Inflation Is Looming On America’s Horizon

[Purveyor]

By Martin Feldstein

Published: April 19 2009 18:54 | Last updated: April 19 2009 18:54

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases.

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FINANCIAL TIMES: http://www.ft.com/cms/s/0/ae436dbc-2d09-11de-8710-00144feabdc0.html

[dkf]

1. Does anyone think that demand is going to outstrip supply anytime soon?

Well that is when you need to worry about inflation.

[snappyturtle]

3. Having paid a visit to Home Depot this afternoon I am assuming that

it agrees with you. I noticed area rugs and dish washers had to be 'Special ordered'. They are available from a warehouse and it takes a few days. But, it was very evident that there was no stock in the store for these items. They didn't even have a replacement for the dish washer and would not sell the floor model. My husband is a builder and he has found he cannot always get the products he needs without first 'special ordering'.

I also noticed items just plain gone...e.g. wallpaper and the large magazine/book section. There were a few assorted mags on small wire stands placed around checkouts. The lighting section was lacking too. Lots of employees though which I was glad to see.

[Cleita]

2. I actually don't see any other way out of the massive debt that was incurred

during the Bush administration and continuing under Obama out of necessity. Be prepared to kiss your life savings good by.

[Laelth]

4. I'll take inflation over deflation any day.

I think the author's fears are overstated and borderline ludicrous.

:dem:

-Laelth

[Davis_X_Machina]

5. Until there's some small, but predictable...

...inflation out there the money stays in the mattresses.

The up-side -- we'll all starve virtuously.

And the bond market will be happy. Clinton used to say if he had to do it over again, he'd come back as the bond market, instead of the president, because he'd be more powerful...

[madrchsod]

6. ya right....

tens of millions with no access to credit and wages that are at the level of the 1970`s. inflation is the least of our worries.

[lib2DaBone]

7. Must be good news.. inflation everywhere except real estate...

Dozen eggs last week $1.00... this week $2.00.

Gas last week $1.90.. this week $2.10

The problem.. government workers are still getting pre-crash wages (and even increases) while the rest of America sucks wind. Hint: property taxes will continue to go up while your house value goes down..

Solution.. get a job on your City Council or County Commission... gold plated silver lined job security.

[exboyfil]

8. You are on to something about getting a government job

Many government jobs (Federal and many states) have inflation indexed Defined Benefit pensions. Most industry pensions are not inflation indexed (some take the last five years average as a baseline for a percentage based on years worked while others like mine take your full career average earnings as a baseline). I see many people who retired early out of large companies thinking they will not have a problem eventually running short if inflation really kicks in.

The pensions above and Social Security (also inflation indexed) will eventually fund a positive feedback inflation loop. Add the usually auto inflation adjustments to salaries, and you are looking at a huge upward push on prices (until the political will is enough to stop it).

I notice longer term Treasury Inflation Protected Bond yields are trending up slightly (my value in them has dropped). If they get back above 3% again then I will pull the trigger on some more. I put 40% of my portfolio in them in November (near the peak yield).