2006.
It is an
important distinction to point out the difference of a “bull market” and an ”asset bubble”. A bull market—rising
prices for an asset (such as stocks, real estate, etc.)—is a natural and
ordinary event. It is an extension of supply-and-demand; there are more
buyers than sellers of the asset so the result is “rising prices.” An asset bubble is an artificial and
unnatural event. The rise in the price of the asset is primarily driven by
monetary inflation (such as through the excessive issuance of credit). Because a
bubble is unnatural and ultimately unsustainable, it inevitably “pops”; the
artificial boom then becomes an artificial bust. As the
economist Ludwig von Mises (www.mises.org) painstakingly pointed out,
booms and busts (as well as recessions,
depressions and hyper-inflation) are not creations of a free market; they are in
fact created by government mismanagement of monetary and fiscal policy. Back to inflation…
Why is it necessary to “fight
inflation”?
Inflation
is a pernicious and destructive economic force. Inflation at a real-world rate
of 2% or lower (preferably ‘zero”) is tolerable for an economy. 3-5% inflation is bad but it can be
manageable. Beyond that, it can be destructive. When inflation soars into double
digits and beyond, it can cause tremendous damage to the economy. Thanks to the efforts of private
sources (coupled with data from the Federal Reserve), it has been
recently (early 2007) calculated that price inflation is in the 6-9% range and
the money supply is expanding at an alarming rate of about 13%. Keep in mind
that inflation is effectively a hidden tax that wreaks the most havoc to lower
income and middle income folks. Inflation destroys purchasing
power and those with limited income, fixed income or little in the way of savings are
hurt the most. This is why there are many analysts that have voiced the opinion
that the United
States (specifically the Federal Reserve)
should significantly limit and/or shrink the growth of the money supply and
eventually return to the gold standard.
During the
hundred-year span of 1812-1912, there was virtually no price inflation as our
country strictly adhered to a gold standard. From 1913 to the 1930s, the
United
States slowly, partially and then
completely abolished the gold standard in
our economy. The end result was that a dollar that
was worth 100 cents in 1913 is now, in 2007, worth less than three cents.
The problem
today is that most people think that inflation is low yet the public record
clearly shows monetary inflation (and the resultant price inflation) growing at
a dangerous rate. The public needs to be informed so that proper planning can
avert a long-term disaster. If the situation does not markedly improve,
2010-2020 could rival the 1930s in terms of economic hardship.
If monetary inflation is the
problem, who is responsible?
“Monetary
inflation” and “monetary policy” are the responsibility of those in charge of
the money supply; typically the nation’s central bank. A central bank is
essentially the government-sanctioned entity that creates and manages the
general money supply of the country whether that money (“the currency”) is in
the form of dollars, euros, yen or what-have-you. For the United States,
our currency is obviously the dollar and our central bank is the Federal
Reserve. The bottom line is that the Federal Reserve is
responsible for the money supply and, therefore, monetary
inflation.
By the way,
let me address a point before people email me about it. Yes…the Federal Reserve
is technically chartered as a private
corporation but please make no mistake about it; it is a government
entity with the full backing and sponsorship of the federal government. What
private corporation has the ability to print money? Only a
government-sanctioned entity; in this case, the “Fed”.
When you
hear the Federal Reserve chairman, Ben Bernanke talking about “price inflation”
and “keeping a close eye on what happens with rising prices” and how ”rising
prices are inflationary” and so forth, it has to make a logical and discerning
person scratch his/her head. It is much like a prolific arsonist wondering out
loud about suspicious fires. Find out for yourself; here’s a research tip: Read
(or listen to) Mr. Bernanke’s recent speeches. He will talk very much about
price inflation but little (anything?) about monetary inflation. The last speech
I heard, he made inflation almost sound like the weather as if it “just
happened” and it was out there floating around in the atmosphere. At
congressional hearings, you’ll even hear him say things like “the Fed will do
everything it can to contain inflation”. At what point will those politicians
just say “stop printing so much damn money and price inflation will
come down!” It would be like the
authorities saying to the arsonist “If you would just stop setting fires there
would be less stuff burning down!” Get the picture?
So what should the Fed be telling us
about inflation?
They should
be informing us about monetary inflation. Specifically, the management and
growth of the money supply. The Fed can start by reinstating the M3 money
supply measurement which they stopped reporting in March 2006. M3 is the
broadest measure of the money supply and it is indeed a critical number for the
financial markets. Fortunately, M3 was reconstructed by private sources (such as
www.shadowstats.com). The money supply
growth rate hit an astounding and disturbing 13% recently. This is the real
problem and all of us need to be informed about excessive monetary inflation and
its’ insidious effects.
What is the core rate of
inflation?
