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No Such Thing as Cost-Push Inflation; Demographics and the "Demand for Money"

Economics / Deflation Jan 14, 2011 - 03:04 AM GMT

By: Mike_Shedlock

Economics

Best Financial Markets Analysis ArticleIn China's Foreign Exchange Reserves Jump by Record $199 Billion; Cost Push Inflation from China? Don't Count On It! I stated ....

Strangely, nearly everyone insists inflation is roaring in the US instead of where it is roaring, China and India. The alleged proof of US inflation is a series of widely circulated charts of various commodity prices even though there has been little-to-no passthrough on any consumer prices except gasoline, and home prices are once again falling like a rock.

In response my friend "HB" wrote ....

There actually is no such thing as 'cost push inflation'. Think about it - if the money supply were to remain stable (which isn't the case, but hypothetically), then a rise in price of some goods automatically would lead to a fall in prices of some other goods.

If you have $100 to spend per week, and you've spent $40 on say gas up until now and the gas price rose to increase your gas bill to $50, your demand for non-gas goods - assuming your gas consumption remains unchanged - would fall by $10. This decrease in demand would pressure the prices of non-gas goods.

Economy-wide , a rise in general prices is only possible if the money supply increases. of course there is non uniformity in such effects on prices and a lag effect as well. furthermore, the effect of the increase in the supply of money is mitigated by productivity increases. In any case, there can be no 'cost-push' inflation, unless the rise in the price of some goods is 'accommodated' by monetary pumping.

No Such Thing as Cost-Push Inflation

My Austrian-minded friend is correct. I should have been more explicit. However, I did state that the idea of cost-push inflation is "silly" once before in "Money’s Already Quite Cheap"

Cost-Push Inflation?

Someone sent me an email stating that I do not understand push-through inflation and that is why I don't understand hyperinflation.

Well for starters hyperinflation is not caused by rising prices, hyperinflation is a loss of faith of currency (typically caused by some political event). The result (not the cause of hyperinflation) is rising prices. For a further discussion of hyperinflation please see "Straight Talk" with Economic Bloggers

Second the whole idea of cost-push inflation is silly. An excerpt from $30 Billion Offer No One Wants - Small Businesses Hit by Deflation will prove it. ...

By the way, there is a subtle error in what "HB" said. Did you catch it?

"Economy-wide , a rise in general prices is only possible if the money supply increases."

An increase in money supply is by far the most likely way there is a general price rise, but it is not the "only" way, even if we assume that "money supply" includes credit.

Prices Affected by the "Demand for Money"

In a general sense, if the demand for money drops for any reason, prices will rise. Conversely, if the demand for money rises for any reason, prices will fall.

The demand for money (the desire to hold on to it vs. consume) can change as consumer preferences change. Demographics is one such reason consumer preferences may change.

For example, someone at retirement age and barely scraping by has a far greater demand for money than a young person at age 30 with a decent job.

Here is another way of phrasing the same thing: A person aged 30 with a good job is far more likely to have high demand for the latest and greatest electronic gadget than someone aged 62 scared half-to-death about running out of money in the near future.

Changing demographics is a very powerful "price deflationary" card at this stage of the game. Indeed, Bernanke is doing his best to counteract the increased demand for money associated with boomer dynamics by pumping up actual money supply.

The result so far has not been the expansion of credit that Bernanke wants, but rather a massive increase in the amount of "excess reserves" held with Fed. (Please see Fictional Reserve Lending for further discussion).

In short, banks have no real desire to lend except to a small pool of creditworthy borrowers who have no desire to borrow.

In the real economy, demand for money is high (as evidenced by unprecedented drops in consumer credit). However, Bernanke (with much help from the Bank of China) did manage to ignite more recklessness in numerous speculative ventures including equities, leveraged buyouts, and commodities.

Thus, the Fed can increase money supply, but it cannot easily dictate where that money goes or even if it goes anywhere at all.

Frugality Revisited

The "Demand for Money" construct forms the basis for many "frugality arguments" I have presented over the years.

It is a topic much in need of discussion and understanding, especially by various inflationistas calling for hyperinflation later this year. The good news is we only have 11 more months to see them proven wrong. The bad news is they will simply bump up their target by a year or two.

Cliff Event In Japan

Meanwhile, Japan is the perfect example of strong demand for money in spite of amazingly low interest rates and in spite of all efforts by the Japanese central bank to cause inflation.

Nonetheless, Japan is at a state in its economy where it has consumed all of its savings and then some just as its retirees need to drawn down on savings that the government spent building bridges to nowhere in foolish attempts to fight deflation.

Please see Japan's Finances "Approaching Edge of Cliff" for details.

As a result of that "cliff event", strongly rising import prices in conjunction with a rapidly falling currency will likely hit Japan before the same thing hits the US.

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2011 Mike Shedlock, All Rights Reserved.


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Comments

W. Peden
10 May 11, 18:53
Inflation and output

There can also be temporary price-level inflation as a result of a fall in output e.g. because of a major natural disaster or other supply-side factors. This is a "healthy" kind of inflation because it is a collection of signals to producers that there is a shortage of supply relative to demand and that they can make profits by producing more.

Inflation can be caused by a fall in the demand for money only if there is a monetary policy that allows for an imbalance between the supply of money and the demand for money. A good monetary policy is one where the money supply grows at a steady rate, except when the demand for money fluctuates. In this respect, the money supply is like the supply of a normal commodity i.e. if demand goes up, supply should go up; if demand goes down, supply should go down.

If Bernanke is really worried about excessive excess reserves, he should stop the Fed's policy of subsidising banks for not lending by paying interest on those excess reserves. However, Bernanke is a slave of the "lending determines spending" doctrine of creditism, for which he is largely responsible, so he cannot be expected to competantly run monetary policy.


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