More On the Coming Inflation

This past weekend's Wall Street Journal published a prominent article on the front page of the Money & Investing section regarding Stephens' Bill Tedford's bet on inflation.

Tedford has an enviable record over the past 20 years, as described by the Journal, as a fixed-income fund manager with Stephens. I found these passages describing part of his model to be extremely compelling,

"The key data point in Mr. Tedford's model: the monetary base, basically money circulating through the public or reserve banks on deposit with the Federal Reserve. Over long sweeps of time, he says, inflation closely tracks increases in the monetary base that exceed economic growth.

For instance, he notes, in the 40 years to 2007 the U.S. monetary base grew at 7.08% a year. Gross domestic product, meanwhile, grew at 3.04%. The resulting surplus monetary-base growth of 4.04% closely matches CPI and the personal-consumption-expenditures price index, another measure of overall inflation."

The piece goes on to note that the U.S. monetary ballooned from less than $850 billion (the Journal stated "million," but I'm fairly sure that is a typo) in August, 2008, to more than $2T at the end of last month. Tedford explained that, even if you subtract $1T still held as reserves, the resulting growth in monetary base is "one of the highest changes I've ever measured."

For evidence, Tedford observed that as of October, the year-over-year CPI had sunk .02%, while the year-to-date change is 2.3%.

This article struck me as one of those pieces that crystallizes common sense.

I've been following the thinking of several prominent economists in the Wall Street Journal this year. Two themes have made a lot of sense to me.

One is that whatever growth the US economy seems to exhibit will be the result of federal printing or borrowing money, not real, lasting, reliable private sector growth.

The other is the incredible growth in the monetary base. Alan Reynolds and Art Laffer have both mentioned this as a reason to worry about coming hyper-inflation. Now Tedford, with a proven track record in fixed income, is taking action along those lines.

You don't have to be really smart or have a PhD in economics to understand the following question.

If the US monetary base, valued to reflect the worth of the US economy, was under $1T at mid-2008, and it now is more than double that, does this represent a true increase in value in the US economy? Especially just after, or still during, an economic recession?

Of course it doesn't. It cannot.

What it represents can then only be one of, or a mixture of, two things- the present value of suddenly-monetized growth, or a simple depreciation of the currency, leading to subsequent inflation.

I can't see how the world's investors have magically granted the US double the prior present value of future economic growth. So it makes more sense that we have about double the amount of dollars in existence to value the same amount of economic worth in our economy.

Any way you slice it, that's depreciation of the dollar that will lead to inflation.

Only this morning, a guest on CNBC expressed doubt that the Fed will raise rates at any time before next November, thus leaving us open to an inflation-tinged bout of 'growth.' He doubted that any equity market gains would be "real," either in the deflated or reliably-sourced sense.

I think he was correct. It's not clear exactly when the effect of the huge monetary base increase will hit, but history strongly suggests it won't be correctly or effectively handled by a Fed reduction in the base in a timely fashion. Second, federal spending will hit the economy in such a manner as to exacerbate inflation and, then, when expended, lead to a fall in equity values as private sector growth fails to immediately pick up for borrowed-money growth.

For anyone else who, like me, remembers the rise of inflation in the 1970s, it is very discomforting to see these economic indicators coinciding- federal spending, higher deficits, much higher monetary base, amid a recession.