Last week’s troubling news on inflation (as detailed in the November reports for consumer and wholesale prices) should come as no shock to readers of these digital pages (assuming, of course, you’ve agreed with our thesis). For some time now, we’ve been expecting that pricing pressures were set to rise. The only question: when? We can answer that question with a confident “now,” allowing us to move on to the next batch of questions: how long will it last, and how high will it go?
The answers are yet to be determined. While we wait to see how the central bank reacts, we can review the lessons that the past imparts. That begins with the recognition that inflation never dies, although it does go into long stretches of hibernation. Even then, it’s always waiting to pounce, looking to exploit any temporary lapse in central banking judgment or the occasional exogenous event, such as oil running higher.
For much of the 1990s, and deep into the 21st century, prices have been relatively contained. But your editor has a deep and abiding respect for cycles, and so one might wonder if the great disinflationary cycle has finally turned, or at least ended? Twenty years or so, after all, is a long time, and nothing lasts forever in economics.
Certainly it’s getting easier to make a persuasive case that risk outlook for inflation has notched higher. Indeed, with producer prices rising in November at the highest annual rate since the 1970s, and consumer prices also bubbling strongly last month, the numbers speak for themselves.
We don’t know what’s coming, of course, but this much is clear: inflation remains a monetary phenomenon, as Milton Friedman long ago preached. To the extent that prices rise or fall far out of line with what shifting demand and supply trends imply, the effect is almost certainly due to decisions by central bankers. So it goes in a world of fiat currencies, where printing presses eventually determine the value of dollars, euros, yen and so forth.
With that in mind, we turn to those printing presses overlooked by the Federal Reserve. As our chart below reveals, the annual pace of M2 money supply (the broadest measure of printing press activity published by the Fed) has been steadily climbing in recent years. For the 52 weeks through this past December 3, M2 is up 6.2% in nominal terms. That’s almost certainly higher (perhaps much higher) than the pace of growth for GDP this quarter.
Why is the Fed creating what some might say is excess liquidity? The usual suspects come to mind, starting with efforts to juice the economy to circumvent sluggish growth or recession. There are also some liquidity problems in the credit markets, spawned by housing correction and the ills associated with subprime mortgages. In fact, it’s never hard to rationalize a little extra liquidity to tide the economy over until the outlook is brighter. The challenge is keep a little nip every now and then from turning into a drunken binge.