A little over a year ago I said inflation concerns in the USA were blown out of proportion and that we were likely to see an environment of disinflation “with a greater risk of deflation than hyperinflation”.  One year later that’s clearly what has occurred in the USA as disinflation ensued.  Overall inflation has continued to decline and deflationary fears became so substantial in Q3 2010 that the Fed panicked into implementing QE2.  In retrospect, it looks like the Fed jumped the gun as September economic data proved that the summer slowdown and double dip fears were overblown (not that it matters as we remain mired in one continuous balance sheet recession).  The good news is we’re not repeating the mistakes of Japan (yet), but we’re also not growing fast enough to meaningfully close the output gap.

But where are we now?  Is deflation still the greater risk?  What about commodity prices and global inflation?  How is this all going to play into the USA’s future inflation/deflation problems?

One thing we know from the credit crisis is that the Fed’s various “money printing” operations have had a far lesser impact on the rate of inflation than most presumed they would.  Despite an explosion in the monetary base inflation is near its lows.  As I’ve previously discussed, this unusual recession (a balance sheet recession) exposed many flaws in the way we understand the functions of modern banking.  The primary myth that has been exposed in recent months is the money multiplier.

Because we’re working in an unusual environment we have to throw out the old playbooks when estimating future rates of inflation.  The Fed’s actions are and will continue to be relatively futile in influencing future inflation.  Fiscal policy remains intact, however, is likely to come under increasing pressure in the coming years.  All of this occurs during a process of de-leveraging by the private sector.

From a demand-pull perspective the story remains little changed from last year.  This environment of low capacity utilization and tepid aggregate demand is likely to result in benign inflation.  This is due to the continuing strains at the consumer level.  A lack of job growth, de-leveraging, falling house prices, etc are likely to continue exerting pressures on the U.S. consumer in the coming years and make demand-pull inflation unlikely.

Although commodities have become the hot button topic in recent months, the truth is that labor is still the most significant input in the cost-push inflation equation.  And that input remains weak.  The strength in corporate America combined with the extreme government response has been just enough to generate some economic growth.  But it hasn’t been enough to substantially close the output gap.  Love the stimulus or hate it, in this process of de-leveraging, we’re still not running a large enough stimulus package to generate significant wage inflation.  Companies are in no rush to hire or increase wages due to a multitude of factors.  With high productivity, high corporate margins, record profits, continuing economic uncertainty and rising commodity costs we’re unlikely to see a surge in incomes or hiring in 2012 though I do believe we will continue to see a modest recovery in the labor market.

From this perspective, it’s likely that higher commodity prices will continue to result in higher prices abroad (particularly those commodity based economies), but a deflationary bias in the United States as wages are unlikely to match the increases.  This will make it extremely difficult for producers to pass on costs and will ultimately squeeze the consumer.  The last time incomes were substantially outstripped by inflation was during the 70’s when surging oil prices created stagflation.  That outcome should not be discounted here, however, it’s highly unlikely that inflation would approach anything remotely close to the levels seen in the 70’s given the uniqueness of the current economic environment.

This all adds up to an environment in which we’re likely to continue seeing below average levels (3.5%) of inflation in the USA.  Although I do expect inflation to approach ~2.5%+ by the end of 2011 we remain in an environment where downside risks remain more prevalent than the risk of high levels of inflation.  An underlying environment of deflation is likely to continue being masked by government intervention and a global recovery that results in higher commodity prices.  The risk of hyperinflation remains extraordinarily low based on this outlook and we’re likely to continue experiencing below average levels of inflation although the tepid recovery in the USA and abroad should contribute positively to inflation in the coming year.


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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  • MMTer

    Sounds right to me although I’d say the risk is substantially to the downside if austerity grips the globe and China slows.

  • Karljr

    Have you told the Tunisians and Egyptians to shut up since there cannot be any inflation in those countries because their utilization rate is too low and hence the high prices cannot be supported by their low wages? Hence there is no inflation just as you claim in the US. If only those people would understand MMT they would stop that damn complaining about food prices

  • LVG

    This analysis is about the USA. Go leave comments like this on a Tunisian economics blog.

  • Kate33

    This is the standard inflation line now. Since they have all been wrong about inflation in the USA they are all latching onto the chaos abroad to try to prove they were right. Idiots.

  • http://www.pragcap.com Cullen Roche

    If you actually took the time to read the analysis you’d notice a few things:

    1) This is focused on inflation in the USA.
    2) I specifically say there is inflation abroad.

    I have very little patience for the group of people who have been screaming about a horribly destructive Weimar/Zimbabwe style inflation in the USA. That analysis simply could not have been further off the mark.

