The old adage says that if you throw a frog in boiling water he will quickly jump out. But if you place the frog in cold water and raise the heat ever so slightly to boiling, he will lay still and cook to death. Replace the frog with “the American taxpayer” and make the water temperature the “level of prices” and you have a metaphor for the current US monetary policy. It would most certainly not be in the best interests of politicians, or central bankers alike, to turn the inflation switch on overnight. That would result in nothing short of riots. In light of that, it is becoming increasingly obvious that the only way out from under the mountainous pile of government debt is through moderate price inflation and erosion of purchasing power over time. The other alternatives would result in a US government default or debt restructuring and we can be sure that no President, Democrat or Republican, would concede to that under his or her watch.
Some economists will contest claims of higher price levels and lower purchasing power with the sagging level of the Consumer Price Index (CPI) relative to historical inflationary periods. Contrary to some beliefs, one can argue that CPI is a manufactured index that is used as a benchmark for keeping wages, benefits, and cost of living indices in check, and fails to depict an accurate basket of goods. While deflationists are constantly pointing toward the multitude of retail discounts and dollar menu offerings they come across during trips to the mall, they fail to mention rising prices in things like beverages, clothing, pharmaceutical drugs, utilities, transportation, college tuition, and most importantly, inputs like metals (hard commodities) and agriculture (soft commodities).
There appears to be a disconnect between where actual commodity prices are going, and where consumers expect the prices of goods made from these commodities are going. Is it reasonable to think that the things we need to buy (food, clothes, cars, etc.) will miraculously become cheaper even though the inputs used to produce them are skyrocketing? NO! Some simple facts: corn is up 43% this year, soybeans are up 30%, wheat is up 34%, coffee is up 52%, cotton is up 100%. Food and clothes will become more expensive unless the labor to make these items becomes much cheaper. Fortunately, East Asia is already under pressure to improve working conditions so do not expect labor to become less costly. On the metal front: copper is up 18% year-to-date, silver is up 62%, platinum is up 20%, palladium is up 77%, and gold is up 28%. ‘Nuff said?
The laymen frequently combat these statistics with the “wealth” they are accumulating in their stock portfolios and retirement accounts. “If the stock market is up, my portfolio rises, and I am getting richer,” they quip. It appears as if American taxpayers forget that they will lose if the dollar wins the race to zero. After applauding the recent strong performance in the stock market, most Americans show no angst from the 13% decline in the dollar over the past 4 months. “So we won’t go to Europe for vacation this year!” some might crack. Unfortunately it is not that simple. The US operates at a trade deficit and we consume many goods from other countries so cutting out vacations abroad will only alleviate part of the pain caused by the weaker purchasing power of the dollar.
To my fellow frogs I fear we must be realistic and face the facts that life will become more expensive. It could get a lot pricier should the Government and the Fed not perfectly thread the needle of igniting an economic recovery while giving our foreign lenders some semblance of confidence in the dollar. We should prepare for higher prices domestically or find a way to denominate our assets in other stores of value to avoid getting cooked (buy some land or some Chinese yuan…or take my grandpa’s advice and buy 4 boxes of cereal before the price goes up!).