Deflation? Try A Tale Of Two Inflations

The crisis in Europe is causing concerns about deflation in the U.S. and other developed economies after weeks of financial-market turmoil. The fears are most pronounced in Europe, where a combination of spending cuts and tax increases could weigh on economic growth and feed into deflation.

Financial markets are reflecting a diverging expectation. Gold prices have been soaring—a potential indicator of inflation fears—while many other inflation indicators are going the other way.

In the United States, the loose monetary policy has not resulted in any significant rise at the consumer level or changes in inflation expectations, as evidenced by the sharply slowing Consumer Price Index and plunging M3 money supply.

Despite the seemingly tame headline inflation numbers, consumers never seem to see price declines in certain categories like education and health. For instance, prescription drug inflation escalated to 5% from less than 3% in 2007 and 2008.

So, it is pretty obvious what we have here--biflation--instead of deflation. Biflation is a state of the economy where inflation and deflation occur simultaneously. (Chart 1)

The price increase of commodities is caused by the increased money flow (via loose monetary policy) chasing them. On the other hand, the growth of economy is tempered with high unemployment and decreasing purchasing power. This has resulted in a greater amount of money directed toward essential items (inflation) and away from non-essential items and things required credit to buy such as house and cars (deflation).

Furthermore, the price at the producer level paints an entirely different picture. Producer Price Index (PPI) for finished goods was up 5.5% year-over-year.

“
In the United States, the loose monetary policy has not resulted in
any significant rise at the consumer level or changes in inflation expectations,
as evidenced by the sharply slowing Consumer Price Index...
“

All these stats may be correct.
BUT, I’ve been a bit staggered to watch the rise in food/produce
prices in our local area of Mid-Missouri.

And was also suprised how Unilever bragged about raising prices
during this latest “Great Recession”.

I know it may be all about sophisticated financial indices, but it sure
feels like prices for consumer goods have held steady or risen during
this economic downturn.
Which is probably not suprising given all the printing-press money
Obama and Co. have issued to the unemployed...and how some folks that
are about to lose their house stop paying mortgages for 6 months to
a year, thus having plenty of disposable income for consumer goodies.

(Of course, I’m not a practitioner of “the dismal science”, nor
do I play one on TV!)

It is always curious that people who crow about deflation never talk about commodity bubbles. It is malinvestment that causes bubbles and malinvestment is mostly caused by the Fed's low interest rate policies (along with some other govt policies and some irrational exuberance). That paricular balance is not between "inflation" and "deflation" but between Fed induced leverage and bubble-pop-driven deleveraging. Once the deleveraging kicks in really good like in 2008, the Fed can't do much but induce a lot more malinvestment to set up the next pop. It is a mistake to look at any of that activity and talk about inflation or deflation.

When deflation actually does occur, people defer purchases to wait for prices to fall causing producers to drop their prices. Now many producers can be propped up by any number of credit mechanisms so there won't be deflation. There won't be any in the future either.

Conversely inflation occurs when everyone gets rid of their cash because it will soon become worthless. That is happening in spades with gold despite intervention. It is happening with guns because guns will keep their value. It obviously won't happen with large screen TV's which are worthless after a year or two or with food because it is also perishable. Commodities don't reflect inflation as much because futures markets are short term and based on global economic demands, not country-specific currencies.

In short, we do not have, nor will we have deflation. We do have and will continue to have inflation and will get worse.

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