Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘Mervyn King’

• An incendiary mix! Inflation, CPI and the U.S. Federal Reserve

Posted by Ron Robins on May 28, 2008

The U.S. Consumer Price Index (CPI) does NOT measure inflation
It is stunning how confusion reigns on the subject of inflation. Simply put: the Consumer Price Index (CPI) does not measure inflation. It tries, imperfectly, to measure the cost-of-living. Inflation and cost-of-living are not the same thing! As elite economists from Nobel Laureate Milton Friedman to the Bank of England’s Mervyn King comment, inflation is a monetary phenomenon. It is evidenced by excessive expansion of the money supply which exceeds economic growth. Therefore, the basis for higher prices in an economy is ‘too much’ money.

One measure of current U.S. broad money supply shows it growing at an annual rate of over 16%! However, there is considerable debate as to what money supply measure best links it with inflation. (I suspect that for developed countries, we might see credit expansion playing a much more important role in understanding the inflationary process than is currently appreciated. But that is for another post to research.)

Most people believe the CPI measures a fixed basket of goods and services over time. That is again, incorrect. It used to be the case, but not anymore. The current CPI basket of goods and services is constantly changing according to what bureaucrats think people are buying, and by numerous statistical alterations they deem ‘appropriate.’

How the U.S. Bureau of Labor Statistics (BLS) modifies the CPI to show tame inflation
The kind of huge modifications the U.S. CPI is subjected to include the following:

  • Substitution of products. Should prices rise, it is inferred people will substitute with something less expensive.
  • ‘Hedonic’ adjustments. If computers’ performance doubles, the relevant index component is halved.
  • Weighting changes of index components. If an item becomes suddenly expensive, it may receive a smaller index weighting.
  • Chain-weighting. Applies to some ‘versions’ of the CPI. This smoothes-out sudden price changes over many months and means indexes using this are always ‘behind-the-curve.’
  • Intervention analysis/seasonal adjustments. Bureaucrats adjust index components according to historical seasonal variations, whether warranted in the current year or not. (See: The Government’s Statistical Whopper of the Year, by Robert P. Murphy.)

Hence, the BLS is able to manipulate the CPI to whatever doctrine holds sway at the time. Prior to about 1980, there actually was a fixed basket of goods and services that comprised the CPI. It did a much better job of measuring inflation caused by monetary expansion. But politicians and some academics did not like this as they said it overstated the actual cost-of-living. For instance, they figured that if beef became expensive, people might buy chicken, and so on, thereby reducing living costs, and thus effectively lowering the index.

Of course, these types of changes also inferred lower living standards. But no politician, or a bureaucracy headed by a political appointee such as the BLS, would want to say that!

CPI inflation over the past year: using 1980’s configuration, nearly 12%; using current methodology, 3.9%!
So around 1980 the CPI began to be massively modified and thus began the trek of divorcing it from monetary inflation. The difference in numbers between the 1980s CPI inflation measure and today’s cost-of-living CPI is extraordinary! John Williams at http://www.shadowstats.com/alternate_data shows that for April 2008, the CPI using 1980s methodology shows inflation over the past year of close to 12%; using CPI (CPI-U) as constructed today it is just 3.9%!

There is no doubt that the ideal of trying to get a consumer price index that reflects the reality of consumer buying behaviour is a good one. But to rely on the current CPI as a means of determining U.S. inflationary pressures so as to modify its monetary policy, is, at first glance, illogical. However, there is something else going-on here.

The Federal Reserve uses current CPI to fool the world in supporting U.S. economy and artificially high bond, stock prices
The U.S. Federal Reserve often cites the CPI as being very influential in shaping its monetary policy. From the foregoing this seems to be a very strange policy. When viewed through a political lens and the need to maintain confidence in the U.S. economy though, it makes sense to try to fool the world at large that inflationary pressures are minimal within its economy.

The U.S. economic problems are so big that if the Federal Reserve and other government agencies came clean on the true rate of inflation, we would see:

  • U.S. economic growth would be shown to have been negative for several years now (real GDP growth rate = nominal growth less inflation)
  • Bond yields would soar
  • Stock market could rise in highly inflationary environment or crash should deflation take-over
  • U.S. government deficit rocket higher
  • Severe economic downtown. Perhaps a depression

As consciousness rises investors everywhere will begin to understand the distinction between U.S. monetary based inflation that is in the double digits, and a highly stylized, theoretical, consumer price index that minimizes the monetary inflationary threat. Prices of everything will then be re-set accordingly.

