CPI, Inflation and Monetary Confusion

Confused? Precious metals, gasoline, and food prices are going through the roof and yet the CPI hasn't moved. The stock market and GDP indicate improvement, yet the economy has hemorrhaged 7 million jobs, net of anti-productive government job expansion. We remain highly leveraged in the worst debt crisis ever, and yet interest rates are historically low. What's going on?

There is a serious problem with the dollar as a measurement gauge. One of the functions of currency is to maintain value over time. But, this is clearly not happening, particularly when we measure the dollar against other currencies and the ultimate in monetary stability, gold. Recently President Obama mistakenly suggested that there is "no silver bullet" available to fix gas prices, when in fact the price of gas as measured in ounces of silver has gone down.

Chairman Bernanke claims that inflation is under control, since core inflation (CPI) is still modest. He anticipates that those more volatile rising prices (conveniently exempted from the CPI) will eventually revert to the core inflation mean. However, prices are only a symptom of true inflation. Inflation is expanding supply of currency relative to underlying assets.

Control of the money supply is an incredibly complex topic and discussion of endogenous and exogenous factors make one's head spin. Regardless, it is clear that under the current approach the dollar is not retaining value. In addition, monetization of debt has driven interest rates down artificially, distorting this other key monetary metric.

Inflation never occurs across the board, but shows up in financial markets first, with banks the source of monetary expansion. The rapid rise of multiple commodities should be worrisome signals that normal investment is tanking, and with it, future growth.

As an added complication for business, in an inflationary environment, normal accounting procedures cease to give an accurate picture of actual events. A gas station might show a $.20 profit per gallon, as they buy gas at $3.00 and sell it at $3.20; however, if replacement cost is $3.50, this "profitable" gas station might go out of business, because of cash flow difficulties. Alternatively, they should have filled their tanks with $3.00 gas and temporarily closed the station; making more on speculation than normal business activity.

To pull out of this slump, our economy does not need gimmickry, but rather a surge in productivity from market based investment. Instead, resources have been allocated to government functions, which burden the economy with additional overhead. Savings dried up, because of artificially low interest rates. Investment capital was diverted away from reinvestment and entrepreneurial ventures and into commodities. A stable currency and market determined interest rates are imperative for long term recovery.

Is the conscious erosion of monetary value a form of tax and a way for those in power to maintain the appearance of a wholesome economy? Maybe. The more important question is how to recapture monetary stability, so we have a chance to grow out of our dilemma. Ron Paul and others suggest getting rid of the Fed and returning to a gold standard. However, there is 21st century alternative.

One possible solution: The Fed currently does not face competition for its Federal Reserve Notes, which are "legal tender" in the US. Gold [and silver] should immediately be set free to compete as parallel currencies. Obviously, taxes related to capital gains on gold must be abolished. Contracts written for gold must be upheld by the courts, including gold time deposits. Competition will force the Fed to maintain a stable dollar.

The 21st century aspect is that transactional physical gold will not be necessary. Ludwig von Mises never anticipated the availability of real time conversion prices via iPhone. Transactions in the present will be primarily in dollars. Transactions that involve time and possible monetary decay will be negotiated in either gold or dollars, depending on each party's anticipation of probable dollar weakness and alternative interest rates. Let the market decide.

This approach would be far easier to implement than reversion to a gold standard and should immediately stabilize the dollar, laying the necessary groundwork for a broad based recovery.