Price
inflation is usually reported in two basic ways; “headline inflation” and the
“core rate of inflation”. Headline inflation generally includes a cross section
of the prices of a representative basket of goods and services that consumers (“the public”) contends with. The “core rate” is inflation excluding
“food and energy”. As headline inflation was running 6-9%, the core rate was
running at just under 2%. Ironically, even though headline inflation is a more
realistic measure of price inflation, it is the core rate that actually gets all
the headlines!
Why does the core rate exclude food
and energy?
That is a
good question and quite frankly, you will not get a rational, logical answer.
The answer most frequently given as to why food and energy are
excluded are because they are too “volatile”. I think a reasonable
response should be “So what?” If you can’t provide a meaningful measure on a
monthly basis, then do it quarterly, semi-annually or annually. If we can “send
a man to the moon” then surely we can provide a meaningful measurement of the
rising prices of consumer necessities (which definitely includes food and
energy!).
Why is the core rate
important?
Here is
where the controversy lies. When you talk to some reporters and economists, they will tell you that the core
rate is important to the Fed and to the financial markets. Please understand the
following point; the core rate is not important and it should be dropped or
ignored. As a financial planner, educator and writer, it is definitely not
important to me or to my clients, students and readers. What possible importance
does it have? It is only important to the Fed and to some politicians but beyond that, the core
rate is useless, meaningless and misleading. If this commentary sounds too harsh, then let’s
think about it for a moment. Think about why the core rate is
only important to the government.
It is not
an accident that Bernanke and other officials spend most of their time talking
about the core rate and not about monetary inflation or “real-life” inflation.
Imagine for a moment that you are the head of the Fed.
Would you rather talk about monetary inflation and the money supply (what you
are directly responsible for) or about something vague and distant like … the core
rate of inflation? If you were responsible for inflation, what would you rather
talk about; an inflation rate of 6-9% (the realistic inflation) or about
some benign, vague rate that is only a
measly 1.9%?
Let’s face
it; the more Bernanke talks about “the core rate” and about “being under 2%”,
the more the financial press reports the same. The average reporter ends up
thinking “gee, he’s talking so much about the core rate…it must be important!” Again, it is
important to the government because that way they can talk about
some seemingly innocuous measurement and
essentially keep everyone calm. “Excited? Concerned? About
what? After all, the core rate is only a measly 1.9%!”
The more
tangible reason for the government to under-report inflation is so that payments
to Social Security recipients and other pensioners are lower. Keep in mind that
the initial wave of baby boomers (78 million total.)
start retiring in 2008. Over time, every
percentage point that is not being paid is worth trillions. So now we can
see a solid reason why a lower inflation rate is important to the government. A
lower rate is good publicity and it also means trillions in
savings.
Why isn’t the core rate important to
the financial markets?
After the
government, who’s left? Is the core rate important to the financial markets? In
the financial markets, there are trillions of dollars in bonds and other
fixed-interest vehicles. Much of it is with rates in the 3-5% range. If they
think that the official rate of inflation is under 2%, they will presume that
they are ahead of the game. But is that reality? Of course
not. What good is a 5%, 30-year bond if inflation is 6-9% (or higher)?
Over time you are falling behind. In regards to the financial markets, the core rate is
misleading.
Why isn’t the core rate important to
retirees?
Millions of
retirees have their money in safe investments such as savings, certificates of
deposit and bonds. They have worked all their life to accumulate money for their
retirement years. Unfortunately, inflation is a cruel and stealthy tax that can
destroy their purchasing power. The “cost-of-living” increases they will get
from Social Security and other pension
programs will not keep them ahead of real-world inflation. Millions of older
citizens will see their prosperity erode over time. The core rate is useless to them. It is
in fact very detrimental to retirees.
Why isn’t the core rate important to
investors?
As you read
this, millions of investors are making choices with their money. What will they
invest in? If they think that inflation is benign, then they will invest
accordingly. But what if they were aware of real-world inflation? Think about
your own actions. What would you do differently if you knew that inflation was
8% instead of 2%? You would certainly invest at least a portion of your
portfolio in inflation hedges such as gold, silver, energy and related
securities. For investors, a return must
be generated that meets or exceeds the real-world rate of inflation. Yes…that
includes the costs of food and energy. Therefore, for investors, the core rate is
meaningless.
Perhaps I
have missed someone in this inflation discussion. How
about you… the reader? How important is the core rate to you? If it is
important, then please tell me why it is important. Please feel free to email me
at my website, www.supermoneylinks.com. If you have been able to
get by without food and energy costs…hey…I’d love to know how you do it. I will
even provide your answers to the readers of my newsletter, the Prosperity Alert
(with your permission, of course). I thank you in advance!
But before
you send me any messages about inflation (core or otherwise), allow me a
moment to write my own
letter…
An Open Letter to Ben
Bernanke
Dear Mr.
