Explaining Inflation, Again

By Brad Zigler

In a recent column, I referred a reader to our real-time inflation indicator (explained in "Computing Inflation In Real Time"), naively thinking that the method - or the madness, depending upon your point of view - utilized to derive it would bolster my argument for an impending recession.

Well, no such luck.

Our indicator gauges inflation through the gold market by comparing the metal's dollar-denominated price to its value in euros. The fact that gold was used as a medium, however, vexed our erstwhile reader.

"If you're going to measure inflation in terms of gold," he shot back, "your 12-month measure will show massive deflation in a few months because the price of gold dropped this summer/fall (or the price of dollars rose, whichever). This doesn't tell us anything a price chart for gold wouldn't tell us."

Oh no?

Take a look at the accompanying chart. At the beginning of the year, gold was selling for $841 an ounce. Gold was fixed on October 3 at $842, virtually unchanged from its beginning price. Yet look what happened to monetary inflation in the intervening nine months. The annualized inflation rate slowed by nearly 7.5%.

Monetary Inflation Vs. Gold

Inflation, in fact, was slowing while the price of gold was rising early this year. If that sounds counterintuitive, keep in mind that the indicator is measuring monetary inflation.

Commonly, inflation is confused with rising consumer prices. The mostly widely followed metrics usually associated with inflation are those produced by the Bureau of Labor Statistics. But the Consumer Price Index (CPI) and the Producer Price Index (PPI) measure price changes, evidence of "demand-pull," not monetary, inflation.

Monetary inflation is caused by working government presses overtime, printing more greenbacks to cover deficits. Demand-pull inflation rears its head when credit is easy, spurring demand for goods.

The accompanying chart shows that monetary inflation can still be measured positively on an annualized basis. In this sense, it hasn't disappeared. But it is decelerating even as gold prices have stagnated.

Comments

[PastTense:]

So, should we buy Gold or not? If if we have it hold it or sell it?

2008 Oct 06 02:27 PM

[whidbey:]

Nice post, but it would be even more helpful if you were to note that without rising wages we can have no inflation. Second, rising wages is out of the picture unless we elect a democrat who is servant to the unions, and still only about 24% of all labor is unionized. The damage will come via increased minimum wage laws. We need to let the free market for labor price wage payments. Give away free education if you must do something, but leave waqe payments alone to start the recover.

2008 Oct 06 02:34 PM

[Smarty_Pants:]

It's not terribly reassuring to see that monetary inflation has slowed to "only" 11% as measured by your calculations.

While that's much better than 18%, it's not going to stop the dilution of the unit dollar very much.

2008 Oct 06 02:35 PM

[Cesato:]

Everyone is somehow rigth but bear in mind that what Gold Bugs would actually like to see is a well established trend which would indicate that a real inflation adjusted Gold price would eventually be reached (at least a lot higher than 900). If you play the volatility short term you will more likely be disappointed and eventually lose money when you see the price dropping and then you dump your Gold. The consolidation pattern in the last 6 months has been wild and indicates that whenever there is a break of the consolidation range (920-750) it is gonna get ugly either side. October's Monthly close price will be the best indicator of the price move towards the end of the year, data is helpful to understand the fundamentals but in the current environment only a combination of data, market sentiment, interventionists needs and your own gut feeling will let you make a decision, Short term technical analysis has become all but unuseful. If you exercise patience, you may be able to buy Gold at USD 750 sometime between now and the end of October, if the price doesn't make you feel comfortable before the Thanksgiving weekend, then sell and buy back in December. Also make sure you understand what makes the current scenario different than the one in 1980, and if the market suffers from intervention don't waste your time being mad just adjust your strategy. In the monthly chart you can see that a clear break below 730 would not stop until 691 ( we already have lower highs/lower lows) however if the area between 730 and 750 holds then it is gonna be a nice wild run up! But I think that the risk/reward in buying at this levels (865) is not worth the effort and the risk much less now that cash is king. Wait patiently.

2008 Oct 06 03:44 PM

[Managing Ed...:]

Whidbey -

You CAN have inflation without rising wages. Rising wages characterize "cost-push" inflation. What we've seen recently, though, is monetary inflation overlaid with "demand-pull."

2008 Oct 06 06:37 PM

[Managing Ed...:]

Here's a homework suggestion, JasonC: civility.

The "lecture" that galls you so offerred an explanation of inflation past, not future. Domestically, it wasn't a wage spriral that inflated asset prices,. In large part, excess liquidity was supplied by the Fed.

Perhaps you didn't read that when you did YOUR homework.

2008 Oct 07 09:24 AM

[User 30121:]

Past Tense:

Look at it this way. If you don't buy gold (and don't forget SILVER!), then what WILL you buy? Where do you place your $$$ to be able to sleep nights? Short term it may be volatile, but over the next 2-3 quarters, it should rise nicely. As to "when" to buy. I refer you to a quote by a BILLIONAIRE gold investor: "Don't wait to buy gold. Buy gold and wait". Good luck.

Oh, by the way, buy from a source that has it IN HAND! DO NOT buy where you can't take physical possession within a couple days MAXIMUM! That keeps you out of BIG problems trying to either get your money back or the bullion you purchased!

Again, don't forget silver! Silver may well be the BEST opportunity for INCREDIBLE gains down the road. Some very astute precious metals gurus predict that silver could rise in price/value MANY TIMES that of gold!

Good Luck

2008 Oct 07 11:39 AM