Monday, March 16, 2009

How Much Will Your Dollars Buy In 10 Years

Here are a couple of charts that you might want to study for a while.

The top chart shows the Consumer Price Index(CPI). We can estimate the rate of inflation between any two years by calculating the percentage change in the index value between those years.

For example, from 1970 to 2008, the CPI rose from about 40 to about 200. That means the average level of consumer prices rose by a factor of 4 over that 38 year period, or about 10.5 percent per year on average (200 - 40)/40 = 4.0 = 400%, or 400%/38 = 10.5% per year.

The bottom chart shows what's called the monetary base, which is pretty much under control of the Fed. Notice the close correlation between the growth rate of the monetary base and the resulting rate of inflation. If it appears to you that expansion of the monetary base leads to inflation, congratulations; you got it.

Now notice the sky rocketing of the monetary base that the Fed has caused over the last several months. Does this look frightening to you? Do you think it could be a problem in a few years? Me too.

The Fed will have to withdraw monetary base from the banking system to battle inflation in future. How long do we have before that begins? No one knows for sure, since the banks will have to start lending again, expanding the money supply, before the giant rise in the monetary base will lead to giant rises in consumer prices.

Does it seem like a great idea to you that the Fed alternately pumps up the monetary base and then contracts it? If you were wondering where recessions come from, you need look no further.

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