To understand inflation, one must first understand what money is and how to measure it. Please read What is Money and How Does One Measure It? before attempting to understand what follows.



Unfortunately there is no general agreement as to the definition of inflation. Here are some of the widely used definitions as noted in Inflation: What the heck is it?



Commonly Used Definitions





Decline in purchasing power of the currency held

Rising prices in general (essentially the same as #1 although some might disagree)

Rising consumer prices (CPI) Rising producer prices (PPI)

Rising prices due to expansion of money supply

Rising prices due to expansion of money supply and credit Expansion of money supply Expansion of money supply and credit

Popular View

possible

Theoretical Stance Yields Poor Results

Merriam Webster Definition Of Inflation

Main Entry: in·fla·tion

Pronunciation: \in-ˈflā-shən\

Function: noun

Date: 14th century



1 : an act of inflating : a state of being inflated: as a : distension b : a hypothetical extremely brief period of very rapid expansion of the universe immediately following the big bang c : empty pretentiousness : pomposity

2 : a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services

It is by design of the Fed and bankers that the definition has morphed into common usage to something that removes the Fed from its role in causing inflation.

Cause Of The Great Depression

theoretical

Base Money Supply

M Prime

True Money Supply

Wide Difference Of Opinion About What Money Is

The True Money Supply (TMS) was formulated by Murray Rothbard and represents the amount of money in the economy that is available for immediate use in exchange.

In recent years, more and more economists have begun to include time deposits in banks in their definition of the money supply. For a time deposit is also convertible into money at par on demand, and is therefore worthy of the status of money. Opponents argue (1) that a bank may legally require a thirty-day wait before redeeming the deposit in cash, and therefore the deposit is not strictly convertible on demand, and (2) that a time deposit is not a true means of payment, because it is not easily transferred: a check cannot be written on it, and the owner must present his passbook to make a withdrawal.



Yet, these are unimportant considerations. For, in reality, the thirty-day notice is a dead letter; it is practically never imposed, and, if it were, there would undoubtedly be a prompt and devastating run on the bank. [2]



Everyone acts as if his time deposits were redeemable on demand, and the banks pay out their deposits in the same way they redeem demand deposits.



The necessity for personal withdrawal is merely a technicality; it may take a little longer to go down to the bank and withdraw the cash than to pay by check, but the essence of the process is the same. In both cases, a deposit at the bank is the source of monetary payment.



Practically Speaking, Both Money AMS and True Money Supply Contain Credit

practical path

In a fiat world, money is printed into existence by the central bank - in the United States the Fed. Given there is nothing backing up this money, it is inherently worthless. However, one can think of as real. It was printed (even if only electronically), therefore it exists.



In addition to the previously mentioned money supply, fractional reserve lending allows credit to be extended by banks and financial institutions on top of that inherently worthless money. Indeed, banks and financial institutions have leveraged credit to base money at ratios of 30-1, 50-1 or even higher.



It's pretty amazing if you think about it: Credit is extended with 30-50 times leverage on inherently worthless paper.



Ponzi Financing



Borrowers have to pay interest on the amount borrowed. However, the interest and the debt cannot possibly be paid back except by an ever expanding Ponzi scheme of lending. That scheme can last only as long as everyone believes the debt can be paid back and the market value of that debt keeps rising.



It's a faith based system in which banks extend loans and hold the credit on the books (or in many cases off the books in various structured instruments). The banks are thought of as being well capitalized as long as the value of credit on the books in relation to their reserves meets some ridiculously low minimum set by the Fed.



This is how the system works, using the term "works" loosely.



Day of Reckoning



The day of reckoning comes when asset prices start falling, defaults soar, and the value of credit on the books starts plunging. That day of reckoning has arrived.



And if leverage is high enough, as it was with Bear Stearns and Lehman, the institutions are wiped out overnight. Citigroup (C), Bank of America (BAC), Fannie Mae (FNM), Freddie Mac (FRE) and AIG are essentially in the same position of Lehman except the taxpayers via the Treasury are funding the bailouts.

symptoms

Valid Measures Of Inflation?

Monetary Inflation

Total Bank Credit

Excess Reserves At Depositary Institutions

Will this printing create [price] inflation? This is dependent very much on what money will do next. If banks will not lend and banks sit on that cash forever and ever like the great depression because the risk is too high and the banks do not know if the lending will end up in good assets or bad assets, and because banks are in so many bad assets now they probably will not lend at all.



That is the observation that Murray Rothbard made, that during the Great Depression that banks have chosen not to lend because the risk of accumulating bad assets was far to high. So they were sitting on massive reserves. That is what is developing right now.



A good example is what happened in Japan in 2001-2002 where the Bank of Japan pumped 300% at one stage and lending continued to collapse. I expect similar things to happen here. If lending will not increase we can conclude this will not be inflationary.

Why Aren't Banks Lending

Assets at Banks whose ALLL exceeds their Nonperforming Loans

Square Pegs And Round Holes

Kass: The bond market is in a bubble that is reminiscent of (and quite possibly as extreme as) other bubbles during previous eras. From my perch, the only issue is the timing of this trade.



