Inflation is Coming (Or Is It?)

Watching recent monetary policy, not to mention price activity, makes it easy to expect that significant inflation is on its way. That outcome is not a certainty.

Columns From: 4/26/2011 Modern Machine Shop, ,

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Peter Zelinski

Do you expect the U.S. economy to see significant inflation in the not-too-distant future? It’s a big question. If you do, then frankly you want to resist hiring. Better to borrow to add higher-end equipment, and try to expand capacity that way, than to add employees who will press for higher wages. 

 
On the other hand, if you do not expect significant inflation, then now may be the time to hire. The scarcity of manufacturing professionals is only going to get worse, so put good people in place today. With wages still depressed, it may be possible to add good people at bargain prices.
 
The case for expecting inflation is probably clear. Through measures such as “quantitative easing,” the Federal Reserve has been expanding the dollar supply. As those dollars accelerate into circulation, prices will rise—or so goes the fear. Is there another scenario?
 
Perhaps there is. A case can be made that significant inflation is not a foregone conclusion, and that we are not guaranteed a repeat of the rampant price rises of the 1970s. Here is why:
 
1. Banks themselves determine how many dollars are moving. By making loans, banks expand our economy’s purchasing capacity, and this is something they were doing quite a lot more of before  2007. Today, many can see how one big bank, the Fed, is printing money. Fewer people appreciate the extent to which other banks are now releasing money more slowly. Between the two, how much “excess” money is actually entering the economy? This is unclear.
 
2. The fact that wages are still stagnant is significant. In The Great Inflation and Its Aftermath, Robert Samuelson describes how the inflation leading into the 1970s actually began with high employment and wages. Government action to keep these levels artificially high ignited the inflationary spiral. Today, certain prices are indeed rising—commodities, food, fuel, the cost of government—yet all but the last of these might be due to increased demand. Meanwhile, wages are not rising. That means consumers will pay for the costlier items by reducing other purchases. The shrunken demand in these areas means the price rises might depress the prices of other goods.
 
3. Inflation was successfully stopped in the 1980s. It wasn’t fun—the medicine involved a recession. Today, the Fed says it can do the same thing if the need arises. We’re right to be wary of officials professing competence against a problem so large. Nevertheless, history does provide evidence of the Fed being effective against inflation.
 
With the points above, I am not saying I do not expect inflation as a result of today’s policies. I am saying I don’t know what to expect. Rampant price rises are a credible concern, but not necessarily imminent. Like usual, we live in uncertain times. Should you expect inflation as you make plans for your own facility? Perhaps the best choice is to commit to the plan that you will be best able to continue with, in case your inflation expectations should happen to be very wrong. 
 
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