Yes, that’s right. inflation is not always a bad thing. Lets get our macroeconomics books out here and take a look.
Inflation is a persistent increase in prices, often triggered when demand for goods is greater than the available supply or when unemployment is low and workers can command higher salaries.
Moderate inflation typically accompanies economic growth. But the US Federal Reserve Bank and central banks in other nations try to keep inflation in check by decreasing the money supply, making it more difficult to borrow and thus slowing expansion (by increasing interest rates)
Hyperinflation, when prices rise by 100% or more annually, can destroy economic, and sometimes political, stability by driving the price of necessities higher than people can afford.
Deflation, in contrast, is a widespread decline in prices that also has the potential to undermine the economy by stifling production and increasing unemployment.
Inflation is, as Milton Freidman said, always and everywhere a monetary phenomenon. His point is that if there are too many dollars chasing too few goods, the price for the goods goes up (the dollar becomes worth less) conversely, he argued that deflation could be fought by dropping money out of helicopters. Money supply creates/destroys inflation. He would say this: M x V = P x Q: M is the quantity of money in the economy, V is the velocity of money in the economy: Velocity associates the amount of economic activity associated with a given money supply, P is the general price level, and Q is the real value of final expenditures.
Inflation is also a signal that there are not enough of a certain kind of good in a market, this is a signal for more producers to enter the market to chase profit. When there is deflation, or no inflation, there is no incentive to invest in new production. SO, inflation has two components, the first is demand for goods as it relates to money supply and second the velocity in which the money is being spent. The higher the velocity, the higher the inflation; and as inflation rises so does velocity as people make purchases sooner rather than later. When there is very low velocity, there is low inflation, and low incentive to invest in new factories or hire new employees. Each factor, money supply and velocity can effect each other. If interest rates go up, the flow of money is slowed and in effect the money supply goes down.
So, without some inflation, we don’t have growth. I don’t think we are going to see any appreciable inflation in the foreseeable future because of two things. First, is that Europe and maybe the rest of us are entering a liquidity crisis. A liquidity crisis is described as this:
“This is a quintessential liquidity crisis,” said William Cunningham, head of credit strategies and fixed-income research at Boston-based State Street Corp.’s investment unit, which oversees almost $2 trillion. “It’s not inconceivable to imagine a situation where the markets behave so poorly, the liquidity behaves so badly, and risk-tolerance just evaporates that — particularly in Europe — consumers contract, businesses stop hiring and stop investing, and economic activity halts.”(my emphasis)
There is a flight to quality, that is helping the debt/finance problem in the US:
The dollar has strengthened 8.74 percent this year while the euro has weakened 5.92 percent, according to Bloomberg Correlation-Weighted Indices. The euro dropped to $1.2144 on May 19, the lowest level since April 2006.Global purchases of U.S. equities, notes and bonds totaled $140.5 billion in March, more than double economists’ estimates, after net buying of $47.1 billion in February, the Treasury said May 17. Purchases of Treasuries rose by the most since June as China, the largest lender to the U.S., added to its holdings for the first time since September.Demand for Treasuries and dollar-based assets is helping cap borrowing costs as President Barack Obama finances the economic recovery by selling record amounts of bonds to finance a budget deficit that exceeds $1 trillion. More Americans filed applications for unemployment benefits in the week ended May 15 than economists forecast, showing firings remain elevated even as employment rises.
Second, the STRIPS (Separate Trading of Registered Interest and Principal Securities), and the Bond Market as a whole are back with a vengeance. STRIPS were created to win back investors after the Fed had to raise interest rates to almost 20% to halt the 14.8% inflation in 1980. Increase demand for Treasuries of any kind cause the interest rates (the risk premium of the note) to go down as the flight to quality continues. Higher demand for US Treasuries worldwide means lower interest rates in the US which means lower cost to finance the debt and these lower rates mean less chance for inflation.The US may have dodged a debt bullet, and this debt must be paid and spending must be brought under control or we will become Greece. Meanwhile, we may be moving to deflation as the contagion from Europe expands and economic activity stops or slows. Anytime there is a large gain in Treasuries, that money was probably in corporate bonds and stocks. These are what companies use to buy new stuff and expand.
May 24 (Bloomberg) — Corporate bond sales are poised for their worst month in a decade, while relative yields are rising at the fastest pace since Lehman Brothers Holdings Inc.’s collapse as the response by lawmakers to Europe’s sovereign debt crisis fails to inspire investor confidence.
In Final:
So, back to velocity on money. The crisis in Europe and the continual rise of the LIBOR pushes investors from the EU to the US, making the interest rates go down as they move to quality in the Bond Market. This movement also increases the value of the dollar against the Euro. Increase the value of a currency and you import unemployment and export jobs. More money flowing into the Treasury from the risk in Europe(Ted Spread) makes the Treasuries look more attractive and siphons money out of the private market (its called ‘crowding out’) while the companies that actually create jobs and pay people cant expand, wont hire and the unemployment problem continues while people quit spending which causes a lack of inflation as the economy goes stagnant and looking for a hint from somewhere other that the Bond Market. The economy cant expand on FedGov Bonds.
