Thursday, April 14, 2011

Inflation, Commodity Prices & US Debt

Kelly Evans wrote on Tuesday, in her Wall Street Journal Ahead Of The Tape column, about M2's relatively slower growth in February. Her point was that, from Friedman's perspective ("inflation is always and everywhere a monetary phenomenon"), we aren't actually experiencing rampant inflation.

I've written in prior posts about the confusion between concepts such as that embodied in the misnamed CPI and monetarily-defined inflation. There's no question that the broadly-defined price indices are measuring a rise in the prices of commodities such as food and energy. But this isn't Friedman's view of 'inflation.'

But after reading Evans' column, I began to reflect on how Friedman would view the overall US monetary policy situation today.

The Fed's balance sheet is obscenely bloated. Some pundits are seriously discussing whether there would be a QE3 in light of the still-struggling US economy.

The Fed is monetizing US Treasury debt on a previously unheard of scale.

In this context, is it really sensible to limit the measure of monetary-based inflation to relatively-narrowly-defined concepts such as M2? What is velocity? Surely overall velocity of money and near-money is, on average, higher today, with increased use of electronic fund transfers, than it was in Friedman's prime. What has it been lately- rising, steady or falling?

With the Fed so queering the markets for money with its post-2008 easy money and excessive asset purchase policies, it seems silly to only look at the conventional monetary base growth and pronounce it tame.

Surely, amidst such huge amounts of net external US debt holdings and discussions of raising the debt limit, the notion of possible deflation seems contradictory.

Perhaps it's instructive to consider the past three years. With the US having been in a recession, while the Fed embarked on a program of propping up US financial institutions and the value of many of their assets, it's unlikely that monetary value growth during the period was slower than GDP growth.

While some prices remained fairly tame, due to recession-related lower demand, that seems to have ended, at least for agricultural and energy commodities. Meanwhile, GDP remains tepid.

So it's hard to believe that the net effect of the past several years has been US GDP growth that has outstripped that of US government money and credit creation. This situation does not seem to be changing now, or in the near future. Federal spending continues at levels which are increasing net external debt, while recent GDP growth was just scaled back the other day..

That would seem to me to qualify, from Friedman's perspective, as inflationary.

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