The BLS announced that producer prices increased at an alarming rate compared to consumer prices --
The Producer Price Index rose 1.6% in February alone, the Labor Department reported Wednesday, the biggest jump in nearly two years. The rise was far worse than the 0.6% increase that economists surveyed by Briefing.com were expecting. Overall, prices rose 5.6% from a year ago....
Despite rising gasoline prices over the last month, economists surveyed by CNNMoney are forecasting only a 2% rise in overall consumer prices over the last 12 months, and a 1.1% rise in core-CPI.
This, naturally, is unsustainable. How will it resolve itself? That depends on what exactly is going on to cause it.
Classical theorists would say that as crude goods' prices increase, they will drive up the price of finished goods as costs increase. That is also what most meathead business reporters think. The problem is that finished goods producers can only raise prices if their own buyers are able to pay. If they can't, those expensive goods are either going to sit around rotting, or more likely, the companies that produced them are going to sustain losses when they sell them.
Of course, it may be true that the final buyers really do have the money to pay, and we will see higher CPI in the near future. Even meatheads get it right sometimes.
My own guess is that the recent increases in the money supply are principally available to banks and corporate borrowers, who have used it to drive up prices of crude goods since we are at the latter stages of the business cycle, but not to most consumers, a large fraction of which are unemployed or desperately clinging to the work they have. If that is the case (and it doesn't change relatively quickly), there will be less 'passing on costs to consumers' than producers would like. Either prices will fall, causing losses, or sales volumes will diminish and production will be cut until the inventory clears. That would also reduce pressure on prices upstream, moderating the disparity. But that is just a guess. I could be wrong.
But why is this happening in the first place?
The current capital structure was devised under the impression that there were ample resources available -- FED-suppressed interest rates, warped pricing structure -- so that now most goods are produced in a way that is highly resource intensive -- lots of capital, highly complex processes, lots of shipping goods all over the place rather than local production -- and at volumes often in excess of what consumers actually will want (for many goods, anyway). Meanwhile, labor sits idle, unnecessary, unproductive, and therefore unable to buy up those goods.
Had a correct interest rate prevailed and prices not been warped by banking and government, there would have been a better match of capital to labor, fewer resources would have been applied to multiplying labor (capital goods) and more to the production of final consumer goods. Everyone would be employed and supplied with appropriate goods by the marketplace. Problem solved.
My guess anyway. It is also possible that CPI will show a large increase in the future, meaning the money will have worked its way down and consumers can pay. That will be the final signal that inflation is off to the races. But if nothing else, this should serve as a wonderful demonstration of the fallacy of neutral money. No Virginia, prices do not all increase proportionally in response to an increase in the money supply. Some people get the money first.
I heard this one from a reliable source.
A man bought a thermometer for his barbecue grill that he really liked, and decided to get another for his son. He went to the same store to find another, but found that they didn't carry them anymore. He asked a clerk what happened to them.
Clerk-- 'Those things were really popular. We'd get in a shipment, and they'd all be gone by the end of the day. The shelf would sit empty and customers would keep asking about them. We just couldn't keep them in stock. We tried for a while, but we finally had to give up. We don't stock them anymore.'
You can't make this stuff up...
The Question the Austrian Inflationists Need to Answer
Robert Murphy posted an article looking at the possible ways the FED might theoretically unwind its ballooning of the monetary base. I have seen many such articles (and even wrote one myself a long time ago), and this one is better than most. Murphy has a discussion about the threats of raising reserve requirements that I had never thought of.
But to me, these 'let me count the ways' approaches fail on one important point -- they all treat the FED as an independent, arbitrary entity able to act in practically any way it sees fit. They act as if the FED might unilaterally inflict whatever policy it saw fit on the banking system, as if the FED wasn't being run primarily by the banks themselves, in the interests of those banks, and in particular, the several very largest banks. They do, after all, get six seats out of ten on the committee to determine monetary policy. They can get practically whatever policy they want.
In that light, all the monetary policy implemented to this point, and more importantly, those which have not been implemented, makes perfect sense. The poor, big banks are holding too many bad assets? The FED will buy them at face value, no problem. The banks are worried that the system as a whole might start lending uncontrollably, touching off mass inflation and ruining the value of long term debt? How about the FED starts offering interest on reserves, paying the banks not to lend?
Gee, two plans for giving free money to the banking system. Who would have thought? Raise reserve requirements to prevent lending, the traditional method to curb that behavior? No way! That would cramp the banks' style!
Which leads to the question -- if you're an Austrian theorist and an inflationist, what exactly is it that leads you to the conclusion that the big banks will get together and decide to instigate FED policy that will spur lending when they all know it will almost certainly touch off red-hot inflation, burning themselves in the process? Why will we ever leave this giant-monetary-base/no-lending limbo? It seems to suit the big banks well enough for now. Why bother going over policy options that won't work when they run against the interests of the big banks, who wouldn't choose them anyway?
It would seem to me that the correct analysis would be to ask what policy benefits the largest banks the most. The banks would not want much inflation at this point because it erodes the value of their assets (debt) and doesn't give them a claim to a larger share of economic spoils as it did in the past. Inflation has gone from being a tool to a threat. I would think that their strategy would move towards maximizing the fraction of GDP over which they have claim, rather than the nominal value of their holdings, which really reflect very little at this juncture. And once you've got that hammered out, to brainstorm what policy backflips it would take to get that result.
What policy would that be? I'm not sure. We do have inflation (M1 and the AMB, anyway, plus the PPI indicator). But allowing that to trickle into the CPI may not be tolerated. In that case, we will get another recession. But then again, who knows how long that might take? We could sit in this limbo for some time.
My guess is that government will intervene. I do not think Washington will allow the FED to do absolutely whatever it pleases for too long. It will demand funding of the deficit, at the very least. If it doesn't get it, it will go bankrupt, taking down the banks with it (FDIC, Treasuries). So, it will get it, with or without a political tantrum, on one set of terms or another. But there will likely be brinksmanship.
The spending will push money it into the economy over time. If the banking system does not come up with a way to prevent this from causing recognizable inflation, the inflation will eventually catch. It will, of course, be the principle fault of government, though. If the big banks had their way, they might very well just sit tight, milking their massive ill-gotten holdings and asking the FED to take losses off their books essentially forever. The question becomes this -- can the banks figure out a way to make this happen, papering over their losses, propping up an overspending government, and preventing too much money from reaching the bottom of the production structure?
Japan did it, so it can be done. The BOJ has not had to inflate to support deficit spending by its profligate government for decades now. I don't think the US can pull of a similar feat. Our savings rate and tolerance for taxation are both too low, culturally. I think the banking system will fail, eventually getting overridden by government, and inflation will take over whether they like it or not. So, there you have my answer. I'd like to see others, though. I'm only an amateur. I bet there are better answers than mine.