The Weird World of Inflation (And what it means for Deflation)

This is why consumer price inflation is meaningless.

The Bank of England released the latest U.K. consumer price inflation data this week and it unexpectedly accelerated in January, recording an annualized rate of 0.7%. Economists had expected the rate to stand pat at 0.6%. Underlying the acceleration was a rise in the prices of furniture, household goods and food. Against that, the prices of clothing and footwear declined by 4.9% from a year earlier.

The report noted, though, that the number of items that were unavailable for checking rose to 69 from 9 in December.

This is the problem with what is commonly thought of as inflation. Consumer prices move up and down for many different reasons and, at any one time, there will be prices rising somewhere and falling elsewhere. So, what prices should be checked by the compilers of the statistics? There are egg-head boffins (PhD quants, for those stateside) in statistics offices around the world pondering that question each, and every, day. The answer, inevitably, contains much subjectivity because the prices of every good and service in an economy cannot be monitored all the time.

This begs the question of what use measurements of consumer price movements are in the first place.

Mark Mobius, the emerging markets investment pioneer, has recently published a book titled “The Inflation Myth and the Wonderful World of Deflation.” In it, he argues that consumer price inflation measurements are severely flawed, a central reason being that no account is taken of changes to the quality of the good or service, or innovation generally. Robert Prechter has made this point in the past – nominal prices might have stabilized for personal computers and TVs, for example, but the product has been so much better year-after-year.

Despite these inherent flaws, consumer price inflation is arguably the most important economic statistic on the planet because it directly influences the level of central bank interest rates which, conventional thinking would have us believe, affects the overall economy.

That’s not the way we see it. The broad economic path is driven by trends in social mood. Social mood can influence consumer prices, but it mainly drives asset prices and debt. This is why the (already-baked-in-the-cake) money and debt-inflation of the past decade is far more important that consumer price measurements. What comes after inflation? Yes. Deflation.