Inflation?

I notice you referred to "experts" and not economists.

It seems to me that most of those shouting about inflation are in the media and could not explain what inflation is if their life depended on it. Wikipedia has a pretty good definition.

"In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.[1] When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money ? a loss of real value in the internal medium of exchange and unit of account in the economy."

Clearly what we have is not inflation since the general level of prices (the price of virtually all goods and services) is not going up.

What we have is an increase in the price of some goods. Oil is going up because demand is growing faster than supply and because oil is priced in dollars and the value of the dollar is falling . Some other imported goods are going up due to the decline of the dollar. Canon cameras are going up due to production disruptions caused by the earthquake in Japan.

To have true inflation you have to have to have some situation that increases demand for or decreases the supply of virtually all goods and services. One example is a prolonged increase in the money supply so that more dollars are chasing the same quantity of goods and services. The inflation of the '70s was caused by Lyndon Johnson running the printing presses so he could pay for the Vietnam war without raising taxes. Easy credit can have the same effect by allowing folks to spend money they do not have and thus causing demand to outstrip supply.

I am neither an economist nor an "expert" but at least I make some effort to understand the basics. Very few people who report on economics in the popular press bother to acquire any knowledge at all.

My opinion of what has happened to journalism in this country can be summed up by reading CNN on-line. You cannot find one single article on CNN on-line that was originated by a CNN writer that does not contain multiple gramatical and typographical errors. I suspect this complete disregard for accuracy is applied to the information being reported as well. Journalism is an endangered craft in this country.

For what it's worth, with "real estate going south" - that takes a lot of the steam out of the top-line inflation number since a huge chunk of the CPI is the cost of housing (a combination of rent and "owner's equivalent rent" part which represents the cost of housing implied by living in a home one owns).

Rent of primary residence and owners' equivalent rent of residences combined represent about 30% of the CPI. And actually, over the last year or so, that component has actually gone *up* by about a percent (actually a touch less for owner's equivalent and a touch more for rent). Excluding food and energy, in the year ended Mar '11, the core CPI was up 1.2%. So everything except housing and food and energy was up by a bit more than 1.2%.

Food and energy total out to about 23% of the CPI-U and if you do include them, it was 2.7%. Energy alone was up about 15% for the year. But energy and food really are volatile as heck and if you look at the chart both including them and excluding them over the last couple of years, it's obvious why folks talk about "core" CPI so often.

As to current bond yields, well, bear in mind that the treasury bond market is astoundingly liquid and there are a lot of folks who believe that there will be higher interest rates and lots of inflation - but they believe as well that they will be able to get out of the long bonds in time to be safe from that stuff. It smacks to me very much of the same problem as some of the leveraged real estate stuff and the tech bubble - the "greater fools" theory - where the current situation doesn't look sustainable, but since nobody knows exactly when or how fast it'll revert to a more sensible place, folks who think they are smart enough dive in and hope to get out before everyone else catches on.

FWIW2, if you compare the "real" rates implied by the nominal bond market's interest rates and the current inflation rate against the real rates implied by the TIPS yield curve, it's, um, interesting. 30yr TIPs have a current real yield of

1.76%. They've bounced around between about 1.5 and 2.2% over the last few years - that's the interest rate *above* inflation whatever inflation does. If the 30yr fixed is paying 4.4% and you assume that the "real" part of that is the same 1.76%, then that bond is pricing in some 2.6% inflation (and, I guess, risk premium) - which as you and I seem to agree seems low - that says to me that the long fixed-rate bond market is either lowballing inflation expectations (really?) or there are a lot of people who think they'll be able to get out fast enough when the time comes.

Anyway, that's just some quick thoughts off the top of my head.

I can't believe that anyone who remembers '94 or the early

80s isn't really wary of the treasury curve.

Here's a graph to go with that comment.

It's the 30yr CMT vs. the CPI-U (less food and energy).

Actually, I added a third line, the difference between them, and a fourth line, the 20yrTIPS CMT, but they didn't add much to the picture - the implied real rate has been pretty stable at around 2.6 or so for about a decade, but of course, this has been a low-inflation decade and having the graph go back to before '85 (and thus include the early 80s), the scale gets a bit squashed because of the early 80s craziness.

HW, perhaps, the real question is "how can we have 30-year Treasury stuck at 4.5% with inflation going on"?

In other words, it is not clear, at least to me, who is wrong here, the experts noting inflation, or the bond market. The bond market experienced very substantial corrections in the past, and is often driven by participants such as foreign reserve systems.

My personal expectation, based on all that I know, is that of a modest inflation, for example 10% per annum.

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While I don't know if we're having inflation or not, there's definitely something weird going on with treasuries when the largest bond fund decides to short them.

The easier question is how we can have short-term rates (T-Bills) at virtual zero for as long as we have? And that easier question is almost punitively hard - the kind of grade-killer one might expect in an MBA Econ course.

It would *seem* the right answer is the simplest:

1) capital is an input of production - a commodity, if you will, subject to supply and demand 2) there's a lot of real capital lying around without a home to invest in - intellectual capital (production ideas) are apparently lacking

But beyond that, it's a real can of worms, and the above isn't good enough for a passing grade. Without solid data, this is speculation, but FWIWm here are some possible contributing factors:

a) in the financial sector, derivatives leverage has replaced real borrowing b) in the corporate sector, the last 'build out' (e.g. high-tech) is still saturated c) public corporations are focused on the next quarter d) corporations don't trust banks and won't pay the rates they ask e) real investment is shifting overseas f) The Federal Reserve is buying Treasuries

The "fear factor" thing is that the financial sector still believes financial engineering can make more efficient use of existing capital, and that nothing will ever go wrong. This fear drives money into "safe" investments - gold and Treasuries, for example. The retiring generation wants to "be safe".

My wild guesses are why Bernanke gets paid $365k some-odd (while CEO's are raking in tens of millions). When the sentiment of a population gets stuck in one direction or on one idea, it's hard to turn it around. Volcker killed infaltion, but really angered a lot of people temporarily with his iron fist. Bernanke has a far more difficult problem, is my guess: how do you convince a population (ready to retire with diminished expectations) in a recessionary economy (not inflationary) that everything's under control after what the financial sector did? I consider myself somewhat sophisticated, and even I don't a) comprehend, b) believe. There's something weird about zero rates, and a lot of moving parts.

As to inflation, I have one comment I've made before: each individual, depending on his anticipated expenditures, has a different real inflation rate. For the young couple who are looking to buy a house today, the crash has been a windfall. Everyone has a different picture.

Other contributors here have made observations similar to mine in replying to your question.

We don't have inflation, yet. We have the potential for inflation. It's all about predicting the future, not reading the present.