Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. — Wikipedia
There’s a lot of talk these days about inflation. Ben Bernake and the government don’t appear to be worried in the least bit. They think the inflationary period will be short and modest. I beg to differ.
The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation. — Ben Bernake, March 1st, 2011.
The first thing we should take note of in Bernake’s statement is the ambiguity of the words “modest” and “short”. Both of these words can have huge variations in their intended meanings when you have nothing upon which to compare them. Is 5 years short, because Japan has been in a recession for 12 years? Does modest mean an inflation rate of 10% because the last inflationary period was 20%? No one knows because the government either doesn’t know, or they don’t want you to know. The government must remain calm and appear in control, otherwise we could have chaos. There could be a run on the banks, the stock market could suffer huge losses or people may start hoarding commodities such as food, water and other necessities.
But first, I contend inflation is already upon us. There are a few early indicators one can look at to see if inflation is on the rise. However, a rise in price of one item means very little. For instance, if wheat prices rise while other food prices stay the same, it may simply be due to drought or some other circumstance that affected that particular crop or growing season. However, when you see an increase in price of multiple products within the same sector at the same time, it is an indication that the buying power of the dollar is under pressure. For example, below is a graph for the price of cotton over the last year. Cotton prices have risen about 166% in just one year! Including adjustments for historical inflation, cotton is now at its highest price in 140 years. Notice how the price is accelerating.
A rise in food prices is what really causes problems during an inflationary period, because it is a necessity to sustain life and everyone buys food. As of this writing, food prices in grocery stores have risen about 35% on average over the last year. If we look at the basic ingredients for nearly all our commercial food, we’ll see why. Corn, wheat, soybeans, and rice have all dramatically risen in price. In the graph below, we can see wheat has increased about 41% in one year. Globally, wheat is the leading source of vegetable protein in food, having a higher protein content than maize (corn) and rice. Wheat is currently second to rice as the main human food crop. When wheat prices rise, every food product made with it also increases.
Corn is another extremely important crop. Not only does it feed humans, it also feeds cattle and other domesticated animals. By looking at the graph below, we can see that corn prices have also increased dramatically over the last 12 months. Now, corn prices have been a little more volatile due to the government subsidies for ethanol production, so that may account for some of the rise. But I still think this is an indication of inflation because as we’ve seen, all the other major food crops are also rising in prices. If you notice, the corn prices are also starting to accelerate.
Coconut oil has various uses in food, medicine, and industry. It’s also very heat stable, so it makes an excellent cooking and frying oil, even though it somewhat unhealthy given its high fat content. It’s also popular in skin moisturizing creams, bio-diesel, and lubricants. As we can see by the graph below, even it is not immune from the inflation period we have entered. It’s also increased in price by about 183% … in one year!
So let’s jump out of food prices and look at some other basic commodities (I think you get the idea on food prices). How about rubber? It’s used in tires, construction materials, industrial products, shoes, and a multitude of other products. As you can see by the 5-year graph below, rubber has risen in price by nearly 200%. Over the last 10 years … it has risen 928%.
Let’s take a look at something a little less specific. For example, the commodity price index. This index is fixed-weight or (weighted) average of selected commodity prices, which may be based on spot or futures prices. As you can see, even this index shows a sharp rise in price. The last spike was during the recession a few years back. It would appear we are heading back to similar levels.
Based on the above graphs, there’s a pretty strong argument to the belief that we are in an inflationary period. The question now becomes how bad will it be and perhaps how long will it last. If you believe Bernake, it will be modest in its affects and short in duration. But again, what exactly does that mean? 1 year? 5 years?
There are a multitude of factors that can cause inflation. One of them is an increase in the money supply. In 2008, there was about $826 billion dollars in paper and coins in circulation (source: Federal Reserve). When the government passed TARP, the stimulus package and with Quantitative Easing (part 2), the amount of money in circulation has dramatically increased. It’s estimated that there is approximately $2 trillion dollars in circulation as of today. That’s more than double what it was just about 2 years ago. Strangely, the Federal Reserve site doesn’t want you to know how much money is currently in circulation. They will only tell you what it was 3 years ago before all the stimulus, bailouts, and quantum easing. Until this money is removed from circulation, the dollar will continue to be devalued.
To make matters worse, the Federal Reserve has monetized out debt, meaning, they are simply electronically adding zero’s to the big bank’s accounts. The money is then lent by the banks to the People and businesses which pumps the money into circulation. This crazy idea is a way to get the banks to start lending again.
From the banks perspective, If they fear that someone won’t pay them back, they don’t lend them money. This is why they do credit checks before lending their money. But if someone gave the banks free money (Federal Reserve) and they were allowed to earn interest on this money by lending it out, then heck … why wouldn’t they? It’s free money for the banks! It doesn’t matter if the lose it or not. It’s sort of like a stranger handing you $10,000 dollars, demanding you to gamble the money in Las Vegas in which you are allowed to keep all the earnings.
When the Fed lends money in this way, it is introduced into the money supply in the form of loans. Basic economics tells us, the more you have of something, the less valuable it becomes. The value of our dollar is dropping, as a result, it has less buying power. Because it has less buying power, it takes more dollars to by the same thing you bought for fewer dollars when the money was more valuable. This is why inflation in devastating; it hits everyone and it doesn’t matter what your money is invested in. It’s this principal that can devastate fixed-income retirement accounts and have a lot of folks either delaying their retirement plans, or re-entering the workforce later in life.