Inflation Revisited

I have written about investing in an inflationary environment before.  It seems that all markets have priced in a significant inflation expectation (see TIPS, gold).

Along comes an article on BusinessInsider.com that seems to start out making a case that expected inflation is not an issue that is dominating economic thinking.  The piece goes to reference a survey of institutional consultants which suggests that more inflation hedging is contemplated for 2011, and concludes that maybe there is something to this trend. 

So I took a look at some of the data.  The Bureau of Labor statistics released its CPI data earlier today.  The full index was up 0.5% month over month in march with a increase of 2.7% over the trailing twelve month period.  Core inflation, the full index less energy and food, was1.2% for the trailing twelve months, core prices increasing only 0.1% from the previous month.  So, inflation has been tame over the past year, and, at least for the past month, has not been particularly virulent.  This seems to validate the view of several Fed governors and Fed Chirman Barnanke that inflation is not the imminent threat.

What about the QE1 and QE2, the systematic pumping of liquidity into the economy?  We can see from Fed statistics that indeed, money has been injected with the force of a fire hose.  However, the money has not found its way into checking accounts and money market funds.  The  money multiplier has plummeted to less than 1!  All this indicates an enormous delevering of the economy: banks have taken free cash and bought treasury bills rather than lending to business; business is taking its profits and paying downs loans; lenders are building cash balances against an uncertain future.  Looking at the graph of monetary velocity, we can see that recent trrends are the opposite of what they were in the 70s and 80s, the last time the US experienced significant inflation:

Ben Bernanke has been telling anyone that will listen that the greater economic risk was deflation rather than inflation.  The monetary data seems to confirm this.  In fact, the inflationary impact of the quantitative easing may have been just enough to offset the deflationary forces unleashed in the recession.  That would suggest that no strenuous tightening will be necessary to avoid a bout of inflation when a full recovery commences.