Why Isn’t Inflation Higher – part 1

Recently we discussed how the official U.S. CPI data is flawed as it excludes and replaces certain items, as well as “adapts” the relative increases in costs for goods and services used to calculate inflation. The end result being considerably lower inflation numbers than would be the case with for example the calculation methodology used prior to 1980.

In this article we take a look at the question: why isn’t inflation higher?

Real inflation, experienced by citizens, is definitely higher than the data the U.S. government publishes. Official U.S. inflation is below 2%. However, alternative methods of calculation – as well as some surveys – puts inflation between 4-10%.

The U.S. is not the only country that experiences price inflation though. In most countries the costs of goods and services are increasing and real wage growth is not keeping up pace – leading to a loss of purchasing power and wealth.

The reason behind the increase in inflation is primarily the stimulus packages that most governments launched in the wake of the credit crunch in 2008. The U.S. is probably the best example, but many other countries have followed suit. In fact, in 2009 all G-20 countries were on some sort of stimulus plan.

Today, Japan also stands out with a $1.4 trillion 2-year stimulus package in an effort to double the monetary base. The ECB in Europe, China, South Korea and a host of other countries are on similar programs.

Even though inflation clearly is higher than what the government says one can make some interesting observations when looking at how much the monetary base has grown and how much money we actually see in circulation. Doing so will reveal that we have yet to see significantly higher inflation numbers – maybe even hyper-inflation.

The graph below illustrates the St. Louis Fed’s measure of the monetary base – which is made up of bank reserves plus cash in circulation.


Source: U.S. Department of Labour

Between 2000 and 2012 the monetary base grew fourfold. Before the crisis in 2008 it was around $850 billion with approximately $40 billion in bank reserves. As a result of the significant QE1-3 programs today’s monetary base in the U.S. is around $3.2 trillion with more than $2 trillion in bank reserves.

Under more normal market conditions such a significant increase would flow over into the actual money supply. This has indeed happened, which is why asset prices have started to increase, but not to the extent that you would expect. The markets are behaving far from normal these days.

In the next part of this article we are looking closer at what we can expect going forward and why inflation is likely to increase.


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