Friday, June 12, 2009

If the economy is in the tank, can there be inflation?

The short answer is yes! Inflation can occur whether unemployment is 4 percent or 9 percent. Inflation can also occur when economic growth is stagnant. The world is replete with historical examples. The US during the 1970s is a textbook case of a sluggish economy with ever rising inflation. (Try German hyperinflation in 1923 for a more well known example).

So, why are people saying that there is no threat of inflation? Curious. Imagine that peanut production doubled every two weeks. What would you think would happen to the price of peanuts? Would your answer depend upon the unemployment rate?

What, after all, is inflation? Inflation is the rate of growth of the decline in the price of money (by definition). If there is a tremendous increase in the supply of X, while supplies of other things are stagnant, what do you think will happen to the price of X? If you said the price would go up, then you are a candidate for the Obama economic team. If you said the price would fall (faster and faster as the growth of the supply of X surges higher and higher), then you are a rational being and do not qualify for the Obama economic team.

So keep on buying those treasuries, Ben.

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