Mish: Timing is indeed everything and perhaps there is a temporary selloff. But the primary trend is for lower yields. Perhaps much lower yields. There is no bubble in bonds. Not yet.



Those who want to see how low treasury yields can get and stay there, need to look at Japan. Yields in the US are going to go far lower and stay lower longer than nearly everyone thinks.

Those focused on the CPI failed to see any chance of the Fed Fund's Rate at 2.00 again. On the other hand, those focused on the destruction of credit from an Austrian economic perspective got this correct. That is just one reason why it makes more sense to watch the credit markets than the CPI. The second is the CPI is so distorted it is useless.



In my opinion, it is very likely new all time lows in the 10-year treasury yield and 30-year long bond are coming up.

It is quite possible the lows in treasury yields are in. Unlike 2008 where I was constantly beating the drums for lower yields, 2009 could be different.

practical matter

Humpty Dumpty On Inflation

Practical Definitions Of Inflation And Deflation



Most know my definitions by now but here they are again for convenience.



Inflation is a net increase in money supply and credit.

Deflation is a net decrease in money supply and credit.

In both cases credit must be marked to market to make any practical sense out of what is happening. Those who focus solely on money supply cannot easily explain stock markets that have fallen in half (this does not happen in disinflation), TIPs yields, a global race to ZIRP, or many other events that are happening.



Humpty Dumpty Defines Inflation



Unfortunately there are many definitions of inflation and deflation strewn about. Some play the role of Humpty Dumpty changing meanings at whim, switching from commodity prices, to consumer prices, to expansion of base money or M3 or whatever measure of money seems to be expanding at the fastest rate.



Some do the inflationista two-step to avoid admitting that we are indeed in deflation, choosing instead to call it "disinflation"





In short: "We are going to have a period of deflation that we will instead call disinflation."



'When I use a word,' Humpty Dumpty said, in a rather scornful tone,' it means just what I choose it to mean, neither more nor less.'



'The question is,' said Alice, 'whether you can make words mean so many different things.'



'The question is,' said Humpty Dumpty, 'which is to be master - that's all.'

A Practical Look At "Flation"

Symptoms vs. Definition

symptoms

Where To Now?



Unfortunately, I cannot state a precise measurement of inflation or deflation given the shell games at the banks and the Fed regarding mark-to-market accounting.

Addendum:

The Man Who Predicted the Depression

Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.



Mises's ideas on business cycles were spelled out in his 1912 tome "Theorie des Geldes und der Umlaufsmittel" ("The Theory of Money and Credit"). Not surprisingly few people noticed, as it was published only in German and wasn't exactly a beach read at that.



Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention.



"Theorie des Geldes" did not become the playbook for policy makers. The 1920s were marked by the brave new era of the Federal Reserve system promoting inflationary credit expansion and with it permanent prosperity. The nerve of this Doubting-Thomas, perma-bear, crazy Kraut! Sadly, poor Ludwig was very nearly alone in warning of the collapse to come from this credit expansion. In mid-1929, he stubbornly turned down a lucrative job offer from the Viennese bank Kreditanstalt, much to the annoyance of his fiancée, proclaiming "A great crash is coming, and I don't want my name in any way connected with it."



We all know what happened next. Pretty much right out of Mises's script, overleveraged banks (including Kreditanstalt) collapsed, businesses collapsed, employment collapsed. The brittle tree snapped. Following Mises's logic, was this a failure of capitalism, or a failure of hubris?



Mises's solution follows logically from his warnings. You can't fix what's broken by breaking it yet again. Stop the credit gavage. Stop inflating. Don't encourage consumption, but rather encourage saving and the repayment of debt. Let all the lame businesses fail—no bailouts. (You see where I'm going with this.) The distortions must be removed or else the precipice from which the system will inevitably fall will simply grow higher and higher.



Mises started getting some much-deserved respect once "Theorie des Geldes" was finally published in English in 1934. It is unfortunate that it required such a disaster for people to take heed of what was the one predictive, scholarly explanation of what was happening.



But then, just Mises's bad luck, along came John Maynard Keynes's tome "The General Theory of Employment, Interest and Money" in 1936. Keynes was dapper, fresh and sophisticated. He even wrote in English! And the guy had chutzpah, fearlessly fighting the battle against unemployment by running the currency printing press and draining the government's coffers.



He was the anti-Mises. So what if Keynes had lost his shirt in the stock-market crash. His book was peppered with fancy math (even Greek letters) and that meant rigor, modernity. To add insult to injury, Mises wasn't even refuted by Keynes and his ilk. He was ignored.



Fast forward 70-some years, during which we saw Keynesianism's repeated disappointments, the end of the gold standard, persistent inflation with intermittent inflationary recessions and banking crises, culminating in Alan Greenspan's "Great Moderation" and a subsequent catastrophic collapse in housing and banking. Where do we find ourselves? At a point of profound insight gained through economic logic, trial and error, and objective empiricism? Or right back where we started?

...

Here We Are Again, Twice.

suggestion