It seems that any way you look, an anecdotal case for inflation can be made. CPI continues to show year over year growth (although not nearly to the levels that they were in 2011), food prices are on the rise, housing prices continue to climb, and American’s are paying more at the pump and to their utilities companies. Many may find it interesting that these inflationary price increases are not necessarily a bad thing; if an economy grows by x% and the monetary base does not grow but the same level, it is easy for an economy to slip into deflation, which can be much more disastrous than inflation. What we must ask ourselves is if price increases are substantiated by economic growth, and what these increases are doing to our economy.
April’s GDP report showed a quarter over quarter change of just .1% growth, and many economists argue that the published figure will be revised down. Remember, inflation can be healthy if we have the economic activity to back up the growth in money supply. However, at .1% economic growth and food prices expected to rise 3.5% this year, the numbers simply do not add up.
Any rational economist has foreseen these problems coming down the pike for years. The United States is not producing nearly enough oil to support our consumption and excessive regulation has hampered the coal industry, both of which have raised our overall energy costs. The harsh winter has resulted in a recent spike of agricultural goods causing food prices to jump at the grocery store, impacting consumer spending as well. We must also not forget the excessive growth in the money supply following the Troubled Asset Relief Program (TARP) and the Federal Reserve’s quantitative easing programs.
While non-discretionary costs are continuing to rise, these same factors (mostly attributed to TARP and QE) have resulted in equities hitting never before seen highs. Historically, a low interest rate environment is good for the stock market. However, this low interest rate environment has diminished the earning power of seniors on CDs, bonds or other interest bearing investments.
What we now must ask if we see ourselves entering a Liquidity Trap. Liquidity Traps occur when monetary policymakers lower interest rates in an effort to spur economic growth, but the policies remain ineffective. These policymakers are then left with few to no options for how to jumpstart growth. I believe that this is exactly what we are seeing; prices are rising, GDP is stalling, interest rates cannot go much lower and the investing public turns a blind eye to the problem and focuses on a record high Dow Jones instead.
This nation has a serious economic problem at hand; rates are incredibly low and have remained as such in an effort to encourage growth. However low rates mean nothing if businesses are utilizing cash reserves and banks are not lending. The Federal Reserve and our politicians have created the environment in which we find ourselves and now we must take our medicine. It is time for rates to rise, which will hopefully encourage borrowing before rates climb any higher. This rate increase will likely shrink money supply slightly and may cause equities to selloff (many would argue a long overdue correction is in store). The economic environment that we find ourselves in now is not sustainable for an extended period of time, and the time to fix the problem is now.