Monetary Inflation versus "Price Inflation"

February 14, 2012
Market Analyst & Professional Speculator, Owner of The Speculative Investor

In our 11th January 2012 commentary we argued that a certain 'technical analyst' was wrong to extrapolate gold's recent price action into a forecast of imminent deflation. We did so by pointing out that a) the year-over-year (YOY) rate of growth in US True Money Supply (TMS) was about 14% at the time, b) December-2011 was the 36th consecutive month in which the YOY rate of TMS growth was 10% or more, and c) if the YOY rate of TMS growth remained above 10% for two more months then it would be the longest period of double-digit money-supply growth in US history. That is, we pointed out that far from being in 'danger' of experiencing a serious bout of deflation, the US was in the midst of a record-breaking period of monetary inflation.

Based on preliminary data for January-2012, the YOY rate of growth in US TMS has accelerated to 15.4% over the past month. The situation is illustrated below. This leaves no doubt that a new US monetary inflation record (the longest period of double-digit money-supply growth in US history) will soon be set.

The question is: considering that there has been so much monetary inflation over the past few years, why hasn't there been much "price inflation"?

The above question is misleading, because it is based on the false premise that prices generally haven't risen by much in response to the growth in the money supply. The reality is that a lot of prices have been driven upward by monetary inflation and are now much higher than they would otherwise be. For example, monetary inflation explains why the S&P500 Index, despite being 12 years into a valuation-compressing secular bear market, is only about 13% below its 2000 peak in nominal dollar terms. For another example, monetary inflation explains why copper is priced at around US$4/pound and oil is priced at around $100/barrel, despite the economic problems in Europe, China, the US and Japan. It also explains why the soybean market, which for decades had a price floor at US$5-$6 and a price ceiling at US$10-$11, now appears to have a price floor at US$10-$11 (the old ceiling is the new floor).

The idea that prices haven't risen by much is based on government price indices that purport to measure the economy-wide movement in prices. These indices clearly understate the extent to which prices have risen, meaning that the amount of "price inflation" reported by the US government is a lot less than the actual amount of "price inflation".

That being said, the actual amount of "inflation" in consumer prices has certainly been less, to date, than we expected to see in response to such a large expansion of the money supply. This is not a shock to us, though, because we understand how monetary inflation works. One of the dangerous characteristics of monetary inflation is that it is never possible to know, in advance, exactly how it will distort the price system. What we do know is that a large increase in the money supply ALWAYS leads to large price increases somewhere in the economy. The best we can do is make an educated guess as to which items/investments will be the main beneficiaries of monetary inflation.

The bottom line is that monetary inflation in the US is doing what it always does. It is boosting prices in ways that can't be predicted with complete accuracy by anyone, let alone by central bankers employing hopelessly flawed Keynesian theories.

Above is an excerpt from a commentary originally posted at on 12th February 2012.

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Steve SavilleSteve Saville graduated from the University of Western Australia in 1984 with a degree in electronic engineering and from 1984 until 1998 worked in the commercial construction industry as an engineer, a project manager and an operations manager.  In 1993, after studying the history of money, the nature of our present-day fiat monetary system and the role of banks in the creation of money,  Saville developed an interest in gold.  In August 1999 he launched The Speculative Investor (TSI) website. Steve Saville has  lived in Asia (Hong Kong, China and Malaysia) since 1995 and currently resides in Malaysian Borneo.  

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