Edward Lotterman: Inflation based on more than cash

I usually don’t see inflation hiding behind every tree, but some current prices give me pause. Gold, the time-honored inflation hedge, is near $600 per ounce – the highest in two decades. Copper is about $2.70 per pound, or three times its usual level during the 1990s. Other metals are at similarly high price levels.

The assessed value of some farmland my wife and I own in southwest Minnesota went up by 31 percent this year, according to a recent tax notice. The value of our house in St. Paul, Minn., has increased an average 13 percent annually for five years.

Is something going on here?

As a teacher of introductory economics, I know that increases in the prices of a few goods – even when they grab headlines – do not constitute inflation. Inflation is an increase in the general price level. We measure general price levels with carefully tabulated indexes like the Consumer Price Index and the Gross Domestic Product Deflator.

Such indexes show only modest increases in general prices, once oil and gas are factored out. Yes, some monthly increases have been higher than the average for the preceding 15 years. But they are not out of line with the average for the six decades since World War II ended.

Moreover, there are fundamental reasons prices for metals and other industrial inputs are high. China’s booming economy, combined with good growth elsewhere in Asia, is sucking in raw materials from all over the world.

Plus, Milton Friedman taught us that inflation “is always and everywhere a monetary phenomenon.” That is, inflation occurs only when excessive growth of the money supply allows it.

Yes, the U.S. money supply grew substantially faster than output from 2001 through 2004. But more recently, money growth has moderated while our nation’s economy is growing quite strongly.

The reasons for housing price increases are an entire subject unto themselves. Midwest farmland prices are based on a very thin market with few sales in any given year. The increase on our farm does not represent a nationwide phenomenon.

So, there’s no need to worry, right? Well, as economists are wont to say, “maybe no and maybe yes.” Not all considerations favor complacency.

The idea that we need look only at money growth in our own country is obsolete. Asian central banks have bought up huge amounts of foreign currencies in the past few years. Some estimate that China now holds a trillion dollars worth of other currencies.

That pumps liquidity into the global economy just as surely as if the U.S. Federal Reserve creates dollars, or the European Central Bank creates euros, through buying bonds on open markets.

One sobering perspective is that it is nearly impossible to find a time in the past 60 years when sharp rises in the price of gold and nonagricultural commodities were not accompanied by inflation. Hold on to your hat with at least one hand.