When will serious inflation catch up with us?

July 31st, 2008

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Recently, one of our readers asked us this question:

If, as you have reported, our money supply is still increasing at over 20% per annum, what is this likely to lead to in terms of price inflation in the years ahead? I suspect that it will somehow catch up with us one way or another, and the result will not be pretty. But this is just a generalised gut feeling, which is not as useful as a more particularised and detailed understanding would be for positioning oneself for the inevitable. Part of a clearer vision would be, of course, a better sense of the likely timeframes involved. How long before the ugly bits start to catch up with us, and how long will it be likely to last? What will be the signs of imminent danger? Or do we already have plenty of them now, as we speak?

First, for those who are new to this publication, we would highly recommend that you read Cause of inflation: Shanghai bubble case study before continuing reading the rest of this article. The reason is because mainstream economics and the Austrian School of economic thought have different definitions for inflation. To make our language more precise, we will refer to the former’s definition simply as price rise and the latter’s definition as monetary inflation. If you have time, you may want to read our guide, What is inflation and deflation?.

Next, the point of this article is about recognising the signs of inflation- we are not airing our opinion on what will happen in the future in this article. Our opinion for that can be found in Inflation or deflation first? instead.

Here are two considerations to think about when considering the future effects of monetary inflation:

  1. One troubling aspect when discussing the economic phenomenon of price rise is the indices used to measure it. As we argued before in How much can we trust the price indices (e.g. CPI)?, the whole idea of measuring general price levels is logically invalid. For instance, as we said in that article,

    … the world is experiencing unprecedented asset price inflation. In Australia, it is the housing price bubble. Since the Reserve Bank of Australia (RBA) does not have the mandate to prick asset price bubbles, then can we give them such a mandate by merely redefining houses as consumer durable goods and include them in the basket of goods in the price index calculation?

    That is, if we include houses as part of the basket of goods in the CPI, Australia will be suffering from severe inflation for the past 10 years! One way for governments to deny the severity of price rises is to fudge the figures and the composition of goods and services, which is what the US government is arguably doing right now.

  2. Also, as we said before in Introduction to the famous Quantity Theory of Money, according to the Austrian School of economic thought,

    Monetary inflation (or ?printing? money or increasing the money supply) results in the distortion of the relative price levels. That is, when money is ?printed,? prices will be affected in varying degrees for different things with different time lags (see How to secretly rob the people with monetary inflation?).

    Monetary inflation takes time to work itself out to the rest of the economy. Sometimes, the effect is not immediate. For example, for the past 10 years, monetary inflation did not result in visible price rises. In fact, thanks to the rise of Chinese manufacturing, we have price falls of manufactured goods, while at the same time, the price of houses sky-rockted (see The Bubble Economy). But lately, we see the rise in the prices of commodities, food and oil. To add to the difficulty, the effect affects prices of different things with different time-lags. Some goods and services are are susceptible to monetary inflation than others.

    Next, monetary inflation may not affect the price levels of of everything to the same degree. For example, the past rise in house prices was probably not going to be accompanied by as great rises in the price of funeral services.

In view of these two considerations, you can see why it is not easy to give a straight answer to our reader’s question. But before hyperinflation can develop, there will be plenty of warning signs. An exponential increase in the supply of money is one sign. The conditions that we described in What is a crack-up boom? is another. Governments turning towards populism and fiddling with the laws is another (see Recipe for hyperinflation). In other words, while you cannot know the precise time-frames of such development, you will have plenty of time to prepare for it as long as you keep your eyes and ears wide open. In addition, the initial stages of inflationĀ are akin to a silent killer that is slowly doing its destructive work. But as it move towards the finale (i.e. hyperinflation), you will see the acceleration of developments.

Thus, we would encourage you to acquaint yourself with history in order to help you recognize the signs. We will be watching and listening too. You will get to see what we see and hear what we hear both in this publication and on our sister site: Contrarian Investors’ News.

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