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Video: Inflation Explained

Here is Omid Malekan back with a video explaining inflation to the layman.  You have seen his videos on Bank Bailouts Explained and Quantitative Easing Explained. The QE explained video was especially popular and went viral on the Internet. So now we have his explanation of inflation.

I think the video does a pretty good job of explaining inflation. The one criticism I would make is that it doesn’t mention how the Fed’s adding more liquidity doesn’t actually mean that liquidity gets into people’s hands. QE is not a helicopter drop. The liquidity goes to banks and much of that money sits as excess liquidity on bank balance sheets. Much of it goes into Treasuries. Some of it goes to speculating. Even more money is pushed into other markets due to zero interest rates and the Fed’s dominant bid on Treasuries.

This is how it works:

Every single time the U.S. is met with an economic downturn (is met by the figurative Grim Reaper), the policy response is always the same: monetary easing (more cowbell). And with interest rates as low as they can go, the Fed has turned to printing money and monetizing debt. This excess liquidity is an economic hazard washing up on the shores of South Korea, Brazil and India, causing policy makers there to consider barriers to reduce the floods from the incoming waves of U.S. money. The excess liquidity is pumping up commodity prices, raising the price of gasoline and food for average American citizens and reducing their purchasing power.

-(Don’t Fear) The Reaper, The Fed Says ‘More Cowbell’

Just because the Fed has a fever and the only cure is more cowbell doesn’t mean the banks want to lend these cowbells on to consumers or that consumers want any more cowbell. Meanwhile the Fed continues to deny it has any impact on commodity prices while taking credit for the rise in stock prices. This is simply not credible. That’s why investors will continue to flee into gold and commodities as a hedge against inflation. As for poor people and retirees living off annuities and fixed income, let them eat iPads.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

14 Comments

  1. People seriously need to learn that an asset bubble is not the same thing as inflation…

    • But it is. That’s why it’s called asset price INFLATION. What the government SHOULD do is include asset prices in their official estimates of inflation including rolling average house prices. UK National Statistics used to use RPI, which includes house prices, as an inflation metric but they stopped using it.

      • I guess what I should say is that commodity prices aren’t going up in the traditional demand push model of inflation. Marginal demand curves aren’t shifting upward and with wage pressures non existant marginal supply curves aren’t moving higher. So we don’t really have to worry about a self fulfilling inflationary spiral. I mean on some level this is the Fed’s fault (they’ve basically said as much vis a vis the wealth effect from equity price increases) but they aren’t holding a gun to investor’s heads and making them buy crude @ 110 dollars when stocks to use ratios are at the third highest level in the past decade.

        • Right, commodity price inflation is very regressive and demand destroying – which is a primary factor for recession in 4 of the last 5 downturns. It would be nice if we saw wage rises aka demand-push instead of asset price inflation because ordinary people wouldn’t be behind the eight ball.

          • I agree with you on that point… I guess what I’m trying to say is that absent further capital heading into the sector I would expect commodity prices to fall significantly. The problem is that absent further fiscal and monetary stimulus the economy will roll over and so the fed will be right back where it started last summer. Not to mention the need to fund the federal deficit at sub market rates. So another round of QE is highly likely which probably means more commodity bubble which brings us closer to some sort of horrible end game. I wasn’t in this investing game in the early 2000s so I might be wrong but it seems to me that the same people who are falling all over themselves to criticize the fed for creating a commodity bubble were strangely silent when housing and equity bubbles were being created.

  2. People seriously need to learn that an asset bubble is not the same thing as inflation…

    • But it is. That’s why it’s called asset price INFLATION. What the government SHOULD do is include asset prices in their official estimates of inflation including rolling average house prices. UK National Statistics used to use RPI, which includes house prices, as an inflation metric but they stopped using it.

      • I guess what I should say is that commodity prices aren’t going up in the traditional demand push model of inflation. Marginal demand curves aren’t shifting upward and with wage pressures non existant marginal supply curves aren’t moving higher. So we don’t really have to worry about a self fulfilling inflationary spiral. I mean on some level this is the Fed’s fault (they’ve basically said as much vis a vis the wealth effect from equity price increases) but they aren’t holding a gun to investor’s heads and making them buy crude @ 110 dollars when stocks to use ratios are at the third highest level in the past decade.

        • Right, commodity price inflation is very regressive and demand destroying – which is a primary factor for recession in 4 of the last 5 downturns. It would be nice if we saw wage rises aka demand-push instead of asset price inflation because ordinary people wouldn’t be behind the eight ball.

          • I agree with you on that point… I guess what I’m trying to say is that absent further capital heading into the sector I would expect commodity prices to fall significantly. The problem is that absent further fiscal and monetary stimulus the economy will roll over and so the fed will be right back where it started last summer. Not to mention the need to fund the federal deficit at sub market rates. So another round of QE is highly likely which probably means more commodity bubble which brings us closer to some sort of horrible end game. I wasn’t in this investing game in the early 2000s so I might be wrong but it seems to me that the same people who are falling all over themselves to criticize the fed for creating a commodity bubble were strangely silent when housing and equity bubbles were being created.

