Mish Shedlock has an awesome explanation of the price inflation we are seeing in goods that we need right now. This is not to be confused with generalized inflation or what many people term, ‘hyperinflation’ – most commonly associated with Zimbabwe or Weimar Germany.
I’m excerpting only part of his post here to try to keep this subject as concise as possible. Please click the link below to read the entire article.
Prices Affected by the “Demand for Money”
In a general sense, if the demand for money drops for any reason, prices will rise. Conversely, if the demand for money rises for any reason, prices will fall.
The demand for money (the desire to hold on to it vs. consume) can change as consumer preferences change. Demographics is one such reason consumer preferences may change.
For example, someone at retirement age and barely scraping by has a far greater demand for money than a young person at age 30 with a decent job.
Here is another way of phrasing the same thing: A person aged 30 with a good job is far more likely to have high demand for the latest and greatest electronic gadget than someone aged 62 scared half-to-death about running out of money in the near future.
Changing demographics is a very powerful “price deflationary” card at this stage of the game. Indeed, Bernanke is doing his best to counteract the increased demand for money associated with boomer dynamics by pumping up actual money supply.
The result so far has not been the expansion of credit that Bernanke wants, but rather a massive increase in the amount of “excess reserves” held with Fed. (Please see Fictional Reserve Lending for further discussion).
In short, banks have no real desire to lend except to a small pool of creditworthy borrowers who have no desire to borrow.
In the real economy, demand for money is high (as evidenced by unprecedented drops in consumer credit). However, Bernanke (with much help from the Bank of China) did manage to ignite more recklessness in numerous speculative ventures including equities, leveraged buyouts, and commodities.
Thus, the Fed can increase money supply, but it cannot easily dictate where that money goes or even if it goes anywhere at all.
The “Demand for Money” construct forms the basis for many “frugality arguments” I have presented over the years.
It is a topic much in need of discussion and understanding, especially by various inflationistas calling for hyperinflation later this year. The good news is we only have 11 more months to see them proven wrong. The bad news is they will simply bump up their target by a year or two.
Cliff Event In Japan
Meanwhile, Japan is the perfect example of strong demand for money in spite of amazingly low interest rates and in spite of all efforts by the Japanese central bank to cause inflation.
Nonetheless, Japan is at a state in its economy where it has consumed all of its savings and then some just as its retirees need to drawn down on savings that the government spent building bridges to nowhere in foolish attempts to fight deflation.
Please see Japan’s Finances “Approaching Edge of Cliff” for details.
As a result of that “cliff event”, strongly rising import prices in conjunction with a rapidly falling currency will likely hit Japan before the same thing hits the US.
Mike “Mish” Shedlock