What Is Inflation, and What Is Its Real Rate?

There are few better illustrations of the fundamental corruption of government than the inevitable destruction which inevitably results when it arrogates to itself the sole ability to define what “money” is and create it whenever it wishes. The consequences of government monopoly money provide an excellent window into the lies and deception which accompany government monopoly on anything, and nothing exemplifies this better than the concept of “inflation”.

Inflation, properly defined, is when the supply of money in circulation increases. This can occur for many reasons. When Spanish conquistadors looted South America of its gold and silver starting in the 16th century, all of this precious metal found its way back to Spain and ended up in circulation, resulting in the Price Revolution which caused the price of goods in Europe to rise, in terms of gold and silver coins, by a factor of six over a period of 150 years. This is easy to understand: it’s just a matter of supply and demand. If you increase the supply of whatever is used for money, then the amount of goods and services that money will buy will decrease by the corresponding amount. A similar inflation followed the discovery of gold in California in 1848, as the subsequent gold rush caused the amount of gold in circulation to rise rapidly and thus its purchasing power to decline.

But if you want inflation on a Biblical scale, nothing beats paper money, where a government, as its monopoly issuer, can just print as much as it wishes to cover the spending of profligate politicians or, in our modern digital age, not ever bother to print it but just create it through pure zap, making up digital “dollars” and dumping them into the banking system with a keystroke or mouse click.

History records a near-endless litany of great inflations followed by economic collapses over a period of more than forty centuries and all around the globe, but at the heart of every one is a government creating funny money and dumping it into an economy in the hope of deceiving the population into accepting it at its original value. As that sage economic philosopher Rocket J. Squirrel said, “Awwww…that trick never works!” But that doesn’t keep them from trying.

In 1913, the U.S. government turned over creation of its money to an “independent central bank”, the Federal Reserve System, with congressionally-mandated goals of “maximizing employment, stabilizing prices, and moderating long-term interest rates”. How well have they done? Well, let’s look at prices, which are just another way to talk about the value of the dollar. Here is the purchasing power of the U.S. dollar from 1913 through May 2022.

dollarcpi

How about that business of “moderating long-term interest rates”? Here, we only have data from 1954 through the present, but let’s see how they’ve done over that period, looking at the Federal Reserve’s own interest rate benchmark, “Federal Funds”.

fedfunds

Moderate, huh? The percentage change over a range of 0 to 22 percent is…infinite.

OK, so their performance on price stability and interest rate moderation wasn’t exactly stellar (unless you consider collapse into a black hole or a supernova explosion as stellar behaviour), but maybe all of this fiddling with the money was toward the end of “maximizing employment”. How did that work out? Here is a chart of the unemployment rate from 1948 to the present.

unemp

Heck of a job!

The Federal Reserve attempts to achieve its goals by adding or removing (HAH!) money from circulation. When it adds money, that is, by definition, inflation, and it reduces the purchasing power of each dollar in circulation, with the effects seen in first graph in this article. Let’s take a gander at “M1”, a measure of the amount of liquid money in circulation, from 1960 to the present.

m1

Notice anything odd? Looks like there’s a lot of new money sloshing around in the system, doesn’t it.

But that’s inflation, and we should expect the purchasing power of the unit of money to fall or, on the flip side, prices in general to rise. Is it any surprise that’s precisely what we’re seeing?

Now we come to the first big fraud in the game. Governments, their trained seal mouthpieces in the legacy media, and the midwit population who listens to and believes them, call this rise in prices “inflation”. In other words, they apply the name of the cause—increase in the money supply—to the effect—rising prices, because this allows them to escape blame, pinning it instead on “supply chain problems”, “greedy corporations”, “price gougers”, “gnomes of Zürich”, wars, foreign dictators, or, heaven knows, “climate change”—anything but the real culprit: printing money out of thin air. Thus, you will see charts in the media like the following, updated through May 2022.

flate1

That bold “Inflation" title is the bold-faced lie. Prices are rising because of inflation: they are not inflation. How and when prices rise as a consequence of an increase in the money supply is a complicated matter, as new money does not flow instantly or uniformly through an economy, but it is absolutely inevitable that eventually prices will rise in proportion to the increase in money supply.