  • http://www.pragcap.com Cullen Roche


  • http://www.pragcap.com Cullen Roche

    I’m one of the few people who actually predicted stimulus in places like China was likely to lead to high inflation.


  • breed12

    I think ib’s are taking fed’s easy money to emergings, causing inflation predicted in us to be exported. I predict this will stop when the gas prices become too high, causing faltering global economy and flight to safety?

  • breed12

    Which will probably just destroy the money created through leverage, causing deflation again, until banks / financials are allowed to fail, or systematic government failure

  • adane

    When the minor things like food, energy, insurances and medical costs (a partial list) are taken out, there is no inflation.

  • ducksoup

    Mr. Roche, have you ever worked in manufacturing? “…the truth is that labor is still the most significant input in the cost-push inflation equation” I have. I do. WRONG. RAW MATERIALS are the more significant portion of manufacturing costs. (60-80%) PERIOD.

    You wrote Friday (Market Minute), “…Rising input costs….. Margin compression is becoming a very real concern in more and more sectors…….” The dead time is passed and now the lag begins to appear. We have, and will see, inflation far beyond “1.2%” and it is because of QE.

  • http://www.NapaWealth.com Tim Ayles

    America is not about to die because inflation may be upon us: http://seekingalpha.com/article/248003-the-end-of-america-not-quite

    I asked in the blog – would your rather pay $1 for 1970 style medical care, or $6 for today’s?

  • ObaMao

    All bets are off if oil price spikes and stays there.

    “Stagflation occurs when the economy isn’t growing but prices are, which is not a good situation for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose dramatically, fueling sharp inflation in developed countries. For these countries, including the U.S., stagnation increased the inflationary effects. “

  • ObaMao

    Correct of cost drivers in mfg. It is often direct labor cost and not so costed BOM. Thus the reason the mfg jobs are disappearing from east and mideast areas with unions.

  • http://loandoctorsnw.com Roger Ingalls

    RE “labor is the most significant input cost”

    Can either Cullen or Ducksoup back up or refute that assertion (with data, I mean)?

    I’m sure it’s a complex question (how much labor goes into the acquisition and processing of raw materials, how are raw materials defined, what constitutes manufacturing, etc.). Additionally, we have to ask in what country? I’m sure Chindia labor cost percentages differ from Germany or US.

    I agree generally, that as far as my family’s situation, inflation is currently a minor concern (of greater concern is stagnant to declining earnings and home value).

    A cursory Google search gave me nothing useful.

  • Dmitro

    I believe that those 43 million Americans on food stamps can really feel the rise in food prices, or decrease in package size (the clever trick), so their monthly food stamps would provide less food. And those people would care less that big-flat-screen TVs have propped in price

  • Steve B

    The stagflation argument/outcome is extremely unlikely given current conditions. Keep in mind the 70’s began with a very severe inventory driven recession followed by cost push inflation from increased oil prices. Given the strength of unions in the 70’s, wages were automatically adjusted upwards, setting in motion the wage/price spiral. None of those conditions apply today.

  • Karljr

    Stagflation in US economy is impossible in Mr. Roche’s worldview. There is no wage cost push inflation due to 75% utilization and food and energy prices are not real inflation because QE2 is an accounting identity and only causing temporary psychological effects in price. So you have nothing to worry about.

  • wh10

    i’d also add that when we’re talking about general inflation, the mfg is only one piece of the puzzle, right?

  • Sanford

    Can you explain why you think QE2 was implemented due to “deflationary fears”?

    Also, for the sake of argument, what would you guess Bernanke would do if deflation begins to accelerate further?

    On paper things definitely look deflationary right now, but in my opinion the markets are in the process of pricing in the inevitable conclusion.

  • http://www.pragcap.com Cullen Roche

    This was the entire purpose of his famous helicopter speech. QE is implemented to halt a disinflation slide into deflation:


    If we had a real slide into deflation he’d likely implement larger asset purchase programs. He thinks the last few worked so why not keep going?

  • http://www.pragcap.com Cullen Roche

    That’s really misconstruing what I’ve said….

  • http://www.pragcap.com Cullen Roche

    Nice way of stating it Tim.

  • http://www.pragcap.com Cullen Roche

    Roger, the evidence is on just about every balance sheet in corporate America. Just go look up the labor costs at these companies. They’re enormous.

  • http://blogfirstrider.blogspot.com/ first

    Oil price and wage increase do not by them self increase inflation if the money supply is constant. The War was very expensive and had to be paid by inflation. War is almost alway inflationary.It took several years to affect the US economy and create a stagflation in the 70’s.

    We are obviously no longer in a deflationary mode and if commodities and consumer prices continue to climb BB will eventually have to raise rates and the possibility of stagflation exist.

