An alternative to popular faith
In the post “Do deficits cure inflation?” we saw that contrary to popular faith, deficit spending (i.e., too much money) has not caused inflation. We also saw that inflation can be cured by increasing the reward for owning money, i.e. by increasing interest rates.
Now we question another piece of popular faith: Is inflation caused by too much money chasing too few goods?
Begin with the notion of “too much money.” We already have seen that federal deficits are not related to inflation. What about another definition of money: M3? Please look at the following graph:
Clearly there is no immediate relationship between money supply and inflation. What about a subsequent relationship. Could “too much money” today, cause inflation later?
The graph indicates no such cause/effect relationship, with M3 peaks preceding inflation peaks by anywhere from 2 years to 10 years. It is difficult to imagine a graph revealing less relationship.
What about “too few goods”? If too few goods caused inflation, this would manifest itself with GDP moving opposite to CPI. Again, that does not seem to happen:
There seems to be no regular pattern, with GDP and CPI sometimes rising together and sometimes separately. In today’s international economy, it is difficult to substantiate the idea of a wide-spectrum commodity shortage when sufficient purchasing power exists.
Individual nations can experience shortages of individual commodities. Individual poor nations can experience shortages of a broad basket of commodities. But can a wealthy nation, with plenty of money to spend, suffer a shortage of a broad basket of commodities, thereby causing inflation? Has it recently happened?
Seems unlikely these days as products are made in multiple nations and shipped to multiple nations, with easy international shipping and instantaneous money convertibility. Your cotton shirt may have been grown in Egypt, woven in India, assembled in China, labeled in Italy and sold in the U.S. Clearly, a cotton shirt shortage would be rare, as any of these steps could occur in various countries, and that’s just one product. A nationwide “too-few-goods” situation, coincident with “too much money,” seems impossible.
There is however, one exception: Oil.
The graph below compares overall inflation with changes in energy prices, which are dominated by oil prices.
Oil is the one commodity that has worldwide usage, affects prices of most products and services, and can be in worldwide shortage. That is why, when oil prices rise or fall steeply, inflation rises and falls in concert.
The large oil price moves “pull” inflation in the same direction. When oil prices increased or decreased the most, inflation came along for the ride.
In summary, inflation is not caused by deficit spending or by “too much money chasing too few goods.” Inflation is caused by a combination of high oil prices and interest rates too low to counter-balance the oil prices.
The high oil prices can be caused by real shortages and/or by price manipulation.
Hyperinflation is a different beast, altogether. Every hyperinflation has been caused by shortages, most often shortages of food.
Zimbabwe, Weimar Republic, and Argentina had food shortages that created hyperinflations.
Rodger Malcolm Mitchell
http://www.rodgermitchell.com
#Monetary Sovereignty - Mitchell 
As usual the european socialists will never know what hit them. Not only the press release is empty of content which is something markets usually do not like, on top of that they forget or ignore the most importnant of things. the will of the people. The will of German and greek electorate.
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“Inflation is more closely related to oil prices than to any other single element.” (From a previous post.)
So when an investor can put lots and lots of “easy” money into investments in oil and cause the price of oil to go up, that isn’t somehow a sign of “too much money” in the system?
Or when an investor can put lots and lots of “easy” money into investments in houses and thus cause housing prices to go up, that isn’t somehow a sign of “too much money” in the system?
Or when student loans are given away to anyone that can fog a mirror that isn’t somehow related to why tuition goes up on average 8% or well over twice the rate of normal inflation?
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I merely reported history (repeatedly, oil prices “drag” inflation) and a possible explanation (oil prices affect all other commodities).
If someone owned several trillion dollars, and decided to use that money to buy oil, which he then hoarded and didn’t release to the world, that would cause inflation. In fact, the Saudis often have done that.
But that isn’t a sign of too much money in the world. It’s merely a sign that someone caused oil prices to go up, which caused inflation. It could happen with too little money in the world. That’s called “stagflation.”
I haven’t seen the same relationship between inflation and housing prices or tuition.
Rodger Malcolm Mitchell
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“But that isn’t a sign of too much money in the world. It’s merely a sign that someone caused oil prices to go up, which caused inflation.”
Yes, exactly. Now, let’s say you can borrow money cheap, pile that money along with everyone else into a commodity like oil. What happens to the price of oil? It goes up. Why, because one could borrow cheaply, using money created with a flick of the finger on a computer.
Same thing happened for housing.
As for tuition, it goes up 8% a year. Why? (And don’t say health care. All industries are affected by health care.)
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I read the argument linking oil and inflation. However, there has been inflation in those countries and oil cannot be a factor since it is subsidized. Would the correlation be rent/housing?
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I don’t know about other countries. I’ve researched the inflation facts only for the U.S. If you can find similar data for other countries, let us know.
Rodger Malcolm Mitchell
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Each nation has its own circumstances, which include size, monetary sovereignty, government spending, interest rates, etc.
The U.S. is a big, monetarily sovereign nation, whose government spending and interest rates have not contributed to inflation.
Rodger Malcolm Mitchell
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oops..when I said those countries..I meant nations in the middle east
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For many years now the dollar has been falling as measured against a so-called trade-weighted basket of other currencies. That can’t be caused by oil, because the owners and users of those currencies are also oil consumers, and would suffer the very same oil-caused price increases as the US.
What has caused the dollar to fall so persistently as compared to other currencies, and is that trend related to “inflation” in any way?
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John,
The exchange rate is like the stock market or the gold market — based not on fact but on opinion about the future.
Rodger Malcolm Mitchell
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I almost choked when I read this post. So let me get this, you compare CPI to GDP and somehow figure that there has been no inflation?
And aren’t you the one complaining about the gap widening through the years? Let’s just say that incomes not going up while the debt load and interest have is INFLATION.The money, in form of credit, has increases and that is inflation. Looking at prices is not accurate.
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Never said there has been “no inflation.” Said there is no relationship between money supply and inflation.
Obviously, there has been inflation. And obviously, there has been an increase in the money supply. But the graphs show the two are not connected.
That is the whole point of the post.
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