But the price numbers they’re calling “inflation” are, themselves, compiled and reported by the same band of thieves and murderers who are printing the funny money. Can you trust them? What do you think? The “inflation” numbers most commonly cited for the United States are assorted versions of the “Consumer Price Index” (CPI), of which there are numerous variants and regional measures. Basically, they take a “basket” of goods and services, apply weights and fudge factors, then come up with an aggregate number that is supposed to represent the impact on a typical consumer of the overall increase in prices. Does it? The devil is in the details, and when it’s the devil incarnate on Earth that’s picking the fudge factors, what do you expect?

The last time the inflation racket became widely apparent in the U.S. was during the inflationary era from the mid-1960s through the early 1980s. During that time, the populace began to wise up to how they were being pushed into ever higher tax brackets due to “wage and salary increases” which failed to even keep up with rising prices, how their savings and investments had a negative return in terms of purchasing power and were, as a double whammy, taxed as if the dollars they returned were worth as much as those paid for them, and how retirees and others on fixed incomes were being reduced to pauperism as the pension payments they had been promised fell in value every month as the dollars in which they were denominated evaporated in value.

Once it became apparent what was going on, and the media even began to report money supply figures as they were released, the natives began to become restless and politicians, always seeking to cover their tracks before things get to the torches and pitchforks stage, rolled out “indexing” (or the even more clumsily named “indexation”) as the “solution” to the problems they had created. If, for some mysterious reason, the dollar was falling in purchasing power, they would automatically adjust tax brackets, pension payments, and interest rates on some government debt to automatically compensate and maintain these at fixed levels in terms of purchasing power, usually defined in terms of some flavour of the CPI.

But, like most government solutions, this created more problems. For many years, government had been using inflation to pick the pockets of the populace without too many wising up to what was going on. Once they let it get out of control and it became obvious, they were forced to introduce indexing based upon the CPI. But this threatened putting an end to the gravy train—more and more money flowing into the trough by pushing taxpayers into higher brackets, increased sales and property tax income for states and localities, taxes on “capital gains” that were mostly or entirely due to currency depreciation, and slow but inexorable liquidation of debt and pension obligations as fixed income payments eroded and pensioners sampled the variety of canned cat food available at the supermarket.

Since all of these indexing adjustments were based upon the CPI which, after all, was calculated by a U.S. government agency, the Bureau of Labor Statistics (BLS), it was not long until the Aha! moment arrived. “The CPI is whatever we say it is!” And so it was, starting primarily in 1980, when the great 1970s inflation was just topping out, that the Department of Jiggery-Pokery—sorry, BLS—began a series of “revisions” and “adjustments” to how the CPI is calculated, changing the mix and weighting of items in the basket, and applying “hedonic index” corrections to compensate for supposed increase in the value of products independent of their price, for example the performance of personal computers at a given price point.

Care to guess in which direction all of these CPI adjustments went?

Right in one: they all reduced the CPI compared to the way it was computed previously, with two major revisions in 1980 and 1990. So when you read that “inflation” as measured by the CPI was 8.6% annualised for May 2022, that means the number reported was that calculated by the 2022 method, with all of the changes and tweaks over time.

Now, if you, as most people, live in the real world and buy groceries, fill up your car’s gas tank or home heating oil cistern, pay your electricity bill, and other regular expenses, you may have noticed quite a gap between these reported “inflation” numbers and how much more you’re paying for everything. Then, you might ask, whether the CPI can be trusted any more than anything else produced by the government and, in particular, what the number would have been without all the jiggery-pokery cranked into its calculation since 1980.