  • Sanford

    Thanks, I guess I’m operating under the assumption that QE was implemented to suppress interest rates, but rising interest rates shouldn’t be a concern if one were expecting further deflation? What am I missing here.

  • ObaMao

    It’s same this time? How about history repeats?

    “The War was very expensive and had to be paid by inflation. War is almost alway inflationary.”

    Guess we just financed the Iraq and Afghan wars by borrowing from Chinese and in the mean time balloon payment looms as we can roll over the debt so long. What IF the foreigners reign in on buying out IOUs? Guess we’ll have to increase the interest rate to make it more appealing. Rising rates in stagnant economy hit by on-going $150 barrel oil price won’t be pretty.

  • http://www.pragcap.com Cullen Roche

    Well, it’s a flawed policy and clearly isn’t working as the cost of credit surges. You might be interested in this:


  • ObaMao

    Helicopter Ben has failed as he continue to bumble along.

    He was so confident on 60min interview that he can control the inflation by ticking up the interest rate. Ah such false bravado and wouldn’t it be nice if it was that easy to kill the inflation monster when it rears its head. Of course he did not see the housing fiasco and the demise of Bear and Lehman either.

    As fro joke QE2 – Bernanke began aggressively easing, the dollar has actually risen in value and interest rates have increased. Exactly the opposite effect of his intentions.With QE2, the Fed gave the green light for every country to try and manipulate its currency, and subsequent to that their trade policies. The US is supposed to be a leader and above that. QE2 has not put us any closer to economic prosperity.

    The sages on the street aren’t buying what Bernanke is selling.

  • NR

    Spain has an unemployment rate of 20% and nevertheless inflation hit a two-year high at 3% yoy recently. UK growth plummeted 0,5% in Q4 of 2010 but inflation was at 3,7% yoy. It`s not labor costs affecting inflation currently. It`s raw material including energy. Inflation will be skyrocketing going forward regardless of a depressed labor market.

  • Obsvr-1

    With all of the technology that has been created for the HC industry ( CAT, MRI, PET, Orthoscopic tools, …) the price of HC should be lowered (e.g. Moore’s Law for computing – PC today $200-800, non-existent in 1970, but Mainframe computers with less performance was $M’s)

    SO … I want 2010 HC at 1970 prices.

  • http://www.pragcap.com Cullen Roche

    Once again, this report isn’t about the UK or Spain. It is about the USA.

  • http://www.pragcap.com Cullen Roche

    Even some monetarists are beginning to admit that QE does nothing.


  • Jimmy

    Who listens to this idiot still? What a joke of an analysis.

  • http://www.pragcap.com Cullen Roche

    So says the person who told us hyperinflation was a certainty…..That analysis was so wrong that it’s amazing that people like yourself still come around here and talk nonsense on this site.

    You can disagree with my past analysis, but it was 100% dead right a year ago…..You would better serve your purpose by actually refuting what I’ve written rather than continually writing comments that make you look like a Neanderthal.

  • studentee

    quick question mr. roche: what are banks allowed to do with reserves? you and other mmters have convinced me that they cannot lend them, but besides buying tsys and mbss, what will they do with them? i assume it will be different based on which agent holds the reserves, but can reserves be used to speculate with in commodity markets?

    thanks for the great coverage. your’s has become one of my go-to blogs

  • http://www.pragcap.com Cullen Roche

    Reserves serve only two purposes – to meet reserve requirements and settle payments in the interbank market.

  • hyperinflationista

    Never knew labor costs were ran through the balance sheet.

  • http://www.pragcap.com Cullen Roche

    Current liabilities. You learn something new every day. Still waiting for your hyperinflation Eric…..

  • Lilguy

    Given low interest rates now, is there any direction inflation can go but up–lead by commodities?

  • http://www.pragcap.com Cullen Roche

    Ask the Japanese….

  • http://blogfirstrider.blogspot.com/ first

    Since the US (as TPC repeatably explained)is not revenue constrained,risk and demand for money is not even an issue for BB at this time. He and is comrade at the Fed see no need to increase rates until of course there is a negative reaction such as inflation.

  • Eric

    The hyperinflationists investment theme is quite simple, it has nothing to do with the CPI. The fed’s continued easy money policies will lead to the loss of purchasing power in the dollar vs the most liquid hard assets…gold, silver, oil, grains, softs, miners, even the S&P…they are not concerned whether housing is weighing on the CPI, with 1 in 10 homes vacant obviously that will weigh on the CPI for some time, money is not looking for illiquid assets. The fact is there is too much liquidity in the system chasing too few liquid assets right now and the fed does not have the ability to take it back or move rates up without impairing the asset values on bank balance sheets.

