Inflation Will Not Take Off Until This Happens

by: Larry Trefz

In order for real inflation to take off people need to have enough money to bid up the prices of goods and services.

As the Federal Reserve and central banks around the world have engaged in unprecedented monetary easing (the fed is currently easing at $85 billion per month) since the financial crisis, many economists and financial professionals have warned of inflation becoming a major problem. However, the Consumer Price Index (CPI) has remained tame.

Historical Data Chart

The inflation rate has likewise remained very tame.

Historical Data Chart

The reason that inflation has not taken off yet is due to the fact that real wages and incomes have been declining while the prices of commodities and assets have been propped up by the Fed's monetary easing.

As mentioned, in order for real inflation to take place, the people have to have enough money to spend to the point where they can bid prices up. The opposite is when people have less and less money and contract their spending as a result (deflation). The latter case seems to characterize the average consumer's financial position as of late.

Real median household incomes have been dropping over the last few years. --WSJ

The monetary easing actions of the Fed flow through specific channels in the financial system -- first to the money center banks, from the money center banks the hope is that the newly-created money then trickles down through the regional banks and businesses where it will eventually stimulate the broader economy. In practice, the liquidly injected by the Fed has the tendency to find its way into more specific areas rather than a broad-based even distribution. One of those areas that seems to have benefited the most is the U.S. stock market.

The place that the Fed's monetary easing has not trickled down to is wages and incomes (as seen in the chart above). Until wages and incomes rise along with the prices of commodities and assets, it is virtually impossible for any significant inflation to be seen due to the simple fact that the people do not have enough money to bid up the prices of assets and commodities across the board.

It is likely that as we go forward, a shift from a focus and dependence on Federal Reserve monetary policy actions to fiscal and legislative economic actions will take place. This shift has been made difficult by a sharp political divide, which still exists.

In other words, when the fiscal and legislative authorities in government start to take on the task of stimulating the economy, the effect will likely be that the money (from the government) starts to flow into the hands of the common people rather than into the money-center banks.

This was the approach that FDR used in the late 1930s and early 1940s to aid the country in recovering from the Great Depression. Government work programs allowed the previously unemployed masses to start receiving wages from the government. This pumped money into the system from the bottom up. Right now the Fed is doing it from the top down.

Should the growth of wages and incomes come into line with the growth of the prices of assets and commodities, then the possibility of inflation becoming a problem is much higher. In a situation of this nature it is likely that interest rates would rise and bond prices would fall. Shorting bonds would likely be a profitable trade in this case.

ETFs and ETNs that can be used to trade bonds include: (NASDAQ:BND), (NYSEARCA:TLT), (NYSEARCA:TBT) (NYSEARCA:LQD), (NYSEARCA:HYG), (NYSEARCA:JNK).

Please remember that leveraged ETFs and ETNs are designed for short-term trading.

Disclosure: I am long TBT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.