Yesterday, I wrote about what I perceive to be the reality of inflation. As an investor/trader, I am concerned about inflation, and you should be as well, especially since the government is trying to inflate our economy. Today, I thought I would go a little deeper into the subject, so we all can better understand the subject and the potential ramifications of government policies.
Economically speaking, inflation is a complex and difficult thing to define. Just ask any economist. The simple definition of inflation, however, is too many dollars chasing too few goods and services, which can happen when the money supply outpaces the production of goods and services in an economic system. Fundamentally, inflation is about the rising cost of goods and services, particularly those that we rely on to live our everyday lives, such as housing, transportation, and food. Yesterday, I wrote, “About the issue of inflation or deflation, I believe the media is unwittingly conspiring to convince Americans that deflation not inflation is the issue with our economy, and I believe the other willful conspirator is the Federal Reserve.” After writing that, I decided to look deeper into the issue. Specifically, I wanted to understand why the “Fed” does not count the actual costs of living in its estimation of inflation and what that could mean for the market in 2011.
Core CPI, does not include food and energy cost and non-core CPI includes everything. Core CPI is important because this is what the Federal Reserve looks at to decide about raising the Fed Funds rate. The Fed uses the Core CPI because food and energy, specifically gasoline, are so volatile and the Fed’s tools are so slow acting. Therefore, inflation could be high if gas prices have increased dramatically, but the Fed won’t react until those increases trickle through to the prices of other goods and services.
I suggested yesterday that non-core CPI “inflation” is here, and if it is about gasoline costs trickling through to other goods and services for core “inflation” to arrive, then get ready . Oil prices are rising and rising fast, thanks to the monetary policies of the Fed, as well as the reality of supply and demand.
So, what does the Fed do when core inflation begins to creep into the economy? It raises rates. Is the Federal Reserve about to raise rates? Not likely. Why? Because the Fed is trying to increase the velocity of money in the system. Simply, a disproportionate amount of the money pumped into the system (mega trillions) from both the Fed and the U.S. government is still sitting in the accounts of big banks (Wall Street), small banks, and mega corporations. The Fed needs to get that money out to small business and the consumer. One way to do that is with Quantitative Easing (QE), which effectively pushes key interest rates down (mortgage rates, for example), which promotes borrowing. QE has another affect as well. It forces those with the money (Wall Street) to find other ways to achieve a decent return (ROI), which, supposedly, creates the “wealth effect,” which is the idea that perceived wealth (rise in investment asset prices) encourages an increase in spending. Is this dangerous gamble working? Tune in tomorrow …
Trade in the day; invest in your life