Fortunately, for many years John Williams has been publishing a Web site called ShadowStats.com, which regularly computes and publishes a variety of government economic statistics, including the CPI, money supply, unemployment index, and gross domestic product, using the formulas employed by the government agencies that compile them prior to their redefinition over the years to produce “better results”. Here is the ShahowStats CPI “Inflation” chart through May 2022 computed according to the way the BLS computed it prior to 1980.

sgs-cpi_1980

This is the same chart, but starting in 2000 and using the method and parameters used prior to the 1990 revision of the CPI.

alt-cpi-1990

So, take your pick. According to the official BLS CPI, “inflation” for May 2022 was at an annual rate of 8.6%. If it were computed using the definition in effect in 1990, it would have been reported as around 12%, and based upon the definition prior to 1980 when the phony figures began to be fudged to cope with funny money, it stands at 16.8%.

Which feels closer to reality to you?

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God willing, after this U.S. Federal Reserve / China Yuan caused disaster – leaders will reflect after establishing a stable currency, “we are all Von Misesians now!”

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No disagreement that the problem is a Political Class spending more money than it takes in through taxes & borrowing, and printing paper to make up the difference. It is worth peeling back another layer of the onion to ask why the government income side falls short of their spending desires?

Part of the issue is that human wants are infinite. Throughout history, rulers have always ended up spending more money than their peons could provide – with grievous consequences for their societies. The other part of the issue is that politicians love to meddle, and their meddling (no matter how well intentioned) inevitably reduces the production of real goods & services, which in turn reduces real tax revenues to governments.

Part of the solution to what ails us is going to have to be a vigorous program of roll-backs of excessive regulation, along with very substantial reductions in the number of people employed in middle class jobs such as lawyers and bureaucrats. And that will be very unpopular (at least initially) with those who are pushed from overhead into production. But it may be less painful to try to balance the Political Class’s books through increased tax revenues from booming real business than through major reductions in government spending.

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While he was Trump’s economics advisor, I heard Larry Kudlow asked about the persistence of deficits in good times and bad, regardless of the political parties in power in various branches. He said, “The truth is, the American people want about 25% more government than they’re willing to pay for.”

But I’m not sure this is the case, and doesn’t put the blame where it doesn’t belong. Suppose you put the big discretionary spending items up to a national referendum. Do you think people would vote for the aircraft carriers, fighters, bombers, etc. that take 20 years to field and don’t work? No less would they vote for hordes of diversity undersecretaries or people writing regulations about the shape of catsup bottles.

What’s going on is the classical imperial capital corruption that a bureaucrat from Babylon would instantly recognise. The political class is voting other people’s money (and money they borrow or just print) in order to enrich their corporate and union patrons who, in turn get out the vote to keep them in power and stuff money in their pockets. This is a closed loop into which the people have little or no visibility or ability to influence.

The only way it ends or slows down is when the bond market takes away their credit card, and with the ten year Treasury closing today at 3.366% (interest rate up 6.65% in one day, which is a three exclamation mark event in the government debt market) we may be getting there.

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Sadly, there is another way for it to end, as the Weimar Republic demonstrated. Why should the Political Class care about the bond market as long as they still have the keys to the printing presses?

The part I wonder about is – What is in it for major exporters to the US (mainly China, Germany, Japan)? How do they gain by trading valuable real goods & services for depreciating Bidenbucks?

We can safely ignore Germany & Japan; their economically irrational behavior is of a piece with their general irrationality. But China? Could it be that the cost to China of making the US heavily dependent on Chinese imports is preparation for economic warfare? If you like your Walmart, you can keep your Walmart – provided you do what the CCP tells you to do.

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This is a bit of a mystery if you look at it on the large scale and a long time horizon, but from the frog (or perhaps locust) perspective of politicians it may make sense. What they are buying is domestic labour tranquility and support from their industrialist patrons. As soon as they stop pumping money into the treasuries of their customers, their export business will collapse, which makes the manufacturers and their workers irate, which is bad for the politicians held responsible.

