Recorded by Brad Zigler  |

October 06, 2008

Explaining Inflation ... Again

Details

In a recent column, I referred a reader to our real-time inflation indicator (explained in "Computing Inflation In Real Time"), naively thinking that the method - or the madness, depending upon your point of view - utilized to derive it would bolster my argument for an impending recession.

Well, no such luck.

Our indicator gauges inflation through the gold market by comparing the metal's dollar-denominated price to its value in euros. The fact that gold was used as a medium, however, vexed our erstwhile reader.

"If you're going to measure inflation in terms of gold," he shot back, "your 12-month measure will show massive deflation in a few months because the price of gold dropped this summer/fall (or the price of dollars rose, whichever). This doesn't tell us anything a price chart for gold wouldn't tell us."

Oh no?

Take a look at the accompanying chart. At the beginning of the year, gold was selling for $841 an ounce. Gold was fixed on October 3 at $842, virtually unchanged from its beginning price. Yet look what happened to monetary inflation in the intervening nine months. The annualized inflation rate slowed by nearly 7.5%.

 

Monetary Inflation Vs. Gold

 

Inflation, in fact, was slowing while the price of gold was rising early this year. If that sounds counterintuitive, keep in mind that the indicator is measuring monetary inflation.

Commonly, inflation is confused with rising consumer prices. The mostly widely followed metrics usually associated with inflation are those produced by the Bureau of Labor Statistics. But the Consumer Price Index (CPI) and the Producer Price Index (PPI) measure price changes, evidence of "demand-pull," not monetary, inflation.

Monetary inflation is caused by working government presses overtime, printing more greenbacks to cover deficits. Demand-pull inflation rears its head when credit is easy, spurring demand for goods.

The accompanying chart shows that monetary inflation can still be measured positively on an annualized basis. In this sense, it hasn't disappeared. But it is decelerating even as gold prices have stagnated.