Consumer Prices and Asset Prices

Monetary inflation causes several things to happen.  First, it redistributes wealth.  The government benefits at the expense of the average citizen.  Debtors benefit at the expense of the savers.  The list could go on, but it rearranges the wealth based on debts and based on who receives the new money early on.

Second, monetary inflation can cause a boom/bust cycle, particularly when the interest rates are distorted.  There is a misallocation of resources and times seem especially good during the boom phase.  When the misallocations are revealed and the lack of real savings is revealed, then the boom turns to a bust.

One thing monetary inflation doesn't do is change the amount of wealth.  However, it does cause future wealth to be less than it would have been due to the misallocation of resources.

Monetary inflation eventually translates into higher prices.  This does not happen immediately.  The Fed could create a trillion dollars out of thin air and release it into the economy tomorrow morning.  This is not to say that your lunch will be more expensive than the day before, particularly if the Fed move were not publicly announced.  It would take a little time for the money to circulate through and increase prices.

There are other factors in prices.  There is the demand for money (or velocity).  This is how quickly money changes hands.  If there is a high demand for money (lower spending), then the lower velocity will keep prices lower than they would have been.  In addition, even in an environment with a stable money supply, individual prices will always fluctuate based on the supply and demand of the good.

One thing that is not well understood by many is that price inflation is not uniform.  If the central bank inflates the money supply and the overall price level goes up, certain prices will go up more than others.  The false boom that occurs from monetary inflation will find hot spots and drive some prices up higher than others.  We can see this by looking at past bubbles, such as the tech stock bubble and the housing bubble.

When we talk about price inflation, we often talk about consumer goods such as food and clothing.  But it is actually asset prices that tend to go up higher in an inflationary environment.  For the sake of this discussion, when I say assets, I am referring to things that are commonly bought and sold and are often sold for a higher price.  For example, asset prices that go up might be stocks, real estate, or gold.

We can see this in China now.  Consumer prices are up.  However, real estate prices are flying high.  Real estate prices have gone up more than food and clothing.  Real estate is a bubble in China and it will pop like all other bubbles in history.

So while I am bearish on the American stock market in many respects, I also see the potential for higher stock prices.  There has been a lot of monetary inflation in the last 3 years and it has not shown up much in consumer prices.  Real estate is not looking like a hot spot right now.  There is definitely potential for stocks to make a run if there is not a recession in the near future.  There is also a lot of potential for gold and oil.

While I expect food prices to go up, I expect some other prices to rise at a greater rate.

One thing I don't expect to rise any time soon is wages.