CPI and Monetary Base Update – July 2015

The adjusted monetary base has been relatively flat, just as it should be.  There are always fluctuations, but the Fed is basically doing what it says it is doing.  Since it ended its so-called quantitative easing late last year, it has just been rolling over maturing debt.

As of this writing, the monetary base is just over 4 trillion dollars.  It is a quintupling from 2008.  But since much of this new money has gone into excess reserves, we haven’t seen huge price inflation.

Most everyone in the world of finance  is making a big deal of the Fed’s intention to raise interest rates later this year.  But the federal funds rate controlled by the Fed does not matter much right now because it isn’t dictating monetary policy.  The overnight borrowing rate is near zero because banks don’t need overnight borrowing due to easily meeting reserve requirements.

The only conceivable way for the Fed to raise the federal funds rate is by increasing the interest paid on bank reserves.  In other words, if the Fed finally decides to raise rates, it will just be another bank bailout.

Meanwhile, the consumer price index (CPI) was up 0.3% for June from the previous month.  The median CPI ticked up to 2.3% for June from the previous year.

Price inflation may have ticked up slightly, but it is still relatively low.  If the Fed is using this number, then it shouldn’t have much concern over price inflation.

Many people think that the Fed’s monetary inflation is bad mainly because price inflation is the consequence.  I have even seen many Austrian school followers make this mistake.  But price inflation is just one possible consequence.

The main issues with monetary inflation are that it redistributes wealth and it misallocates resources.  This happens regardless of whether higher consumer prices are showing up.

The relatively low CPI is somewhat accurate.  It at least shows us the trend.  It obviously does not carry health insurance as a big weight.

Still, most consumer prices are not going up by a lot.  Even if the government’s numbers are off, they aren’t off by that much at this point.

The low CPI numbers are consistent with what is happening with gold.  They are also consistent with the relatively strong dollar.

I am concerned about price inflation in the future because of what the Fed might do in reaction to the next economic slump.  In the short term, I am more worried about an economic downturn/ recession/ depression than I am worried about price inflation.

I hate to put it like this, but we need a correction.  This is why it isn’t fun being an advocate of Austrian economics sometimes.  We are seen as pessimists.  But really, we are just being realists.

While a correction will be painful, it is inevitable at this point.  We also need it in order to clear out the bad investment.  All of the misallocated resources need to be reallocated to reflect actual consumer demand.

Unfortunately, if we do have a big correction, the Fed and the government will likely react to just make things worse.  In this sense, we may ultimately need higher price inflation just to tame the Fed, similar to what happened in the late 1970s and early 1980s.

If we hit another downturn, the Fed will probably just give us more monetary inflation because prices are not rising much.  The only time we can realistically depend on the Fed to not inflate in the face of bad economic times is when there is high price inflation to go along with it.

My immediate concern is an economic downturn.  It is already happening in China.  Still, you should always have some gold and gold related investments as part of your financial portfolio.  You don’t know when the next surprise may hit.

Gold is not likely to go sky high until the Fed starts up its digital money printing again.  Until then, watch out for another recession.  Cash may be king in the short run.

Leave a Reply

Your email address will not be published. Required fields are marked *