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Why Inflation Is The Economy's Hidden Iceberg In 2013
TMO ^ | 12-31-2012 | Martin Hutchinson

Posted on 12/31/2012 11:41:52 AM PST by blam

Why Inflation is the Economy's Hidden Iceberg in 2013

Economics / Inflation
Dec 31, 2012 - 06:35 AM
By: Money Morning

Martin Hutchinson writes: Even though Ben Bernanke's Fed has kept interest rates close to zero, inflation hasn't been a big problem since the 2008 financial crisis.

Despite what many observers have expected inflation has remained quite tame.

However in 2013, that may be about to change. One factor that might cause a surge in inflation is the fiscal cliff.

That's because Bernanke is already buying $1 trillion of Treasury and housing agency bonds each year ($85 billion per month) against a budget deficit that is about the same level.

That means the inflow of funds to the economy from the Fed and the outflow of money to fund the government's spending are about balanced.

However, if we go over the fiscal cliff the Federal deficit immediately falls to about $300 billion per annum. At that point, Bernanke would be injecting an extra $700 billion a year into the economy - which would have a corresponding inflationary effect.

The Case for Higher Inflation

But that's only part of the inflationary story.

Central banks around the world are also expanding their money supply. China has become more expansive, the European Central Bank is buying bonds of the continent's dodgier governments and Britain like the United States is monetizing nearly all the debt it creates to fund its budget deficit.

The big change in 2013 is now in Japan, where the new Abe government has told the Bank of Japan it wants much more buying of government bonds, to push the inflation rate up to 2%.

And just as Bernanke's money creation increases inflation internationally, Japan's new monetary push creation will likely increase inflation here in the United States.

In this case, theexcess money creation will get transmitted to inflation mostly through commodity prices.

The Thomson Reuters/Jeffries CRB Continuous Commodity Index closed recently at just over 300, about double its value ten years ago. And after a period of weakness in 2011-12, the index has recently showed renewed strength.

Now I admit, doubling in ten years may not sound very impressive, but that's a rate of increase of 7% per annum. It only follows that if the basic elements of everything we consume are increasing in price at 7% per annum, then impossible to believe prices overall will rise by only 2% in the future.

In one respect, we've been lucky when it comes to natural gas prices. Thanks to new "fracking" techniques the U.S. natural gas prices have been cut in half over in the last four years.

This has given both consumers and producers a boost, and kept inflation down. But the bad news is that natural gas prices appear to have bottomed out around April 2012, and are now well above their low. Going into 2013, higher natural gas prices may well be inflationary as well on the commodities side.

Why You Can't Trust the Inflation Figures

An additional factor tending to increase inflation is the tendency of official statistics to under-report it. This has not gone as far as in Argentina, where real inflation runs around 30% while official figures report inflation of 10%. Still, the official U.S. price indexes have since 1996 been distorted by "hedonic" prices, which adjusts prices downwards for the supposed "hedonic" advantage of chip capacity and speed enhancements in the tech sector. The effect of this appears to be about 1% a year, and it can be adjusted for.

However, a second fudge is about to be introduced. It's the "chain weighted" price indexes that both political sides have agreed to use to calculate social security and other payments.

The problem with chain weighting is that it assumes that consumers change their consumption patterns optimally according to price movements. In practice, actual human consumers cannot do this because they do not know in advance what relative price movements are coming. If they did it would be the equivalent of a ballplayer batting 1.000.

Here's why. ..

Consider an economy with two substitutable products-call them widgets and grommets. Initially both have the same price, but everyone buys widgets, which are slightly superior.

Then let's assume the price of widgets doubles in year 1. Everyone may switch to grommets, but these have not increased in price, and so the chain-weighted price index remains static.

Then in year 2, let's say the price of grommets doubles while that of widgets remains at the new higher level - so everyone switches back to widgets. But since these have not risen in price in year 2, the chain-weighted price index again remains constant.

So after 2 years, the prices of widgets and grommets have both doubled, but the price index hasn't moved at all. As I said, chain-weighting is a nothing more than a government fiddle.

The bottom line is that there's a substantial chance of a sudden upsurge in inflation in 2013, though the government statistics may reflect it only very grudgingly.

That will increase the costs of everything we buy, whatever the official statistics say.

As investors, we should avoid long-term bonds (even Treasury Inflation Protected Securities, which work off the official fudged price index) and keep a substantial portion of our wealth in gold and silver.

TOPICS: News/Current Events
KEYWORDS: economy; inflation; investing; stocks

1 posted on 12/31/2012 11:42:01 AM PST by blam
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To: blam
Inflation has remained 'tame' if you buy the BLS change from inflation measuring a set standard of living to measuring a declining standard of living.

The Red line measures a declining standard of living.
The Blue line measure a set standard of living

2 posted on 12/31/2012 11:52:38 AM PST by khelus
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To: blam

The current corrupt administration is trying hard to bring back rampant inflation.

Inflation is the statist’s gift that keeps on giving. When the value of money goes down, prices go up, including stock prices. Some mental midgets think that the DOW is the single index of how the economy is doing. When the DOW goes up due to money losing its value, the statists will crow that the economy is improving.

