Peak Oil: The inflationary case

I'm very interested in the whole "inflation versus deflation" peak-oil argument. I started thinking it was clear that peak oil would be inflationary, but I'm getting less sure. I don't understand the deflationist case in enough quantitative detail yet to really assess it, but I'm working on it. Let's start with the case that the post-peak oil era is likely to be inflationary, which can be summarized fairly simply:

US inflation rate (calculated two ways) since 1950 with various oil shocks labeled. The green line is inflation calculated from the quarterly GDP deflator numbers (percentage change from four quarters earlier). Source: Bureau of Economic Affairs. The purple line is calculated from the monthly CPI-U index (percentage change from 12 months earlier). Source: Bureau of Labor Statistics.

Several conclusions can be drawn from this. Firstly, it seems pretty evident that in the past, oil shocks have tended to cause spikes in the inflation rate. The labels mark the dates of:
  • The Abadan Crisis when Mohammed Mossadegh nationalized the Anglo-Iranian oil company, which provoked the British to embargo Iranian oil. This ended with the US-British backed coup that deposed Mossadegh.
  • The Suez Crisis in which Egypt nationalized the Suez canal, the major supply route for oil to Europe, provoking an alliance of France, Israel, and Britain to militarily seize the canal, before being obliged to withdraw under threats from the Soviet Union and the US. The canal was then placed under control of the first United Nations peacekeeping operation.
  • The Arab Oil Embargo
  • The Iranian revolution, and closely following Iran-Iraq war,
  • The 1991 Gulf War following the Iraqi invasion of Kuwait in August 1990.
Clearly, every oil crisis of significance in the last 55 years has provoked a burst of inflation. Of course, it's also clear from the graph that oil shocks are not the only thing that provoke or limit inflation, but it's hard to deny that they have a pretty significant effect on it. But, certainly this would suggest that one might well think that the post-peak period would also be inflationary. It will presumably be like one long slow oil shock punctuated by a number of short sharp oil shocks.

Many economists would argue that the absence of big inflation peaks since the early 1980s means that inflation expectations have been conquered, and that things are fundamentally different now. I don't altogether dismiss this, but at at minimum it hasn't been tested by any good-size shocks. The only oil shock since the early 1980s was that associated with the Iraqi invasion of Kuwait and the first Gulf war. As the following graph shows, as an oil shock, that was nowhere near the monsters of old (if we measure the magnitude of an oil shock by the change in the growth rate of annual global oil production that it produces).

Percentage change in average annual oil production from one year to the next according to various estimates. Click to enlarge. Believed to be all liquids, except API line is crude only. EIA line includes refinery gains, others do not. Sources: ASPO, BP, and EIA.

I suspect that if we had had any really big shocks, we'd have had a lot more inflation. Even the events of 2005, when the growth rate in global oil production certainly slowed sharply, are not close to those of the 1950s or 1970s. And indeed, so far we've had only a modest uptick in the inflation rate.

In passing, I would just like to note that the difference between the two inflation lines in the graph suggests that that inflation is a somewhat imprecise quantity - different agencies can come up with numbers that are only roughly similar by using different definitions. There are considerable difficulties in principle in measuring inflation associated with the fact that dollars in one era are not really commensurable with dollars in another era, since they represent the right to buy a slice of qualitatively different mixes of goods and services. The various agencies have methods of interpolating, but there's something fundamentally subjective about deciding how much a new 1950 car is worth compared to a new 2006 car. Thus I think the inflation rate should be viewed as having an error of a percentage point or two, which means that long-term comparisons of prices are very approximate. This is because those uncertainties compound over time. For example, saying that oil is still cheaper than in 1981 is probably a fairly meaningless statement, as the difference in price is likely smaller than the uncertainties in the compounded inflation from that time to this.

Economists are fond of arguing that inflation is mainly a function of central bank policy - easy or tight money controls whether there's inflation or not. While I think there's been something to this over the long haul in the distant past, and certainly in cases of hyperinflation, it doesn't seem to have been as important as oil shocks in US inflation in recent decades.

Here's the growth rates in the two most common measures of money supply: M1 (notes, coins, and checking account balances) and M2 (M1 plus savings account balances and small bank CDs). M1 is directly controlled by the Fed via open market operations. M2 is not (since reserve requirements on savings accounts and CDs are zero).

Money supply growth. Percentage growth from same month in prior year. Eras of different Fed Chairs labeled above. Source: Federal Reserve Bank.

Again here's the inflation picture for comparison. I don't see any close correlation. The oil shocks look far more explanatory of the details of the inflation graph. There is an upward bulge in the money supply centered in the 1970s, but it's not clear which way the causation runs - when inflation is high, the money supply needs to be increased just to keep the amount of money available constant relative to price levels.

US inflation rate (calculated two ways) since 1950 with various oil shocks labeled. The green line is inflation calculated from the quarterly GDP deflator numbers (percentage change from four quarters earlier). Source: Bureau of Economic Affairs. The purple line is calculated from the monthly CPI-U index (percentage change from 12 months earlier). Source: Bureau of Labor Statistics.

Then here's interest rates. Obviously, interest rates have a broader effect on the economy than their direct effects on money supply: they control the desirability of lending and borrowing in all kinds of credit. When I look at this next graph, I see a relationship between inflation and interest rates, but the interest rate peaks lag the oil shocks, and then interest rates and inflation go up together. What it looks like is the oil shock causes inflation, and then the fed raises interest rates to rein it in again. (Caution: the interest rate graph only goes back to 1960, but the inflation data goes back to 1950)

Effective federal funds rate (source: St Louis Fed), together with real interest rate computed by subtracting CPI-U inflation. Eras of different Fed Chairs labeled above.

