Larry White is an outstanding free market monetary theorist at the University of Missouri in St. Louis. At the Division of Labor blog he notes that although the nominal price of gold is back to the level of 1987 it remains much lower in real terms, after adjusting for the 75 percent rise in prices since then. But the real price of gold has nearly doubled over the past four years, which he interprets as hedging against inflation:
“The upsurge in gold over the last four years suggests that that investor confidence may be slipping again – and not without good reason. As Bloomberg reports: So far this year, consumer prices are rising at a 4.9 percent annual rate compared with a 3.7 percent increase at the same time last year.”
Yes, but . . .
So far this year, consumer prices less energy are rising at only a 2.0 percent rate -- down from 2.2 percent at the same time last year. Energy prices in the CPI rose 12 percent in September alone, but fell slightly in October.
If we look at the superior chain-weighted CPI, prices were up only 1.7 percent over the past twelve months for all items less food and energy. Food is rarely a significant factor (I'd prefer to drop the "core" measure), and food prices were up only 2.1 percent over the year while energy prices soared by 26.3 percent. Leaving out energy alone, the chained CPI would be close to 1.8 percent over twelve months. Since even chained price indexes exaggerate inflation, because of quality improvements and hidden discounts, an inflation rate of 1.8 percent for everything except energy is really quite low.
The main reason this distinction matters is not that rising energy prices don't hurt, or even that global oil demand is only indirectly related to Fed policy. The key reason we absolutely must look at inflation without energy prices is that energy prices cannot and will not keep rising forever. When they stop rising, we'll see how the underlying rate of inflation really is.
If the chained CPI less energy remains around 1.8 percent, then total inflation will likewise drop to about 1.8 percent if energy prices merely stabilize, and to a rate below 1.8 percent if energy prices keep falling.
It is theoretically possible that non-energy prices might accelerate if energy prices fall, because cheaper energy frees-up cash to spend on other things. In the past, however, spikes in energy prices in 1974-75, 1979-81 and 2000 were always followed by slower inflation in non-energy prices for at least a year or two. The Fed’s notion that energy inflation spreads like a virus from energy to everything else is factually false.
Non-energy inflation is now lower than it was during in any year from 1967 to 2001, and also lower than last year. So relax and enjoy a happy new year. But maybe it's time to trim those hedges.