Miscalculating Inflation: The Link to Global GDP

 |  Includes: DIA, QQQ, SPY, UDN, UUP
by: Steven Hansen

Merriam-Webster defines “inflation” as a "continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services."

As prices are not increasing due to increases in the volume of money and credit, I have good news – there is no threat of inflation. 

We do have increases in prices and loss of purchasing power. Call it what you may, but it is “inflation” to me. The major world central banks and the Fed have been effective in limiting inflation caused by currency supply increases. But the current inflation cycle is triggered by non-currency related issues.

US Dollar in a Global Market

Economists use the US dollar money supply M2 as a basis of forecasting inflation potential. However conditions are different now:

  • According to the International Monetary Fund (NYSE:IMF) the European Union 2007 GDP is $16,830,100 million to the USA’s $13,843,825 million. The worldwide GDP is stated as $54,311,608 million. The USA no longer dominates.
  • By any measure the Euro is now the largest currency in circulation.
  • China and India together represent only 5% of the world GDP but use up to a quarter of the world’s supply of iron ore and other commodities.
  • A very significant percentage of goods sold in the USA are imported and growing yearly. As the amount of US content diminishes in products sold in the USA, inflationary forces come from outside the US.
  • According to the 2008 CIA World Factbook:
    • World GDP is $ 65,610,000,000,000
    • European Union GDP is $ 14,380,000,000,000
    • USA GDP is $ 13,840,000,000,000
    • China GDP is $ 6,991,000,000,000
    • Japan GDP $ 4,290,000,000,000.

More and more of the world economic and inflationary forces now are outside the purview of the Fed, and makes the analysis of the US Dollar money supply less and less relevant relating to the control of inflation.

Just the simple growth of GDP can now cause inflation. 

The expansion of GDP closely parallels the world’s expansion of needs of commodities (food, energy, and ore).   With few exceptions, additional supply of a particular commodity is more costly to produce than the previous production levels. We are way past the point of being able to profit from economies of scale. The world is now unable to produce more of a commodity and hold the price. We are now faced with:

  • opening mines with lower grade ores, overburdens or costly transport issues;
  • resorting to higher priced energy producing options;
  • growth exceeding technologies ability to mitigate its effect on costs;
  • farming lands with less productive climate and soil conditions, or
  • approaching a real limit on worldwide production capability,

The chart above shows commodity production growth closely linked to worldwide GDP growth - which is what you would expect. The chart also shows a relationship between price growth and production growth. Both commodity price and production growth exceeds the cpi-u inflation numbers – and in my opinion this is one more piece of evidence that the cpi-u inflation numbers are understated. The cpi-u should be closer to the Worldwide GDP growth percentages.

As the USA percentage of worldwide currency and GDP continue to fall, the Fed’s ability to control inflation will be diminished unless the Fed works in concert with European Central Bank, and the other central banks of Asia.

And the only way to control inflation is for the central banks to control the worldwide GDP.

Disclosure: none