It isn’t your imagination that everything costs more. Of course, we all see it plain as day at the gas pumps. And every trip to the grocery store generally reminds us too when we take a $6 loaf of bread from the shelf, buy apples for around $3 per pound or pay over $5 for a frozen dinner. But in many other product areas of life, prices are also increasing. We’ll get to specifics in a minute, but first, a broader discussion of inflation:
Inflation is one of the most insidious means of eroding purchasing power and thereby diminishing a population’s standard of living. Among its preeminent dangers: inflation can be deliberately introduced by any entity possessing the ability to create money, generally national governments. America’s Federal Reserve (ostensibly and legally run separately and “independently” from the rest of our federal government, including the Treasury Department) is responsible for the quantity of U.S. dollars in circulation. The Treasury Department actually prints the bills we use, but only in response to “demand” in the marketplace which in turn is affected by the liquidity in monetary reserves determined by the Fed. Rather than go into detail about Fed monetary operations (for they are complex), here are several primer links reviewing the process (link, link, link, link).
Why is this subject important at this time? Charles Wallace wrote an article today in Daily Finance entitled, “U.S. Inflation Expands Beyond Food and Fuel.”
First came higher food prices, thanks to heat in Russia and floods in China and Australia. Then came soaring gas prices as a result of the crisis in Libya. Now, imported consumer goods — including almost everything from Brazilian orange juice to imported Toyota automobiles — are going to be joining the upward price trend.
The culprit is the U.S. dollar, which has fallen 5% in the last year. The inflation-adjusted, trade-weighted dollar, which is a measure of the greenback against the currencies of nations we trade with, now stands at its lowest level since the Federal Reserve began keeping records in January 1973.
As the dollar’s value falls, the prices of imported goods grow. The falling trade-weighted dollar is closely correlated with higher import prices, explains Carl J. Riccadonna, senior U.S. economist at Deutsche Bank.
“The weakening dollar is driving up import prices and that is translating through to higher consumer inflation,” Riccadonna says. “We’re seeing it not only in imported goods, but in domestically produced goods that also contain foreign inputs.”
Read this phrase again: “The culprit is the U.S. dollar.” Recall too Fed Chairman Bernanke’s announcement last year that the Federal Reserve would undertake “quantitative easing” for the second time in recent memory (the first time took place during 2008) because the economy had not pulled out of recession despite massive federal spending. Deven Maru provides some brush up on quantitative easing here and in his next post discusses “Quantitative Easing 2 (QE2) implications.” He notes:
There has been debate on the efficacy of QE2 on stimulating the economy. Myron Scholes weighed in on various QE2 implications while Joseph Stiglitz is arguing against trusting the monetary policy of Fed including the QE. The non-executive chairman of Morgan Stanley Asia, Stephen Roach really summed it up nicely:
QE1 didn’t work. QE2 didn’t work. QE12 won’t work.
The stated objective of quantitative easing is to stimulate economy and growth. But in reality the additional liquidity is not resulting in business investments and employment. Most of the QE is in the form of transfer of risky assets from banks balance sheet to Fed’s balance sheet. In as far as QE facilitating credit creation, it does not seem to be happening either. And rightly so. Consumers are deleveraging like never before and they are not interested in going on debt binge anytime soon. On the business side, there is very little incentive for borrowing and investments if future is uncertain and there is no confidence inducing growth story in the horizon. While there is no short cut to a healthy balance sheet, most of the QE will benefit financial institutions as they transfer more assets to the Fed while bloating their excess reserves.
The unstated objective is, perhaps to weaken the dollar, monetize the treasury debt and generate inflation both here and abroad. Additional liquidity devalues the dollar, increases capital inflows in emerging markets appreciating their currency making US exports attractive while simultaneously making emerging markets exports expensive. Emerging markets then intervene to halt appreciation of their currency. The idea of protecting their respective economies in these volatile times is at the heart of the currency and trade wars manifesting by way of currency depreciation in a race to the currency bottom. For now though everyone has promised to play nice at the highly anticipated meeting of G-20 finance ministers and central bankers.
Let’s look at this sentence again: “The unstated objective is, perhaps to weaken the dollar, monetize the treasury debt and generate inflation both here and abroad.” Indeed, the finagling of the Fed is leading to inflation, both here and abroad. Another financial expert, James Nelson, puts it succinctly here,
Quantitative easing is a policy used by the Federal Reserve to increase the supply of money in the banking system. The intent of QE2 is to lower the already historically low interest rates in an attempt to boost our sluggish economy.
With so much money chasing so few goods, however, critics of the QE2 policy are concerned that the Federal Reserve’s actions will lead to much higher levels of inflation in the near future.
Inflation is the rise in the level of prices that you pay for goods and services. As the rate of inflation rises, the purchasing power of your dollars decrease, typically causing a reduction in the amount of goods and services that you can afford to buy.
Not only is your current consumption curtailed by inflation, but higher levels of inflation also eat away at the future purchasing power of your savings, Individual Retirement Accounts and 401-K plans.
Government “stimulus” (something our Rep. Woolsey has fully supported) to get the economy “going” again includes this Fed quantitative easing. Whatever method is used — direct spending authorized by Congress and signed by the president or the increase in “money”as as operation of the Federal Reserve — leads to inflation when done in excess. Compiling TRILLIONS of dollars in national debt through that spending and then trying to “monetize” that debt by in effect “printing money” only exacerbates our financial problems.
Furthermore, because the dollar is still the primary currency in the world (although, the likelihood of that continuing decreases as we mount our debt and monetize it), it isn’t just the USA that is experiencing increases in food and other prices. Although Ben Bernanke recently denied it, there has been widespread international discussion of the idea that our American monetary policies have contributed to “record global food prices” and that, in turn, has been a factor in the unrest in various countries (such as Egypt and Libya).
Our world is so financially intertwined these days that many international events affect product prices and currency valuations. No one should conclude that everything on the bad news side that happens world-wide can be laid at America’s doorstep. Neither can we Americans legitimately claim that the Fed is the root of all economic/financial problems here at home. However, the news today about “U.S. Inflation Expands Beyond Food and Fuel” should be read as a warning to us that the current policies of those in charge in Washington D.C. are not taking us in the right direction and financial markets sense this as indicated in this article, entitled “Dollar Gains on Hopes For End To Fed Quantitative Easing”. Notice that inflation was blamed on a falling U.S. dollar by the Charles Wallace article, while this one indicates that the dollar actually gained a little on the “hopes” of QE2 ending. The Federal Reserve Board of Governors had better act accordingly.
Inflation lags somewhat behind Fed money expansion or other incitements. So, even when QE2 is scheduled to end anyway (June ’11), our economy and the world economy will probably experience further inflation for a time as a result of QE2.
As mentioned, inflation is an insidious means of devaluing the money you earn and decreasing your ability to obtain what you need to live. So, the next time Lynn Woolsey tries to tell you that we need more stimulus to prime our economy, tell her she is wrong. Tell her what we need is a Congress, a president, and a Federal Reserve that will preserve our spending power, not diffuse it.