  • http://blogfirstrider.blogspot.com/ first

    What if Japan had shown huge trade deficit in the last 20 years instead of trade surplus ? What if the Japanese people had no savings?

  • casanova

    Assuming the inflation statistics are genuine, inflation has been low.
    Does this prove PC right? Absolutely not!
    QE is only 3 months old, money suply has increased 150% in the last 2 years. These things take some time to work through the system. And when they do, people like PC and Krugman will find some other cause of the ongoing inflation and the sorry state of our affairs.
    If you more than double the money supply, all other things equal, you really have to be naive to think that this will not manifest itself on higher prices, sooner or latter.
    Remainds me of Krugman rambling about how low treasury yields were 3 months ago, asking for more stimulus, and all of the sudden in one month they went up by 100 points.
    Look at any historical chart, be it inflation or treasuary yields, things are never smooth for too long, but they go up and down vigorously on a very short time.
    So maybe we dont have inflation yet, but dont be surprised if all of the sudden, when economists least expect it, it spikes to level no one could have predicted(not even our brilliant economists).

  • Hyperinflationista

    Last time I checked direct labor costs were ran through COGS. Please show me a balance sheet that lists labor costs in current liabilities. Please show me a 10-k listing that runs labor costs through current liabilities.

  • http://www.pragcap.com Cullen Roche

    The half you conveniently leave out is that it would coincide with a collapse in the USD, a collapse in the bond market and general catastrophe for the US economy. Instead, we’re seeing commodity price increases due mainly to high growth in Asia. It’s not even close to what you hyperinflationists said would happen. It’s time for you all to admit that your thesis on the USA was dead wrong.

  • http://www.pragcap.com Cullen Roche

    Your commentary about the money supply is highly misleading. I am not denying that there is inflation in the USA. But the money supply has most certainly not increased by 150% in the last 2 years. In fact, it’s still contracting on a year over year basis….

  • http://blogfirstrider.blogspot.com/ first

    “A downward slope in this growth curve does not necessarily mean that the money supply is dropping. Only if the curve goes below zero”

  • Hyperinflationista

    I am not ruling out a collapse in the US dollar, bond market, and US economy in the next few years. The thesis has been very profitable so why would anyone admit it was wrong in swapping out of the dollar and other fiat and moving into hard assets to hedge against currency debasement. Everyone keeps talking about this big rally to come in the US dollar…where is it? I never said it would happen overnight or in the next year or to, the ultimate risk is the loss of confidence in central bank’s and fiat currency as a whole. What do you think will happen if oil drifts to 125-130 range this year..do you really think the fed will take short term rates up and squeeze bank’s NIM. With all of the newly 4% mortgages floating on balance sheets do you think the fed will be able to move rates up aggressively if needed in the next 5-10 years.

  • http://www.pragcap.com Cullen Roche

    I know you’re not ruling it out. You’ve been calling for it for 2 years straight. I just hope you haven’t been putting your money where your mouth is and betting against all US denominated paper assets. Because, if you have been you’ve had your clock cleaned. I know it’s convenient for all of you hyperinflationists to look back and say “I was right because I bought gold!”, but the truth is that your analysis was totally off the mark and you got a lot more wrong than you got right and now you’re all changing your tune by focusing on inflation abroad…..Convenient revisionist history. The bottom line is US paper hasn’t collapse so the central tenet of your entire thesis has been wrong….

  • nottpc

    I don’t think UK inflation has a housing component so more reliant on things people buy every day. Whereas US is heavily housing dependent so with multi year slump in housing still to come will show little inflation via official channels. There is little difference between UK and US…both finance based economies dependent on consumption, who serve their banking interests and are enjoying the spoils of such with housing disasters. The main difference today is level of QE; austerity measures at federal level; more protection of worker rights in UK; and they slapped the bankers hard unlike the wrist slap in the US. One finds it hard to believe UK can have such inflation with austerity coming down the pike while US has none….its all in the measurement

  • casanova

    I dont know where you get your information, I see the monetary base exploding by more than 150%.
    And this is high powered money of course.
    But I wont get into a discussion of M1, M2 and M3 as I am an ignorant of the MMT preached here.


  • http://www.pragcap.com Cullen Roche

    I am not calling you ignorant. I don’t pretend to know everything, but this much I understand.

    What you’re referring to is the monetary base. That is not the money supply. M3 (the broadest measure of money supply) is no longer published, but M2 is and it’s only up 6% in the last 2 years:


  • http://www.gravatar.com/avatar/cd4856980b04809705b581e19be0536c.png Nak

    Can China keep flooding the US with cheap goods? My answer is no, less goods will result in Inflation.
    Can the US meet their liabilities to their aging Population and all their social programs? No, but they will sure damn try by printing like no one ever has before. How is this not going to result in Hyperinflation?