Data suggests inflation on the way

Neil Munro White House Correspondent
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The good news is that the economy grew at a modest 2.5 percent in the last quarter. The bad news is that rapid economic growth in 2012 or 2013 could also prompt bank executives to inadvertently jump-start inflation.

The executives are holding back roughly $1 trillion in funds provided in 2009 by government officials to buy over-valued mortgages from banks and Wall Street firms.

The bank executives are now holding that cash because they were traumatized by the near-meltdown of the banking system in 2008.

But if their confidence grows, they could loan out hundreds of billions of dollars and spur inflation, says Steve Horwitz, an economist at George Mason University’s Mercatus Center.

There’s some evidence that inflation is already underway, he said.

New data shows a sharp jump in prices at the base of the economy, he said. For example, consumer prices rose 3.9 percent over the last year, but the price of “crude goods” grew 21 percent.

Crude goods are the raw materials of production, and their increased prices may gradually pass through factories, distribution centers and shops until they bump up consumer prices in future months. The 21 percent growth is perhaps being caused by companies’ use of banks’ plentiful funds to bid up prices, he said.

There’s some evidence this alarming pass-through process has begun. The prices of “finished goods” are up 7 percent, and the the prices of “intermediate goods” are up 10.5 percent, said Horwitz, who is also an economic professor at St. Lawrence University in Canton, N.Y.

“I’d say it’s a two or three alarm [fire], not a five alarm,” he said.

There are also reasons for optimism, he said. Inflation expectations are low, and economic growth might consume those dollars without spurring inflation.

Today’s announcement of 2.5 percent economic growth over the last three months also included news that business investment grew rapidly, at a rate equivalent to 16 percent a year. That number, said Horwitz, is “possibly even a real positive.”

The extra dollars that threaten inflation were created by the White House’s “quantitive easing” policy in 2009. This allowed the government to buy some of the bad mortgage loans created by the government’s efforts to expand home ownership under President Bill Clinton, and especially, under George W. Bush.

What this means, said Horwitz, is that the “monetary base grew from just under $874 billion to just over $2 trillion” from 2008 to 2010.

This money-creation policy hasn’t revived the economy, or reduced unemployment.

However, once economic growth does return, the government will to try to sop up the extra dollars before the banks loan them out to business and consumers.

They can sop up that cash by leaning on banks to buy back all those bad mortgages. The returned money can then be digitally annihilated, Horwitz said.

That buyback would help, but even if the government eliminates half the extra cash, that would still leave the banks with $500 billion in federally-created cash, said Horwitz.

If they release the cash as loans, the borrowers — both consumers and companies — will pass the money onto suppliers, who in turn will deposit their profits in other banks, he said. Those secondary banks subsequently loan out the cash, and spur more business, more bank deposits and yet more loans.

The result, he said, would be lots of cash chasing after a limited supply of goods and services, and “plain, old fashioned inflation.”

Most people would lose amid the inflation, because they can’t quickly shift their assets to cope, he said. For example, inflation would drive up gas prices, but most people would lose value if they have to sell their gas-guzzler to buy a high-MPG car, he said.

The people who would gain, he predicted, are finance professionals who can guide others through financial complexity. “Lawyers and accountants would do well because companies have problems with contracts” whenever inflation picks up, he said.

People who are not sophisticated enough to keep pace would also lose, he said. So would the people who are reliant on fixed-income sources, such as pension-funded Baby Boomers.

Government could gain from inflation, he said, partly because the federal government’s $15 trillion of debt would be diluted by inflation, but also because government would be able to borrow yet more trillions of dollars.

But all this has yet to happen, Horwitz stressed.

The $1 trillion dollars created by Obama’s policies, he said, are “still sitting in banks, they haven’t been leant it out. That’s the key.”

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Neil Munro