A similar (but not identical) dynamic was in effect in the great Wiemar inflation in the 1920s. There are many misconceptions about this, which I discussed in my review of Adam Fergusson’s When Money Dies. One of Rudy Havenstein’s main motivations was to keep Germany’s export market strong to generate the hard currency to meet reparation payments, keep the workers at full employment, and avoid industrialists abandoning support for the government. A weak mark on the foreign exchange market promoted all of these goals while, initially, only causing modest price increases compared to what had been experienced during the war. The inflation was not intended to liquidate the reparation debt: that is a misconception because the debt was denominated in gold. But it did boost exports, which generated foreign exchange that could be used to pay reparations.

We know how it all ended. (Well, actually many of us don’t. The inflation did not even remotely directly lead to the rise of Hitler, who only came to power a decade after it ended and had largely been forgotten.) But it destroyed the middle class and created grievances that led to emergence of radical movements on all sides after the Depression caused the economy to collapse.

It may seem, and even be, a rational decisions by Chicom leadership to keep recycling some of the mountain of depreciating dollars they have accumulated back into U.S. debt to allow U.S. consumers to go on buying the Chinese junk that keeps their factories afloat and their workers out of the street.

If that 10 year Treasury note interest rate ticks back up to its historical mean of 5%, however, all bets are off.

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Maybe it is a simpler calculus for the CCP. They are an old civilization with a much longer time horizon (decades-centuries) than ours (minutes-seconds). Surely, they can see that this country’s competence, coherence, competitiveness and whatever else makes a going nation, are rapidly disintegrating. If, in the near future, we can no longer buy their stuff, how can the workers blame the Party? Our dissolution may be the Party’s “get out of jail free” card.

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That is a possibility – although the CCP has (with some historical justification) for some time been heavily promoting the theme of the “Century of Humiliation” which began with England’s Opium Wars; collapse of the West would undoubtedly be presented as a victory for China and appropriate punishment for our ancestors misdeeds. The question would be what to do with the excess labor freed up when it would no longer be necessary for China functionally to donate real goods to the West?

We might ask what did the West do with Western excess labor when we outsourced all those manufacturing & design jobs to China?

We sopped up some of those now unnecessary labor hours by greatly expanding educational requirements – effectively disguised unemployment; the classic is the German student finishing university and entering the work force at the age of 30. We also sopped up a lot of that excess labor by hiring people as government bureaucrats to impose & enforce ever-expanding regulations, and we topped it off with diverting many talented individuals into counter-productive lawyering.

What should China do with its excess labor when they decide to bring the West to its knees by insisting on payment in Renminbi for all exports? They would be well advised not to follow in Western footsteps. Instead they could employ massive numbers of people as would-be authors of the Great Chinese Novel. Those individuals would mostly be unproductive, of course. But at least – unlike in the West – they would not be getting in the way of the essential continuing level of production to meet China’s internal needs.

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While I fully acknowledge that incompetence and corruption in government have led to horrible economic and monetary consequences, I don’t think it’s helpful to think about inflation in terms of the money supply.

When dollars were backed by gold and silver, every new dollar meant a little less value behind every other dollar. When dollars are backed by the state itself, every new dollar is just another dollar - as long as trade is being done in dollars.

What we’re seeing in the past few decades, and more pronouncedly in the past 5-10 years, is the decline of the USA as the dominant world power, and the weakening of the USD’s international reserve currency status. The introduction of the Euro was a blow, but given the near-vassalage of the EU to the US, not fatal. However, cutting off Russia from the USD was a great blunder by one of the weakest administrations in living memory. Biden et al. seem to have tried to alienate as much of the world as they can with a somehow even more disastrous foreign policy than past regimes, and played the nation right into the multipolar ambitions of Russia and China. Their lackeys in the EU were only too glad to follow suit, and also suffer.

Now the Gulf States, Latin America, Africa, and central and south Asia are flexing their sovereignty. There’s almost no possibility of effective diplomacy from an ideologue like Blinken. Sanctions are a double-edged sword that seems to have dulled from overuse. Can we coup our way back from the brink? I doubt it, but I don’t doubt we’ll try.