There is huge danger ahead should the U.S. monetary and credit expansion continue unabated. The excess funds will find their way into more asset classes and lead to further big asset bubbles – and busts. Commodities anyone! Oh, what an incendiary mix!

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© Ron Robins, 2008.

Posted in Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , | 2 Comments »

• Out of the Ashes. A Global Central Bank!

Posted by Ron Robins on March 12, 2008

Our financial overseers will create a world central bank in the next few years. Growing higher consciousness in the world will enable it to become a reality. This bank will have a mandate to monitor, regulate, and maintain global currency, credit, and debt issuance. It will ensure that growth of these activities roughly matches global economic output. It will come about as the chaos and inadequacies engendered in our present monetary system become evident to everyone and a world central bank seen as the best solution.

Individuals and groups in financial markets everywhere, lacking inner fulfillment, have demonstrated inordinate greed resulting in reckless financial games and gambling – are bringing the financial system to its knees.

Such mismanagement in the financial system, I believe, will require the new world central bank to disallow banks everywhere from continuing in unfettered debt creation and speculative excesses. In search of ever higher returns, banks created overly lax lending standards, highly leveraged loans, obscure financial entities bearing major financial risks unconsolidated in their financial statements, and generally ran down the quality of their assets and reserves to unsafe levels.

‘Shadow banking’ system larger than conventional banking
All the while an even bigger, massively leveraged, totally unregulated, thinly capitalized, ‘shadow-banking’ system was allowed to balloon by bank regulators. And it is now in the process of imploding! Bill Gross, managing director of PIMCO, the world’s largest bond fund, said this recently about the shadow banking system: “Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever.”

Due to the enormous growth of irresponsible central bank and banking activities globally, plus the vast, mushrooming credit creation of the shadow banking system – the world’s money supply is expanding out-of-control.

Unprecedented money supply growth creates inflation as bad as 1970s
Globally we see that, “China [is] registering an 18% plus growth in money, India 22.4% a year growth, Singapore 14%, Britain up by 12.3%, Western Europe 11.5%, Australia 16%, Canada 13%, and Saudi Arabia 22%!” So says The Mogambo Guru, Richard Daughty. These are ‘broad money supply’ figures. John Williams of www.shadowstats.com shows the US broad measure of money supply, as of early February 2008, increasing at annual rate of 16.8%. (The US Federal Reserve stopped publishing this measure in March 2006 claiming it costs too much to produce. Many economists suspect that they just wanted to hide the ramping-up of the US money supply.)

Even Marketwatch’s chief economist, Irwin Kellner, is concerned about US money supply growth. He said recently, that, “The rate of growth for highly liquid funds which the St. Louis Fed calls MZM [i.e. physical money, checking and money market accounts, etc.]… soared by an annual rate of 22.7% between December 24, 2007 and February 18 of this year.” He adds, “… it has created a whole lot of inflation.”

The link between an expanding money supply and inflation is firmly established. As the Bank of England’s Governor, Mervyn King quoting a highly respected study, said, that “Over the 30 year horizon 1968-98, the correlation coefficient between the growth rates of both narrow and broad money, on the one hand, and inflation, on the other, was 0.99.” Thus in the words of Milton Friedman, the recently deceased Nobel Economics prize winner, “… inflation is always and everywhere a monetary phenomenon.”

In the US, consumer price inflation using the politically biased, understated, consumer price index (CPI-U) is in January 2008 up 4.3% from a year earlier. But using the CPI methodology as of 1980, it is almost hyperinflationary at close to 12%! Inflation in China is now running at 8.7%, while in the EU and the UK, though more moderate at 3.4% and 3.1% respectively, it is picking-up significantly and well above their respective central bank targets.

The foregoing suggests that the present global monetary and financial system is reaching a state of extraordinary instability. The danger is the possibility of rapidly growing, unstoppable inflation culminating in a hyperinflationary episode such as is now occurring in Zimbabwe. Or, a threat of a deflationary bust similar to the Great Depression.

Higher consciousness the only real answer
The only real answer to such economic threats is higher global consciousness. This, I am convinced, will gain traction. (See my post, The Missing Ingredient In Economics — Consciousness!). In future years, this higher consciousness will, amongst other things, first manifest itself by allowing our financial overseers to see the need for, and create, a world central bank.

In ages past central banks utilized gold to help create monetary order. A new world central bank might well find a role for gold again, but in an updated, modern form. I will write about this in another post.

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© Ron Robins, 2008.

Posted in Banking, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , | 6 Comments »

 
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