Inflation is a Function of How You Measure It

A frequent question posed to those who tilt toward the inflation side of the alleged inflation/deflation debate is that if inflation is such a problem, why isn’t it registering in the consumer price index? The answer to this question lies in reports of pricing pressures around the world.

As readers of the major newspapers have doubtless seen in recent months, prices – particularly commodity prices of the food and energy variety – have been increasing on the way to rising consumer price measures in places such as China, India, England, Euroland more broadly, and in the increasingly inflamed Middle East. Looking at China (NYSE:FXI) and India alone, despite the fact that the yuan and rupee rose 2.4% and 1.3% respectively against the dollar through November of last year, inflation rates in both countries dwarfed the relatively tame readings stateside; Chinese consumer prices up 4.4% and India’s up 8.6%.

In that case, the answer to this supposed riddle of non-existent inflation despite a weak dollar is a very simple: inflation is all in how you measure it. As the Wall Street Journal reported last week, “Food accounts for 47% of the basket of products that make up India’s consumer-price index and 34% of China’s.”

If the above is doubted, readers need only ask themselves how much more they’re paying (versus 2001) for a gallon of gasoline, for a pound of ground beef, and for other commodities whose prices tend to rise when the dollar weakens, and fall when the dollar strengthens. Depending on the makeup of a price index, the number could be high or low no matter the health of the currency.

Assuming once again a basket of goods that might tilt toward commodities such as food, fuel and housing, U.S. inflation since 2001 (when the dollar’s substantial fall began) would presently register at nosebleed levels. On the other hand, if a basket were created that tilts toward more advanced products such as computers, cellphones and long distance calling, the inflation number would have registered a major decline over the past ten years.

More important, thanks to constant productivity improvements, prices as a rule are supposed to fall. So while we should all cheer that former luxuries such as the cellphone (Motorola (NYSE:MMI) released its first handheld device in 1983 which retailed for $3,995) are well within the reach of most Americans, we’d do well to consider the unseen when it comes to prices in amid a falling dollar. In this case, the unseen is how much cheaper everything would be across the board if the dollar were strong as opposed to weak.

Of course, to concentrate on consumer prices on the way to divining the existence (or lack thereof) of inflation is surely a fool’s errand. That is so because rising prices are merely a symptom, not a cause, of inflation.

Indeed, to suggest that rising prices cause inflation is akin to arguing that perspiration is the cause of humid weather. In truth, weak currencies (inflation) cause rising prices, and humidity is the author of perspiration.

Looking at inflation presently, it is high and rising around the world, and revealing itself through price spikes in certain goods precisely because over the last ten years there’s been a run on paper currencies globally. The driver? The answer there is simple: the weak U.S. dollar.

To put it plainly, when we devalue in the U.S., it’s always and everywhere a worldwide event since every monetary authority in the world maintains at least a vague dollar peg. Seeking to avoid substantial increases in the value of their currencies versus the greenback, central banks the world over sell their currencies for dollars as a way of propping up the latter in order to keep their currencies from declining too much.

The end result is what it’s always been: price spikes. Much as the world suffered an illusory Malthusian crack-up in the 1970s when global currencies mimicked the dollar’s fall, and commodities skyrocketed, the same is occurring today as global central banks once again seek to avoid an overly substantial rise in their currencies versus the declining dollar (NYSE:UUP).

Considering the above, since 2001 the dollar has been the weakest of the global currencies, so whatever the highly suspect (and malleable) price indices say is wholly irrelevant. The dollar is and has been weak, and we’ve been and continue to suffer inflation. That our inflation rate is low compared to the rest of the world where currencies haven’t fallen as much as the dollar is merely a function of what’s being measured, and not a signal that all is well.

So while productivity and the government’s ability to massage numbers may continue to reveal itself through “benign” inflation readings in the U.S., readers shouldn’t be fooled. Inflation – a decline in the value of money – is what it’s always been, and with the dollar the weakest of all the global currencies over the last 10 years, the U.S. economy will continue to suffer rising prices, and much worse, a continued flow of limited capital into the ground, and away from the innovators and entrepreneurs who’d be well-positioned to author our recovery absent extreme dollar weakness.

John Tamny is a senior economic advisor to Toreador Research & Trading, a senior economist with H.C. Wainwright Economics, and editor of RealClearMarkets and Forbes.

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