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A Time for Reckoning | AIER points out that a lot of the new money in 2020 went into the stock market. But the P/E ratios don’t justify more investment, so it’s now going elsewhere and pushing prices up there.

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Inflation IS the money supply. It’s simple supply and demand. If you can suddenly buy more things, your money would be worth more (deflation). If you suddenly have more money, you will want to buy more things, but so will everyone else, so the prices go up (which we call inflation).

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This has been the historical pattern for previous injection of new money into economies, especially during times of economic slowdown. Newly created money flows first into the banking system, driving down interest rates. This immediately makes leveraged speculation more attractive, which results in bidding up the price of financial assets (a.k.a. stock market boom/bubble) and, by reducing mortgage rates, real estate prices. The money takes a while to move through the python, but eventually the effects become apparent in producer prices (raw materials, manufacturing capital equipment, construction costs), and as these prices are passed on, consumer prices come next. Wages are usually the last to move, as workers demand raises to cope with rising cost of living. So far, this episode of money creation (which started in 2008) has pretty much followed the usual pattern.

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As an indication of how differently price increases can be perceived depending upon an individual’s spending pattern, here is a chart of the U.S. Consumer Price Index (CPI) from 1966 to the present, plotting only the components for utility costs, gasoline, food at home, and electricity—in other words, necessities where it is difficult to reduce demand.

This indicator has now reached 25% year on year growth, just slightly below its peak in the late 1970s inflation.

The Bureau of Labor Statistics publishes the individual components of the CPI every month, so it is easy to compute your own custom CPI including whichever components and weighting you wish.

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Shadowstats isn’t a serious alternative to the government statistics. His main contribution is a faulty methodology, in essence mistaking cumulative inflation error for yearly inflation error since 1980:

Even before reading that, my instant reaction to the Shadowstats inflation graph was “what has he done other than take the official graph and add three percent to it?” That was more than a decade ago; now it’s more like six percent. But it’s still the total difference over time, yet interpreted as if it were the yearly difference.

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I don’t disagree that ShadowStats overstates CPI and the BLS understates it. However, I think the key point John is made is correct. The CPI isn’t inflation. It is one result of inflating the money supply and calling it inflation has been used to confuse the people.

I see so many economists and business people taking about how all the money printing from 2007 onwards did not cause inflation. That QE doesn’t cause inflation.

Let me ask a simple question. Who got those dollars? Imagine creating 10 trillion dollars and giving it to Bill Gates. Will food prices rise tomorrow? No. Did it make everyone’s money worth less? Yes. Those closest to the printer in 2008 got the dollars and they used them to buy up assets. How many houses did the finance sector purchase between 2008 and now? How many Senate seats? Wonder what PPI (Politician Price Increase) has been?

A couple charts based on those $100 contributions from Joe the plumber.

image

FusionCharts

That is an exaggerated example in an attempt to illustrate a couple points.

Money printing may not show up in CPI based on how it is distributed. Those closest to the printer get most of what comes out of the printer. Money printing is a problem even if it doesn’t run up the CPI. If that money is not equally distributed to everyone such that everyone’s money goes up an equal percentage, then a small group of people become hugely advantaged. The more evenly distributed the printed money the more likely it will be seen in CPI. Thus, as soon as we had stimi checks that distributed the money more evenly, it resulted in CPI.

Third, the system is complex. Simply because economist have some formulas and show some math doesn’t mean they understand jack. Results tell us they don’t. I used Bill Gates because Bill thinks you can change a couple lines of code, not check it and if it compiles, it was successful. This is how economists think. Wait for the blue screen of death.

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One thing about “printing money” these days is that sometimes they actually can “un-print” it. A lot of what they did in 2008 was to buy up bonds. (Likewise in 2020). The Fed prints money, they use it to buy up bonds, and this increases the money supply. But then they can reverse this by selling those bonds again: the bonds go out, the money comes in, and the money goes into the shredder – metaphorically speaking, that is; all this money is really electronic.

