Thursday, October 09, 2008

Inflation, CPI, TMS, Real Price Index (RPI)

The following statement is from the Federal Reserve and was taken from the Wall Street Journal Blogs:

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

Federal Reserve Actions
The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1-1/2 percent. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.


The lies that the Fed is telling us are downright shameful.  The idea that inflation is easing is silly, given that the Fed has injected nearly a trillion dollars of "liquidity" in the past two weeks.  Inflation, as I have said many times before is a result of easy credit monetary policy.  Adding paper dollars to the money supply is inflation.  The resultant price increases in everything we buy is reflected in price inflation or the consumer price index, CPI.  

In a non manipulated currency, the money supply should be relatively stable.  Money is a scarce resource, therefore prudent investment decisions are made because generally economics is a zero-sum game.  If the money supply is constant, only business owners that make good investment decisions will come out winners.  Our currency, and nearly every other currency in the world is credit based.  This means that people can go to banks to take out business and consumption loans; and that money is created out of 10% of the deposits at the bank.  Money creation has taken place and the money supply has been expanded out of thin air.  Economists will tell you that there have been transactions taken by the Fed to reduce the money supply after credit creating transactions, however the net effect is that the money supply increases.  Credit is therefore not a scarce resource and a credit based currency is not necessarily valuable in the respect that a stable supply commodity based currency is.  The credit based currency feeds on itself because in order to continue making returs to outpace monetary inflation, businesses must continue to borrow money and create "value".  


In a capitalistic society that seeks the lowest cost of production, newly developed goods will experience price deflation.  This is a good thing for consumers and businesses alike that use these goods.  Therefore it increases the efficiency of resource allocation.  The Federal Reserve would have you believe that prices should tend to rise as a result of some type of naturally ocurring inflation.  As we now know, prices tend to rise precisely because of monetary inflation; pumping more currency into the money supply.  This begs the question:

If we were to adjust prices (CPI) to the true money supply (TMS) would we see a real price increase or decrease over time?  If the tenents of capitalism and free market competition were true, then prices would tend to decrease.  If the Keynesian or Interventionist view of capitalism were true, then we would see a stable or uptrending line in prices.  The following graph shows the newly constructed and formulated (by me James Lien, yes I will take credit for it), Real Price Index or RPI.  

As we can see, there is price deflation in real terms.  It accelerated in the mid 1980s with developments in technology and has leveled off since the late 1990s.  This would suggest that even with the interventionism provided by governments, that capitalism does work to the advantage of consumers by lowering prices.  I would hope that people ultimately begin to realize that prices decline in real terms even with excessive monetary inflation from the clowns at the Federal Reserve.  Let it be known: Capitalism Works! 

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