A recent piece of research from Casey’s got our engines going on the whole inflation/deflation debate.  It’s been quite a while since I revisited the topic so let’s have a look at the evidence.  Let me begin by saying that after having been a deflationista for several years I have substantially pared back my deflationist position to a more neutral position.  I no longer have skin in the game per my market bets so consider me an innocent bystander.  While I still believe there is much de-leveraging to be done we have likely thwarted the deflationary spiral that I feared was developing in late 2008.  Nonetheless, inflation remains a minor concern in the United States for several reasons.  Let’s take an in-depth look.

The tendency is to argue that more money = inflation.  After all, the great Milton Friedman said that inflation is always and everywhere a monetary phenomenon so it must be true, right?  Not so fast.  Friedman lived in a different time.  A time when the velocity of money was stable and the gold standard was still a viable idea.

Let’s start with the various types of inflation – demand-pull inflation and cost-push inflation.  As of now, demand-pull inflation appears unlikely.  Recent data shows this is unlikely due to high levels of spare capacity, low capacity utilization rates and generally tepid demand for goods (aggregate demand is still very weak).  Despite the oodles of excess money (mostly due to government spending) in the system there is nothing in the data that currently suggests this recovery will result in massive demand-pull inflation.  In fact, the evidence as of now suggests a potential disinflationary environment.

The cost push inflation debate can be answered in one word – jobs.  The majority of cost-push inflation is due to labor.  As of now, labor remains near its lows  and the unemployment rate is unlikely to tank any time soon.  Anyone looking for a bout of wage inflation better own a leveraged portfolio of stocks because that would require a remarkable economic turnaround.  There is no evidence as of now that the jobs picture is picking up substantially.

Some inflation proponents argue that we are about to begin importing inflation from abroad, but again the evidence suggests this is unlikely.  The scenario generally goes something like this: the dollar will collapse and import prices will skyrocket.  Most inflationistas learned this the hard way last year when they assumed that gold and other metals were the safest assets on the planet.  Unfortunately for their portfolios, in a fiat world with a dollar reserve, that safehaven asset happens to be the dollar.  Besides, a 10% decline in the dollar contributes approximately 0.5% to CPI according to  recent research from CitiGroup.  And if the dollar truly does collapse?  You’d better own lead bullets, a bomb shelter and canned goods.  Inflation will be the last of your worries.

Next up is the old “commodity prices drive inflation” debate.  This is another falsehood.  Did you know that a $20 increase in oil adds just 1% to annual CPI?  Despite this, a rise in commodity prices without a subsequent rise in wages is essentially offsetting in terms of future inflation.  We learned this in the Summer of 2008 when oil and gas prices shot up to their all-time highs and wages remained stagnant.  At the time, I was calling for a massive deflationary decline because the two simply didn’t add up.  Without a rise in wages you simply can’t support the high commodity prices.  Free markets working at their best.  This goes back to the cost push debate.  If commodity prices are going to continue to climb substantially we are going to need to see substantial wage inflation.  It’s not happening as of now.

The Fed actions take us into the real heart of the debate.  Investors are infatuated with the explosion in the money supply.  This horrifying image:

What this chart doesn’t show is the decline in real credit.  This explosion in the money supply does not mean it is actually getting into the system (in fact, reserves don’t ever “get into the system”).  I will simplify this with my iced tea example.  Imagine you have a full pitcher of water (the economy).  If you place in a scoop of iced tea mix (new freshly printed money) it will sink to the bottom.  But you don’t have iced tea yet.  You have to mix it in.  Inflation works in a similar fashion.  When the Fed prints money the banks need to actually lend the money for it to get into the system, but an extension of the monetary base does not necessarily equal an increase in lending.  That’s just not how bank lending works.  Without the mixing (lending) you don’t get iced tea (inflation).  As of now, the lending markets remain very weak.


All of this adds up to one thing.  Demand for credit is weak and the supply for credit is weak.  That means an expansion in the broad money supply is highly unlikely at this time.  In other words, we’re not getting any iced tea and that’s why inflation readings continue to come in well below what the inflationistas are betting on.  I would describe the current environment as disinflationary with a greater risk of deflation than hyperinflation.

Of course, this is not to imply that inflation doesn’t become a very real concern down the road, but as of now, there is almost no evidence that suggests inflation (or hyperinflation) is a real near-term concern.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • vfsvfl

    A few comments caught my eye:
    1) Let’s start with the various types of inflation – demand-pull inflation and cost-push inflation.
    —I submit there are (at least) two more types. For lack of more-professional terms, I call them “tax inflation” and “global debasement.”

    Under “tax inflation” prices paid don’t have go up across the board before wage earners have less left over to pay expenses. (See California…)

    Under “global debasement”, commodities go up. Using y-o-y comparisons ignores that commodity prices are up substantially since the melt-down started in early-2007 when the latest round of money-printing actually started.

    I submit we now have both of these types now. Just like the banks invented ways around risk regulation, governments & CBs engineered policy which dodges traditional measures of inflation.

