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How Bad Could Inflation Get?

By: Steve Johnson

4/15/2008 - 89 Comments

The Labor Department reported Tuesday that wholesale prices rose by 1.1 percent last month, the second largest increase in the past 33 years.

This is a bad time for inflation to make a run, with the economy on the edge of a recession, inflation is climbing fast – and this may be just the beginning.

“For the past 12 months, wholesale prices are up by 6.9 percent and core inflation is up by 2.7 percent, the biggest year-over-year increase in nearly two years.  For March, energy prices jumped 2.9 percent, the biggest increase since November. The price of gasoline was up 1.3 percent while natural gas rose by 4.2 percent. Home heating oil shot up by 13.1 percent and diesel fuel, used to power the nation's trucking fleet, increased by 15.3 percent. “

“Analysts believe the economy will be hit with more energy pressures in coming months, reflecting the fact that crude oil costs are remaining at record levels above $111 per barrel.”

Reference Article: Wholesale Prices Soar in March, Up 1.1 Pct.

The falling dollar is the primary cause of the increase in the cost of oil, which just hit another record above $113 per barrel today.  Higher oil prices and inflation will likely continue until the Fed reverses course and starts protection the dollar by increasing interest rates, but that is unlikely to happen until after the presidential elections in November. 

The other problem is that the government inflationary calculations are a lagging indicator excluding food and energy.  Because of this, not all economists trust the consumer price index (CPI) as a valid measure of inflation.  Some economist say that inflation is more like 8-12%, while the CPI says it was only 2.7% in March.

Reference Article: Inflation Maybe More Like 15%

Not being able to trust the CPI is a very big problem because inflation can sneak up on a nation and before you know it you are looking at hyper-inflation. Nixon started wage and price controls in 1971 when inflation was only 4.9%.  Despite the government efforts, inflation continued to rise until 1979, when it peaked at 13.3 percent.

Today, depending on whom you talk to, we have 8-12% inflation - far beyond the 4.9% of the Nixon era. Therefore, because the CPI doesn't reflect the actual inflation, the nation is not aware of the problem we will soon be facing as we are on the verge of double-digit inflation with hyperinflation on deck if we don't change our monetary policy quickly. 

Wages Are Not Keeping Up with Inflation

Most ‘cost of living’ pay increases are based on the government inflation rates, which are reported by the CPI.  If inflation is at 8% and wages are increasing by 2.7%, than a lot a people are getting forces to live on 5.3% less each year.  After three years, everyone will be forced to give up 15.9% of their purchasing power.  This is even worse for those living on fixed incomes that don’t get a ‘cost of living’ increase. They will be out 24%.

Higher Inflation Coming

The Fed's insists that we focus on "core" inflation - a measure that strips energy and food from the consumer price index (CPI) because core inflation is not subject to short-term volatility. The problem is that the US economy has cheap goods primarily because we have cheap gas/diesel coupled with a very good transportation system that can deliver goods at very low prices. As energy prices go up, so will all prices of goods.  It’s easy to see that when the truckers finally get sick of losing money delivering goods with $4/gallon diesel, consumer prices will jump and the CPI will suddenly show a large increase. When that day comes, the Fed will say, ‘how did that happen?’, and it won’t be an easy problem to fix. 

Inflation Is Increasing Around the World

As bad as it is in the US, it’s much worse in many nations around the world. The reason we don’t feel inflation as much as in other parts of the world is because we only spend 7% of our income on food, while other nations spend as much as 50%.  If food prices increase by 10%, we can cut back on the other 93% of our budgets while many of the poor around the world are on the brink of starvation.

Russia's inflation has hit 12.7% last month. President-elect Dmitry Medvedev called it a necessary evil. "This is the price we are paying for our presence in the club of world economic powers," he said.  What he means by that is that there is little they can do – because all nations are deflating their currencies in an effort to keep pace with the dropping dollar.

Reference Article: Capital flight puts Russia on the ropes

As I have wrote about before, the US governments monetary policies to increase their money supply, is forcing other nations to either follow by increasing their money supply (in order to keep the dollar from dropping against their currencies, but this causes inflation within their own nations) or let their currencies rise with respect to the dollar (which will drag their nation into an steep recession).

Wake UP and Smell the Inflation

Sooner or later, the US Federal government is going to have to reverse its monetary policy and turn its attention to fighting inflation.  Inflation is likely to plague the entire world for several years because of the decisions that have already been made.  Once the decision is made to fight inflation, it will take a few years just to stop inflation from continuing to increase and then several more years to reverse its direction. 

All governments around the world are going to have to fight inflation, because the dollar is the world currency – and the primary cause.  Looking at other nations who have suffered through hyperinflation, they were able to stabilize their currency by using the dollar within their country. But, now that the dollar is inflating, there is no other currency to use to stability the dollar.  There are no good choices because even the other leading currencies, like the Euro, Yen (Japan) and Yuan (China) are being debased by their governments - although slower than the dollar.

Reference Article: Surviving the Global Financial Meltdown

Congress Needs to Take Drastic Action

Last week Ben Bernanke told congress that they need to take action to prevent further economic decline.  This statement further distances the Federal Reserve Chairman from the looming economic collapse by putting congress in their rightful position to take the blame.  Congress needs to cut back on spending drastically – which they have not started talking about nor have any intension of doing anytime soon. Instead, congress wants Ben Bernanke to fix the economy problems so they can continue spending like there is no tomorrow.

Instead of cutting, congress is busy working on their next stimulus package. Package after package will be created until they realize that it is not working and they need to cut spending drastically. In the mean time, inflation is likely to increase for years to come.

Hyperinflation Is Worse Then A Recession

In the years to come, the leadership of the US is going to have to turn the ship directly into the recession, because avoiding the looming recession is leading us to hyperinflation - which is a much worse storm.  

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