Inflation: Should We Worry? Now is a confusing time in our country. Every expert seems to have a different opinion. We are in a recession? Yes, but its almost over-no, its just beginning. Are we spending too much? Yes we are, no we need more stimulus...and on and on. However the most ubiquitous concern seems to be about inflation. After how much we spent injecting liquidity back to the markets, it seems like a rational concern. "Concern" though would be an understatement. Overall there seems to be a genuine fear, an increasing worry that maybe in our haste to salvage our faltering financial system we may have haphazardly committed financial seppuku. I'm not here to rule out such a scenario. Some of the brightest economic minds of our time are at work on this very problem and even they seem to have come to contradictory conclusions. My objective is not to convince you one outcome is more likely than the other, as I mentioned before, there are much more qualified people to make those cases. But I do think its important that we see all sides and, perhaps most importantly, understand the debate that's taking place. However, given the near panic that seems to have gripped quite a few people over spending and inflation, it seems worthwhile to look at some alternate possibilities and to explain why not everyone is of the opinion that the US economy is near collapse due to inflation. This is one chart that seems to everywhere. Its a chart of our national debt and, as you can see, illustrates the dramatic rise of our debt in relation to past years. <img src="http://4.bp.blogspot.com/_3lnHyxdeYU4/SatO6kZ8eII/AAAAAAAAAbM/_jfX5XxJDQE/s400/NationalDebtChart"> The chart isn't displaying any false data, but it is misleading data. I have to assume that the reason most people are looking at this chart isn't because it illustrates our national debt, but because it conveys sense of urgency about that debt and about our ability to repay it. In this sense the chart fails miserably. The reason the chart doesn't paint an accurate picture of our economic condition is because it fails to take into account the growth of our gross domestic product (GDP). In other words, though the chart accurately shows our debt, it doesn't convey how much we can afford in relation to that debt. The debt is higher in the year 2001 than 1990, but we are also generating much more revenue in 2001 than in 1990. In order to gain an accurate perspective from which we can draw a conclusion about our economy, we have to judge America's financial situation by looking at our debt while simultaneously looking at our GDP and it's growth. This gives us our debt to GDP ratio. To ignore GDP growth and simply assume more debt is bad for the economy is like saying Bill Gates or Tiger Woods are worse off financially than a busboy because the busboy has less debt. The concept exists in residential lending as well, only its called an individual's "debt to income ratio" or DTI. This chart gives us a more accurate representation of our national debt. <img src="http://zfacts.com/metaPage/lib/National-Debt-GDP.gif"> As you can see from this chart, our debt to GDP ratio is definitely climbing. However, we are not in the new territory that the other chart would have us believe. Today it looks like our debt to GDP ratio is around 80%, 50% higher than the lows under Carter and 30% lower than the highs during world war 2. Some would argue that it was the deficit spending before and during world war 2 that took is from the great depression to the booming decades after. Now that we know we are sitting at 80% debt to GDP we can look around the world to see how we compare to other countries. <img src="http://upload.wikimedia.org/wikipedia/commons/3/35/Public_debt_percent_gdp_world_map.PNG"> According to the CIA, America has the 23rd highest debt to GDP ratio as of 2007. Japan has the second highest at 170%! France, India and Italy all place above us. As I mentioned before, I'm not advocating deficit spending. I'm not saying our debt level is acceptable. I'm just trying to understand the dilemma. After all, if we are concerned we are nearing a collapse of the US government due to unprecedented deficit spending, this information causes me to ask questions. I'm not an economist. I can't refute the notion that some kind of inflationary collapse is imminent. But I would ask some questions to those who say it is. For example: Why us and why now? How can Japan thrive with a debt to GDP of more than twice ours? Why didn't such a disaster happen when our own ratio went much higher than it is today for around 10 years? How can we explain the increase in economic activity in the years after we reached those highs in debt? What exactly is going to trigger such a collapse? After all, Jefferson assumed such a thing would happen the second we moved to paper currency. People said the same thing would happen when we went off the gold standard, and when our national debt first hit $1 trillion. These are the questions that come into my mind. I'm not suggesting that there aren't answers for each of them, but I haven't been able to find them so far. There is another concept we should examine and that's the concept of low interest rates causing inflation. I'm not going to get into the complex macroeconomic calculations. Frankly, such equations go whizzing over my head. But there is one we should look into. In 1885 Simon Newcomb and Irving Fisher developed the Quantity Theory of Money which can be expressed simply as MV=PT. The supply of money (M) times velocity of circulation (V) equals Price (P) times real output (T). In this original form velocity of currency (V) and T (real output) are fixed, thus any change in monetary supply (M, i.e. the fed dropping interest rates) has a proportional impact on price level. Basically this equation is saying if the Fed drops rates and pumps more dollars into the economy, the dollar as a currency loses some of its purchasing power. I don't think anyone disagrees with that, but there was one person who had something to add. His name was John Maynard Keynes. Keynes postulated that the the velocity of circulation (V) isn't constant. Put simply, velocity of circulation is the rate at which money changes hands. If the velocity of currency slows it means people aren't spending money for whatever reason, they are saving it. This happens in recessions and is indicative of slowing economic activity. Keynes argued that during the slow economic times, though the Fed may increase the monetary supply, velocity is also slowing; people are saving their money. This decline in velocity of currency, as we are seeing today, could potentially offset the rising monetary supply. According to Keynes, inflation is unlikely to rear its ugly head until economic activity increases. Once again, I am not at all an authority on the quantity theory of money, but it appears Keynes has a point. These are all just a few points to consider. I'm investigating this myself and haven't made up my mind yet. But I think its important that we all comprehend the situation our country is in, no doubt its an important time. I hope this article provided you with more information because we all know cable news doesn't do a very good job of that. -Jon
Going into debt is not a problem, providing that the money borrowed goes into investments that ultimately earn more than the interest being charged.
Keynes argued that during the slow economic times, though the Fed may increase the monetary supply, velocity is also slowing; people are saving their money. This decline in velocity of currency, as we are seeing today, could potentially offset the rising monetary supply. --------------------------------- I have trouble buying into the fact people are saving per se. Who is saving this money? The growing ranks of unemployed, ss reciepients, people receiving food stamps, one wage earner families, down from two, etc. ? Why are credit lines reduced if credit worthy people are saving? I venture a guess, rather than reporting "people are saving" perhaps people are budgeting their money for future known expenses.
One point I don't understand. Your post and others that are similiar offer up theories on inflation and from what I've read the Fed policies follow Nairu, which is inflation/employement. It seems confusing with a policy the fed applies and other thoughts as you've posted. Though not contradictory but different. http://en.wikipedia.org/wiki/NAIRU
I guess that's it then... This is what happens to the ET P&R forum when someone makes a real point...Nothing