    2) “a rise in commodity prices without a subsequent rise in wages is essentially offsetting in terms of future inflation.”
    IMO, a rise in commodity prices without a rise in wages is the very definition of inflation. Wage earners have less money left over after paying for heat & gas.

  • Frederick

    The deflationists may be correct, but if the point they are ultimately going for is that gold will collapse because they will be correct in the near and medium terms about U.S. deflation, I believe they will be wrong.

    Japan has been trapped in a 20-30 year deflation, but gold has gone up in yen.

    It can’t and won’t ever be a ‘permanent’ win for the deflationists, and therein lies the reason gold will continue to climb. Governments will continue to try to inflate. They might not ever win, but they will still try. They will so abuse their currencies that they will always be on the edge of not even being viable.

    I know nobody here was expressly talking about gold, and I agree completely that deflation has a real chance to grip society right now. It just seems that often the argument inevitably heads toward at least a cursory mention of gold.

  • http://ourmaninnyc.blogspot.com/ Our Man in NYC

    Obviously, based on my comments elsewhere, I’m in agreement.
    PS. As a fellow Hoya fan, I hope you also enjoyed Saturday’s (and yesterday’s) win!

  • http://www.pragcap.com TPC

    I would only argue that 1) Taxes in America are already very high (particularly here in CA) and 2) commodity prices will not rise in spite of the laws of supply/demand. Prices will only rise as much as a market can bear.

  • jenny


    Thank you for the explanation and analysis on an otherwise confusing and contested subject.

  • http://www.pragcap.com TPC

    Gold is an anti-dollar bet. Plain and simple. To me, the idea that gold will ever become a currency again is wrong. Therefore, high gold prices should not be so directly tied to the dollar and should move solely based on supply/demand and not this fictitious demand that is created due to potential currency uses. We’re moving into an all electronic world. No one is going to start toting gold bars around again.

  • http://www.pragcap.com TPC

    We’ll find out how good we are this Sunday. Bench depth is the only concern right now….

  • http://www.pragcap.com TPC

    Glad it helped clear things up.

  • P Sean

    Your arguments are very lucid and have merit.
    I will, however, point out a couple of anecdotal thoughts:
    1) CPI is a number that is published by the US Govt and its’ calculation is highly suspect as well as its’ assumptions. So basing an inflation analysis on this number is also suspect. I think if one does a personal analysis one would find that the things that you purchase on a regular basis are not getting cheaper.
    In fact quite the contrary. We often get so caught up in statistical analysis that we ignore the real world, everyday, data that is right in front of us.
    2) The third world is purchasing commodities in very meaningful quantities and I submit that they do not care one iota for the United States’ labor wage situation. In short the “New” environment of commodity purchases in countries that have never before purchased commodities is creating inflation pressure accross the globe. That impact is being flet here, in the US now.
    3) Yes it is true that Consumer credit has declined since 2008, as the American people are starting to understand what massive debt can do to their personal balance sheet. And yes banks are hoarding cash as they know what is around the corner. And if this is where it ended the deflationists would have a better argument. The US Govt, however, has simply replaced the private sector in the debt markets. Our Total Debt as a nation has actually gone up in 2009 as opposed to going down because the US govt is replacing the consumer. The US govt is certainly not hoarding cash and their spending is most certainly hitting the markets with fresh dollars and THIS IS inflationary.

    SO there are indeed multiple forces pushing and pulling. In the end I hope for controlled inflation but I am not optimistic about it.
    Keep up the good work people.

  • http://deleted VCC

    It’s clear as day that inflation is not a threat..CPI was effectively flat to further reinforce this claim. The charts on bank lending and the money multiplier say a lot more about the broader economy than answering the deflation/inflation argument. The $64M question is why aren’t banks lending? The most common reason cited in the media is they refuse or are unable to do so (for some undisclosed reason). However, NFIB said 92% of small biz has access to credit! http://www.cnbc.com/id/34820253

    The problem then must be a lack of borrowers. If people are drawing down bank deposits to pay down debt (ie fixing their broken balance sheets), the money multiplier will turn negative because a decline in deposits means a decline in the money supply. No amount of QE can alter this process.

    The significance to the broader economy should be obvious. Real, organic growth cannot occur until this deleveraging process is complete. Unfortunately, we’re far closer to the beginning than the end.

    TPC, as CRE melts down and housing continues to deteriorate, don’t you believe the deflationary pressure will remain significant and unabated? Once the deflationary spiral starts, it’s really tough to get out. That’s why the Fed’s greatest fear is deflation. They can’t seem to grasp how powerless they are in defending against it. I completely agree with you on gold being an anti-dollar play. The dollar will ultimately be judged on a relative basis..Europe’s problems are just as bad if not worse.