  3. At what point could this spiral out of control? Other CBs are trying to tighten their policy but yet here in the U.S. our Fed just keeps them loose. Something will have to give, and unfortunately, I feel sooner than later.

    • All of these central banks are behind the curve everywhere – In Asia, in Latam, In Europe and in the US. The Fed is not the only one getting away with negative real rates.

      The question is how long will this go on? IS the commodity price inflation really going to subside or will it force more tightening.? My sense is that you’ll either get demand destruction or higher prices until that occurs… or at least until rates march higher, precipitating some demand destruction.

      • DavidLazarusUK says:

        I suspect that QE3 is becoming more likely as the real economy fails to recover. They cannot stop it because Wall Street will start to take big losses. The central bank has been captured by Wall street desperate to maintain its ill gotten gains.

        Another reason that they will not raise interest rates is because it will hurt exports as the dollar strengthens. There is no reason to do that because they do not count food and energy inflation in their inflation figures, so even if the population are being squeezed by commodity inflation they have no reason to worry.

        Food commodity inflation has already lead to revolutions in north africa and the middle east. I do think that eastern europe nations could be in line for revolutions, as the poor there have had a tough time. I suspect that Ireland could even succumb as benefit cuts seriously impact the unemployed. The US I think is very vulnerable if this continues. With more than one in seven US citizens on food stamps, this will eventually have to be dealt with.

  4. At what point could this spiral out of control? Other CBs are trying to tighten their policy but yet here in the U.S. our Fed just keeps them loose. Something will have to give, and unfortunately, I feel sooner than later.

    • All of these central banks are behind the curve everywhere – In Asia, in Latam, In Europe and in the US. The Fed is not the only one getting away with negative real rates.

      The question is how long will this go on? IS the commodity price inflation really going to subside or will it force more tightening.? My sense is that you’ll either get demand destruction or higher prices until that occurs… or at least until rates march higher, precipitating some demand destruction.

      • Anonymous says:

        I suspect that QE3 is becoming more likely as the real economy fails to recover. They cannot stop it because Wall Street will start to take big losses. The central bank has been captured by Wall street desperate to maintain its ill gotten gains.

        Another reason that they will not raise interest rates is because it will hurt exports as the dollar strengthens. There is no reason to do that because they do not count food and energy inflation in their inflation figures, so even if the population are being squeezed by commodity inflation they have no reason to worry.

        Food commodity inflation has already lead to revolutions in north africa and the middle east. I do think that eastern europe nations could be in line for revolutions, as the poor there have had a tough time. I suspect that Ireland could even succumb as benefit cuts seriously impact the unemployed. The US I think is very vulnerable if this continues. With more than one in seven US citizens on food stamps, this will eventually have to be dealt with.

  5. Edward – I read in your other article on hyperinflation that one of the reasons Weimar and Zimbabwe suffered was lack of productive capacity. However, when it comes to oil, isn’t the U.S. in the same boat since we import so much of our oil? We have some refineries but a large bulk of it comes from abroad. Also, inlight of your analysis, how would you explain the hyperinflation in Argentina – they are one point were South America’s leading nation, and they suffered. Thank you.

    • FWIW the #1 producer of Oil consumed in the US is the US.

      • So then why are we experiencing the shock that we are as a result of the middle east? I can understand a slight increase, but it’s shot up in the last two months.

        • I’d say look at the CFTC data you’ve seen massive spec buying on the possibility that there might be a meaningful disruption to Saudi Production. Even though we don’t really use Saudi Crude other countries do. If Saudi Oil wasn’t available then they might start buying from the US or places we import from like Canada etc. Think ppl are basically owning WTI right now for portfolio insurance purposes…

      • And oil is priced in US Dollars

  6. Edward – I read in your other article on hyperinflation that one of the reasons Weimar and Zimbabwe suffered was lack of productive capacity. However, when it comes to oil, isn’t the U.S. in the same boat since we import so much of our oil? We have some refineries but a large bulk of it comes from abroad. Also, inlight of your analysis, how would you explain the hyperinflation in Argentina – they are one point were South America’s leading nation, and they suffered. Thank you.

    • FWIW the #1 producer of Oil consumed in the US is the US.

      • So then why are we experiencing the shock that we are as a result of the middle east? I can understand a slight increase, but it’s shot up in the last two months.

        • I’d say look at the CFTC data you’ve seen massive spec buying on the possibility that there might be a meaningful disruption to Saudi Production. Even though we don’t really use Saudi Crude other countries do. If Saudi Oil wasn’t available then they might start buying from the US or places we import from like Canada etc. Think ppl are basically owning WTI right now for portfolio insurance purposes…

      • And oil is priced in US Dollars