Inflationary pressures have risen sharply over the past few months, largely due to Federal Reserve Chairman Ben Bernanke’s decision to lower the target Fed Funds rate by 300 basis points over the past six months. (As many of you know, the exchange-value of the U.S. dollar tends to decline when short-term interest rates fall. The purchasing-power of the dollar therefore tends to fall whenever the Fed significantly lowers its target Fed Funds rate).
In addition to the pickup in inflation in the U.S., the declining value of the dollar has caused inflation rates in numerous other countries around the world to rise significantly over the past year; (see the chart below).
This past weekend, members of OPEC suggested that the oil cartel won’t even consider increasing its output of oil until September, at the earliest, in an effort to preserve the revenues that OPEC derives from the production of crude oil. (OPEC’s revenues fall whenever the value of the U.S. dollar declines, because oil is priced in dollars).
I expect the value of the dollar to continue to fall during the next couple of months regardless of whether the Fed continues to cut the target Fed Funds rate. Why? Because of the substantial increase in the money supply during the past year; see the chart below for the change in the MZM Money Stock — the broadest measure of the money supply.
As a result of the recent decline in consumers’ expectations concerning their job security and future economic conditions, consumers have significantly cut back on their spending during the past few months. The slowdown in consumer spending has, in turn, led consumers to increase their demand for money – to increase their demand to hold cash and other forms of money rather than to spend that money.
In economic jargon, the velocity of money — the number of times that money is spent, or turned over, during a given period of time — has fallen sharply during the past six months. Once economic conditions improve, however, you can be sure that the velocity of money will rise — that consumers will begin spending briskly once again. In light of the dramatic increase in the money supply, and the outstanding supply of money, I therefore expect inflation both here and abroad to gain momentum later this year.
Meanwhile, I expect a continuation of rapid economic growth in China, India, and several other emerging economies to add further to inflationary pressures during the months ahead due to the huge investments that those two countries are spending on building their basic infrastructure (i.e. the construction of electric utility plants; roads, bridges, and dams; telecommunications projects; etc.).
Keep in mind that a significant portion of today’s inflationary pressure is being caused by what is referred to as “cost-push inflation”. Cost-push inflation is the type of inflation that results from large increases in the cost of goods for which there are few alternatives (i.e. petroleum products and raw materials, such as industrial metals and textiles). When the demand for such goods exceeds the supply, the prices of those goods tend to rise.
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