  • chris

    great post, especially the charts

    i would agree with your assessment that consumer price inflation is not a near or likely medium term concern; what i am thinking, and invite comment, is whether one could still take the investment position that long dated treasuries are about to rise even in the absence of inflation

    the treasury has been borrowing short maturity much more than long maturity and is expected to start issuing more long dated supply…if you look at a 20 year chart of the 30 year treasury you would wonder what took them so long; and i have read reports that the chinese are expected to increase their buying of short maturities at the expense of long term. the fed has been buying long maturity govt debt recently and they are on record as committed to stop this in the near future (which will no doubt be less near than advertised). i see the treasury curve steepening. while i don’t normally care that much whose company i am in, i find some some succor knowing that the two of the best investors around, steinhardt and robertson, both think likewise.

    all of the excess reserves at the fed (the result of printing money to buy the govt debt) is not bearing interest and while the fed is on record as saying that they will start to pay interest on it soon now that they have legal authority, they won’t do so until they raise the fed funds rate, and this date is also receding into the future, so at some point i see these excess reserves being used by banks to earn their opportunity cost as the banks get healthier.

    all this to say that i am sticking with my long term treasury shorts for now, even though they are starting to itch; those charts look to me like a lot of dry gun powder, and at some point we will catch a spark.

  • chris

    that would be yields on long dated treasuries are about to rise

  • Paul


    I usually give you a hard time, but this time I have to give you a lot of credit. A very lucid and simple discussion of what seems to me to be the key issue in the next few years. Hats off to you on this one.

  • http://www.pragcap.com TPC

    Thanks Paul. I enjoy the back and forth debate. It’s all part of the discovery process so please don’t stop with the “hard time” comments.

    Have a nice weekend.

  • Amy

    whether we are in an electronic world or not has no bearing on gold being a valuable source of money or part of a basket of assets that currency is tied to

  • http://www.pragcap.com TPC

    I am dying to hear a coherent and logical argument why we would move back to a gold standard? It’s quite obvious that any future move would be to a currency basket or a commodity basket that is based on copper, gold, oil, etc.

    There is almost no evidence that we would ever move back to a gold standard. Let’s get real here.

    You can accumulate all the gold you want, but the evidence does not suggest that gold will serve as a future currency.

  • jt26

    Broad inflation (ignoring narrow inflation, e.g. oil, particular assets etc.) could be sparked when the showdown with big special interests comes to past … healthcare & public employees are two good examples … watch for tax hikes and state cutbacks, public pension issues, layoffs, … and pushback …

  • Frederick

    TPC: Gold need not ever serve directly as a future currency to have it go up long and hard in U.S. Dollars.

    I agree that it would be impossible to take the U.S. Dollar back onto the gold standard after having been taken off.

    Also, I agree it won’t expressly ever become in and of itself a new, or born again, currency. It is simply too rare at a .9999 fineness to accomodate 6.7 billion humans and counting to be the actual coinage.

    But, a currency has to be linked to a physical, tangible entity in the real world no matter how electronic we ever get.

    Ask cutting edge gamers about online currencies, and what eventually happens to them. I know people who have literally lived for months in the real world off currencies of online games by selling them back to other players online. Eventually those electronic currencies blow a gasket due to poor, or even no, money supply management and inflation destroys their worth, and then they all go create a new game and start again. Sound familiar?

  • Amy

    My response was to the point that you seemed to infer that we could not be tied to gold if we were an electronic society which I believe is wrong. I was not commenting on whether we would go back to a gold standard. I do however think that gold will continue to play an important role going forward as it has through out history. This is especially true whenever a society continues to print copious amounts of currency.

  • Todd

    Monetary and fiscal policy is about the ability to control the economy by offsetting economics stress in one area with offsetting policies. You can analyze stats all day long to look for trends in one direction or another, but neither inflation or deflation will happen until the Fed looses control due to some unforseen disruption which is large enough to knock Benanke on his proverbial back side. I would guess that monitary policy nudging here and there may work to create a long and flat economy to buy time to bail America out of its excess borrowing if no major disruptions occur. To that point, I would suggest we will have neither deflation or inflation without a major catalyst. Perhaps a terrorist attack or large global default that nobody sees coming?

  • http://info@alfredtolhurstbook.co.uk David Tolhurst

    The cause of inflation is government spending more money than it raises through taxation and honest borrowing times velocity or putting it in laymen’s english defrauding the currency by printing money. There is at present no velocity due to the enormous debt in the world. Guvernment, state, company and individual bebt. So your conclusion is at present correct. Once the irresponsible borrowed money pushed out into the system by governments throughtout the world goes to money heaven then we will see savage deflation and depression.

    David Tolhurst

    Bury St Edmunds


  • Mark

    Currencies (money) is only a medium of exchange used for buying. The fact that the Feds printed money like drunken sailors trying to re-flate asset prices only strengthens the defaltionary forces we will be faced with in the short term and probably long term. The money that was created out of thin air will not fuel inflation and will be wasted on the current fake recovery. Only “real consumption” caused by job creation and real wages will do that. Without a “REAL ECONOMY” (not a government stimulated one) the worlds production capcity, consumption, wages and job creation will be under-utilized, causing a protracted downward spiral in real GDP, which will lead us into a Depression.