There is an intense debate on Wall Street about whether or not we are heading towards a massive inflationary problem or if we are stuck in a deflationary problem. Inflation is when prices go up and deflation is when prices go down.
If you are investing money, it is going to be important to get this one right. So many of the talking heads on CNBC are declaring that we are heading towards extreme inflation. They cite that the printing of money by the government is causing it. They also point to this “incredible” rebound we are seeing in the economy.
If you will bear with me, I need to put the KOOL-AID down so that I am not tempted to drink it. On the surface, it is inflationary when the Government prints enormous amounts of money. However, the story goes well beyond the printing of money. I regard these financial hosts as pretty smart people. I often wonder if these hosts are all told to always be positive no matter what? After all, they do work for CNBC, which is owned by GE, a publically traded company.
Here is the evidence of deflation:
The velocity of money – Dig out your economics book. The velocity of money measures the circulation of money throughout the economy. The velocity of money would need to be running pretty high to potentially create inflation. Currently it is very low primarily because banks aren’t lending money and consumers aren’t spending money.
A world overloaded with debt – Debt in itself is deflationary. Deflation is brought on by a debt crisis.
The money supply – The money supply has been decreasing and not increasing. You would need to see the money supply expanding at a great pace to see inflation.
The CPI and the PPI – The PPI or Producers Price Index shows whether or not the prices or increasing or decreasing at the producers level. In other words, are the widgets getting more or less expensive to make? The CPI or consumer price index shows what is happening to consumer prices. Are they going up (inflationary) or down (deflationary)?
The latest PPI numbers showed an increase in prices at the consumer level. When that happens, typically those higher costs get passed onto the consumer and are reflected in the CPI number. However, the CPI numbers released on Friday showed the first drop in 27 years. That tells me that companies are getting hit with higher costs but are not able to pass them on because the consumer is so strapped. That keeps a lid on prices. In fact, companies are dropping prices to get consumers to buy items. That in itself is deflationary.
To be fair, the CPI minus energy and food costs decreased. Yes we depend on energy and food which have been going up. I think that net effect is clearly deflationary.
In short, the reason that the printing of money is not causing inflation is simply because the printed money is not circulating. It is absorbing losses of all kinds due to the effects of the debt crisis. Until you get massive circulation which would show up in the above indicators, I think that we are stuck with deflation. Plus you better hope that it doesn’t turn into inflation. That would force the Federal Reserve Board to start aggressively raising rates which would easily throw us into a double dip recession if we aren’t already heading that way.