Bernanke,
I hope all
is well with you. I write you as a concerned citizen regarding your recent
public testimony. Your job as the head
of the Federal Reserve, America’s central bank, is assuredly
a daunting and difficult task and I wish you much success. The Federal Reserve plays a vital and pivotal
role in our country’s economic well-being. Forgive me for being so
forward but please consider the following. I think that you could serve our
citizenry much more effectively if you enact a few relatively simple changes.
They may be simple but they may not be easy. After all, nothing worthwhile is
easy. Here goes…
- Please reinstate the M3 money supply
metric. It is an
important measure of monetary inflation. This is a good way to know how monetary
inflation is affecting us today and how it will impact our future real-world
cost of living and the value of the dollar.
- Please stop talking about the core
rate. It is a
useless, meaningless and misleading metric that serves no one except the
government. It is very much like my local grocer boasting about the low “price
of clouds”.
- Give us a realistic measure of
inflation. This is
critical to know so that we can better manage our finances and that of our
families and businesses.
- Stop excessively inflating the
currency. History
tells us overwhelmingly that excessive monetary inflation has driven man-made
currencies into oblivion and has resulted in economic & social chaos for civilized
society.
Suggestions
# 1, 2 and 3 could easily be implemented immediately. Suggestion #4 will take
some fortitude since many influential
politicians (in both major parties) would prefer you do otherwise. Don’t take
the politically easy choice. Millions of hard-working folks need you to do the
right thing.
I realize
that you inherited most of your challenging tasks from Mr. Greenspan but that doesn’t excuse
you from your role as a responsible chairman of
the most powerful central bank in the world today. If you don’t enact the hard
and diligent responsibilities at hand (see four items
above) then America’s future will be a difficult
one for us and future generations.
I have had
the pleasure to hear you speak and to read your comments. As I listen to you, the following
comes across loud and clear to
me:
* You
spend little or no time addressing the problem
(monetary inflation).
* You spend
too little time addressing real-world price inflation
* You spend
very little time addressing the point that the dollar is losing value due to
excessive monetary inflation.
* You spend
too much time talking about the core rate of inflation which has no real value
to consumers, retirees, investors or anyone else for that
matter.
Doing the
right thing for our country would mean resisting political pressure and shunning
political expediency and popularity. But doing so would mean no less than our
country’s ability to survive and thrive as a great republic. If this sounds to
extreme than you may want to take a look at the scope of our daunting challenges
as documented at the Grandfather Economic reports (http://mwhodges.home.att.net/summary.htm).
I
appreciate your time in reading this sincere letter and again, I wish you much
success.
Regards, Paul Mladjenovic
P.S. Since
you keep telling us how low the core rate is, can you tell me what consumer
necessity has only gone up only 1.9% in the past 12 months? Can you tell us
where you shop? It would be nice to know! Thank you…J.
- - - - End of open letter - - -
-
In Summary (the bottom line) …
- The core rate is useless,
meaningless and misleading.
- Monetary inflation is the problem
and price inflation is the symptom.
- Real-world inflation and the growth
of the money supply (which shrinks the value of the dollar) are very real
problems and are getting worse.
What you can do about inflation to
help yourself and your country…
- Voice your displeasure and concern
with policy makers at the Federal Reserve. There is contact information at www.federalreserve.gov.
- Feel free to pass this article
(unchanged) along to others to alert them.
- Voice your displeasure and concern
with your representatives in Congress. Find them at www.house.gov and www.senate.gov.
- Voice your displeasure and concern
specifically with the members of Congress’s House Financial Services
Committee at http://financialservices.house.gov
.
- When you read financial articles and
see obvious errors about inflation or a glowing report on the useless “core rate
of inflation”, voice your concerns. Again, feel free to reference this
article.
- Take steps to protect/ grow your
wealth in an inflationary environment. Add some gold/silver and other tangible assets
to your portfolio, etc.
- Make sure your financial advisor
understands inflation and how to strategize to benefit you and his/her other
clients.
- Get and keep informed. See the next
section on resources.
Resources to keep you informed about
inflation and related economic issues:
There are
other great sites as well but these are good for starters. The wealth of data
and informed commentary at these sites will be very
worthwhile. If you need more resources, feel free to go to www.SuperMoneyLinks.com to either contact me directly or to get a
free subscription to the Prosperity Alert, my financial & business email
newsletter.
The
coming years will be treacherous for our
financial well-being and making informed decisions will not be a luxury; they
will be a necessity.
--------------------------------------------------
Paul
Mladjenovic, CFP is a national speaker, author
of Stock
Investing for Dummies and the editor of the Prosperity Alert Newsletter, A financial
& business email newsletter available free at www.SuperMoneyLinks.com and
www.PaulMladjenovic.com.