Friday, February 20, 2009

Inflation Signals

Is inflation dead? While Ben Bernanke and most of the economics profession believes that it is, this is largely because of the Phillip’s curve — which argues a trade-off between unemployment and inflation, or recession and recovery. Since jobs and the economy are falling, and unemployment is rising, this Keynesian view argues that inflation is dead.

But the January inflation report suggests otherwise.

Today’s consumer price index (CPI) showed a 0.3 percent monthly rise for all items and a 0.2 percent increase for the core inflation rate, which excludes food and energy. Yesterday’s report on the producer price index (PPI) for January showed a 0.8 percent gain for all wholesale prices, plus a 0.4 percent rise excluding food and energy.

Obviously, the plunge in energy prices, which amounts to a huge tax cut for the economy, has brought inflation way down from its peak last summer. For example, the CPI has dropped from nearly 6 percent to 0 percent. Inflation is the cruelest tax of all. And this disinflation provides a significant tax cut for the economy — even when Obama’s stimulus plan does not. So that’s all to the good.

But inflation trends may not be as quiescent as the Phillips-curvers would have us believe. In classical terms, inflation is too much money chasing too few goods, leading to a decline in the purchasing power of money and the exchange rate of currency. Now, while the Greenback has been strong, it’s worth noting that the core PPI has increased 4.2 percent over the last 12 months. For consumer prices, the core rate is 1.7 percent.

Kind of makes you wonder: With the Fed pouring in all this new money, and the recessionary economy producing no new goods and services to absorb that new money, perhaps we are building a base for higher future inflation. That could be the signal of $1,000 gold, which is one of the big stories in today’s trading. Year to date, the yellow metal has been a star asset performer.

There are dissenters to the inflation story, such as my friend David Malpass. David thinks gold is way too high and that it will succumb to continuing deflationary pressures. But my sense is that the deflation threat at present is overrated.

Whether inflation comes roaring back remains to be seen. But I think the Fed’s balance-sheet expansion and the rise in M2 — even during a period of falling velocity — could be a longer-run inflation problem.

What’s the best way to curb this problem? Grow the economy, and produce plenty of new goods and services that will absorb the new money without inflation. I know folks have heard this from me before. But the best antidote for inflation — or sagging asset values in housing, stocks, and business — would be to slash the corporate tax rate, create a capital-gains tax holiday, and flatten the tax-rate structure for real pro-growth tax reform.

Contrary to what Obama is doing, let’s start rewarding producers and investors across the board, for all income levels. That will grow the economy, stop inflation, rescue housing, and reignite the stock market. And let’s keep the dollar steady while we undertake tax reform.

I believe it’s called supply-side economics. Oops. That’s out of favor now in Washington — isn’t it?