Inflation: An Analysis

Oct 2009

Now that people are less concerned about the end of western civilization, we get calls expressing concern about rising inflation, so let’s apply some economics and discuss this possibility.  Simplistically, inflation results from too many dollars chasing too few goods.  Put differently, when the demand for goods and services grows faster than supply, prices rise in order to ration existing supplies.  Right now, and for the foreseeable future, demand is too low to trigger significant inflation.  Further, with factories operating at relatively low levels of utilization, the supply of most goods is not constrained.  Yes, the Federal Reserve has increased the money supply, but much of that money is not being used to buy goods and services.  (Technically speaking, the money supply’s “velocity” is down.)  If demand were commensurate with the money supply, the economy would be booming—and the Fed would be taking steps to restrain money supply growth.  There is (always) a possibility of rising inflation down the road, but whether or not inflation increases significantly will depend on things that have yet to occur.  Anyone who claims to be sure that inflation will shoot upward is kidding himself (and perhaps his audience).  If government spending and money creation spiral out of control, then inflation will be a risk.  However, if that were to happen, smart investors would want to own stocks of companies with pricing power.  We are already there.