Where does this fail? Easy: when they buy real crap bonds. Then they don’t get as much money back as they spent to buy them. The extra money is still out there boosting the money supply. But both in 2008 and in 2020, they were pretty conservative about what they bought, so this didn’t apply. Or at least it hasn’t yet in the case of 2020; the Fed still owns a lot of those bonds, so the final verdict hasn’t yet been delivered. But they were pretty conservative: although there was much talk about the Fed buying junk bonds in 2020, they ended up buying hardly any of them. Most of what they bought were government obligations: Treasury bills and government-guaranteed mortgages. (It’s crazy for the government to guarantee mortgages, but once having guaranteed them, for the government to then buy them up introduces no additional risk.)

As for “how can they do any of this without at least some temporary price inflation”, most of the money in existence is created by the banking sector: people who deposit money in a bank still think of it as their money, but that money is mostly loaned out, and the recipients also think of it as their money: it will eventually have to be repaid, but they borrowed it in order to spend it. Both sets of dollars are competing for the same goods, which tends to drive up prices. But when there’s a banking panic and this process stops working, it destroys money; in that circumstance the government can print money to fill in the gap without it raising prices.

What’s making for real inflation now is that much of the money wasn’t printed in response to a banking panic: it was printed to just give out to people who weren’t working because of the lockdowns. The idea was to maintain their incomes so they could continue consuming even though they weren’t producing. Of course in such circumstances goods become scarcer and their price is driven up.

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We can keep track of this by watching the Federal Reserve balance sheet (total assets).

fedbal

From this it’s clear where they went from regular fiat money to ironic money in 2008, then down the rabbit hole in 2020. There has been precious little “un-printing” along the way.

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There is another sponge of seemingly unlimited capacity which soaks up fiat dollars in ways which are more difficult to quantify without a deeper dive than I know how to do. Bonds are only one small piece of this. The “financialization” which is now considered the “new normal” is truly unprecedented in its scope and depth. The total nominal value of this class of “assets” is astronomical. Who understands derivatives in depth? OK, start with futures contracts and work your way all the way down to NFT’s. What this is, at base, is an exponentially-growing mountain of paper or electronic (for which people pay money) increasingly-tenuous claims against a linearly-growing quantity of actual wealth. It is in the tradition of Signore Ponzi writ extraordinarily large. Think cosmic inflation of space-time just after the big bang. Like all exponential functions representing reality, it simply cannot keep going.

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Hmm, I’d thought that they’d at least sold their stockpiles of mortgage-backed securities after 2008, but even those seem to have only halved (or so).

This doesn’t mean they’ve gone to funny money, though. A consequence of the banking sector doing most of the money creation is that if after a crisis the government orders the banking sector to permanently retreat from its previous extravagance in money creation (as in no longer being in debt up to their eyeballs), then the government can leave the money it printed for the crisis circulating in the economy rather than trying to un-print it, and still get stable price levels.

After 2008, requirements on the financial system got tougher: leverage ratios of 40:1 or so, which financial giants like Goldman Sachs had been operating with, were no longer permissible. Now as the anatomical analogy goes, perhaps current leverage ratios (more like 10:1) should be described as being in debt up to their shoulders, and seen as only slightly less decadent, but in terms of money creation it matters a lot: that leverage ratio is also the monetary expansion ratio.

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I have been told that one of the reasons prices haven’t risen as much as we would expect given the massive expansion in the money supply is that banks are hoarding great amounts of cash. Here is a graph from FRED showing the total cash assets of U.S. commercial banks from 2000 to the present:


Why are commercial banks holding so much cash? Are they waiting for interest rates to rise? If they are, then wouldn’t an interest rate hike trigger a massive influx of cash into the economy with accompanying price increases (the opposite of the intended outcome of such a policy)?

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