With inflation, the government pays entitlements in dollars that are losing their value; this enables the statists to claim that they are increasing benefits, while in reality they are just giving more worthless dollars.

Inflation doesn’t disturb the ruling elite’s benefits, (pay, health insurance, pension) which are adjusted for inflation.

Inflation turns savings into meaningless electronic digits, thus rendering poor all who have worked honestly and saved some money for their retirement.

Inflation makes all dependent on the state, except the ruling elite which doesn’t give a $h!+.

Out of control inflation can lead to a breakdown in the civil order, giving the statists an excuse to increase their control of the public or to do what they really want: establish at long last a Socialist Paradise.

The only reason why we don’t see more inflation is that the country is doing extremently poorly. This reduces demand on goods and keeps prices lower than they would have been.

3 posted on 12/31/2012 12:01:20 PM PST by I want the USA back (Inflation is the statist's gift that keeps on giving.)
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To: I want the USA back

———and saved some money for their retirement-——

The fallacy is saving. The money should be invested in assets that will rise in value to keep pace with the inflation.

Investing in the American economy via an index fund should preserve the capital and even register real growth. and then there is gold or real estate. All of the above should preserve the relative value after being inflated ,

4 posted on 12/31/2012 12:18:46 PM PST by bert ((K.E. N.P. N.C. +12 .....The fairest Deduction to be reduced is the Standard Deduction)
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To: blam

I live in northern California, so I am no stranger to regulation and price increases, even when the government pronounced that there is no inflation.

This economist shows that while The Fed claims there is little inflation, prices are skyrocketing.

5 posted on 12/31/2012 12:32:19 PM PST by whitedog57
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To: bert
'The fallacy is saving.'

Not at all. If 'we' did have more of a free market, and not what we have today. Saving would be perfectly fine.

Savers should and would be doing well if the Gov't wasn't the one sponsoring guarantees, loans, and investments. Banks would 'reward' savers with higher interest rates and the such.

As for the advisement of putting funds into index funds, sure, might as well be well rounded. But, since we don't have savers being rewarded; stock investing is fueled because of low interest returns. Thanks Gov't!

6 posted on 12/31/2012 12:40:18 PM PST by Theoria
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To: I want the USA back

Inflated dollars are the only way to “manage” federal and state debt, if it truly can be managed. Nobody really expects politicians to make drastic spending cuts. Do they?

For that reason, I am changing my portfolio from safe cash investments to a greater emphasis on stocks. I am about 5 years from retirement, and that is usually the opposite direction people go when they are my age. However, a 3% annuity is a worthless investment if inflation is 6%.

7 posted on 12/31/2012 12:42:47 PM PST by neocon1984
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To: blam

We’re Greece. This mess cannot continue. At some point all this debt is going to blow up in our faces and the economic bomb will explode.

8 posted on 12/31/2012 12:45:44 PM PST by RetiredArmy (1 Cor 15: 50-54 & 1 Thess 4: 13-17. That about covers it.)
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To: blam

I fully expect a transformational SHTF situation to begin showing its head this Spring and to get really bad before year’s end.

9 posted on 12/31/2012 1:08:56 PM PST by trebb (Allies no longer trust us. Enemies no longer fear us.)
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To: blam

The economy is like a giant Rube Goldberge machine. Even though you see the printing presses running overtime and not much yet is coming out the end, as sure as night follows day the real economy (wages and prices) will in fact respond to changes in the general amount of currency.

But consider this: if 47% of Americans depend to some extent on government money, and if 50% of government spending is borrowed and if the Federal Reserve buys 90% of federal debt by printing air-backed money, how much are incomes and spending being financed by money-printing?

If one fourth of all spending is financed by money-printing, how much would prices and wages have fallen had the money-printing not been done? Those wages and prices are the real economy. The economy we have at this very moment is being held up in mid-air by money-printing. I contend that we already have massive inflation, but we can’t see it because we cannot see the real economy. And if the gnomes at the Treasury and Federal Reserve have their way, we will never, that is until they lose control and the Federal Reserve gets exhausted by money printing.

That day will come, and when it does, we will have to deal with an economy that is grossly out of whack and we have such distorted price metrics that nobody will be able to adjust to what prices really must be.

10 posted on 12/31/2012 2:40:14 PM PST by theBuckwheat
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To: bert
The fallacy is saving.

Saving is not a fallacy. Government has made saving [intentionally] a foolish activity, but saving, under normal circumstances, is what creates economic growth and rising living standards.

11 posted on 12/31/2012 3:08:06 PM PST by BfloGuy (Workers and consumers are, of course, identical.)
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To: BfloGuy

-——Saving is not a fallacy-———

In the present context, there can be no saving in the old context. What you consider as saving, socking cash away, is actually losing. There is no return, the value decreases because of devaluation/inflation.

12 posted on 01/01/2013 7:33:20 AM PST by bert ((K.E. N.P. N.C. +12 .....The fairest Deduction to be reduced is the Standard Deduction)
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To: bert
What you consider as saving, socking cash away, is actually losing.

Oh, under the current circumstances, you are absolutely right. I took your statement about the "fallacy of saving" to apply in general.

13 posted on 01/01/2013 1:49:39 PM PST by BfloGuy (Money, like chocolate on a hot oven, was melting in the pockets of the people..)
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