It's also striking how low real interest rates are still. No wonder Americans are borrowing like crazy.

So what would a deflationist peak oil story look like? Well, here's an outline story about it. I'm not close to evaluating this quantitatively yet, so take it for what it's worth - it could easily be wrong in important respects.

The idea is that deflation occurs because of major failures in the banking system causing a contraction of the supply of credit to the economy. In the US great depression, lots of banks actually went under, causing a fairly short sharp deflation. In Japan in the 1990s, the government propped the banks up, meaning they were just stuck with large volumes of bad loans and couldn't do much new lending. This led to a long slow deflation.

In the US, after the great depression, bank regulation was greatly tightened up, FDIC was set up etc. We haven't had deflation since. However, what has happened in the last twenty years is that we've started securitizing mortgages and selling the risk on the credit derivative markets. A lot of it has been bought by a completely new and unregulated animal: hedge funds. This has led to decent volumes of fairly risky mortgage lending that would not have been countenanced decades ago.

Suppose peak oil is initially inflationary as above. In consequence, the Fed has to raise interest rates a lot more than the markets are counting on to counter the resulting inflation. Since around 40% of recent mortgages are ARMs, this causes massive strain on household finances in those houses, and leads to a much higher level of defaults than markets had been counting on.

Since hedge funds are new, have been growing like topsy, and are unregulated, there's probably a good deal of craziness happening (it always goes down like this: think joint stock companies in the seventeenth century, junk bonds in the 1980s, dot-coms, Enron, etc in the 1990s). The hedge fund boom is probably likely to end in tears at some point, just out of the general nature of financial humanity.

So then if we start to get major failures in hedge-fund land, either the Fed has to step in and prop them up, or it lets them fail. Either way, there's likely to be a sharp contraction in mortgage (and probably other) lending - much worse than the ending of the housing bubble by itself would have occasioned. That is strongly deflationary.

So that's kind of the story - an initial burst of inflation and high interest rates pokes a big hole in the credit markets, which then contract enough to more than offset the inflationary pressure.

Could this happen? I don't really know, but I'm sure you'll have opinions. The floor is yours.

The price spike in 1999/2000 is noteworthy as well. In your graph you can also see increased inflation which was probably stopped by the post 9/11 economic slowdown and the new economy bubble. These days, there was no major crisis around. However, oil prices ascended precipitously from a very low level.
Oil and Inflation will be over-used terms in the future.  What people forget, is that between the years of 1961-1970 the price of a barrel of oil was $1.61.  Now, that's a nine year contract the USA paid for oil.  Today, oil goes up or down that much in a day.  It goes to show that there is some relationship between the cost of oil and the cost of housing, autos and gasoline.  In the sixties you could purchase gas for dimes a gallon.  Again, today, gasoline goes up sometimes a dime or more.

Debating whether or not Oil is inflationary, is not the question.  The price of oil and the future scarcity of it, is unmistakenly inflationary.  Now if one wants to add the US FED printing presses or whatever, you have a double or triple whammy.  

Because the Government is no longer producing M3 money figures for the public, one can easily track inflation by the price of Gold.  As Gold inches over $600 an ounce and on its way to $1,000, you can deduce, there is alot of inflation going on.  If anyone still has money or investments in paper assets, unless they are good mining companies or oil service would be wise dumping everything in Gold and Silver bullion.

Unfortunately, the coming Inflationary Sprial and resultant Depression will be like no other felt in history.  If you can find an old-timer who lived during the depression of the thirties, they will tell you how rough it was.  Today, we do not have the billions and billons of untapped barrels of oil, millions of tons of metals and minerals that have been consumed in our Wonderful World of Suburbia.  What we have is many more millions of people living in places that will not be able to sustain them.  There will be an all out race out of the Suburbs.

Those who lived in the depression days of the thirties, were considered lucky.  They were lucky because they had decades of Dam Building, Highway building, Residential, and Commercial building, Manufacturing and etc.  Today, our future will be nothing more than a glorified "ROAD WARRIOR" type of existance.  Get ready, because playing video games and driving out to eat and to a movie will be things our children will be told around the woodburning stove fire.

I grew up in the dirty 70's, that was bad enough. Sewing clothes by hand, using kerosene lamps at night because the power's out or can't be paid for, cookin' on a campfire, one phone per 5-7 families, washing clothes on a washboard, working all afternoon for $3, the whole thing.

I am not bullshitting - I experienced all these things.

Helping my mom clean hotel rooms (the original spoken contract was $1 per room but it became merely the chance to get some of the food the visitors often left behind), experimenting with new foods (I gained much respect for the humble sweet potato, the young leaves are like a starchy spinach) and learning the finer points of hitchhiking (which almost no one seems to know how to do now, you need to hitch at places that are natural stopping or pausing points for cars you amateurs).

I imagine a possible future being like the worst of the 70s. Whee.

It's an interesting discussion, but in this case, I am not going to even try to PRETEND I know the just brings up more questions...
>oil consumption as a percent of GDP growth is lower than it was even in the 1980's due to efficiencies...this has to have an effect as the oil price does not go as directly right into the price of everything
>likewise, oil consumption has dropped as a percent of electric power production, which in the old days was to blame for everything..."you know, the oil price goes up, and it costs more to refridgerate your food, or to process shampoo,etc....that linkage is now much looser...

What we might want to look at is average btu price, which would include oil, natural gas, coal, propane and even nuclear...and compare that composite average to could be interesting.  I am becoming less fascinated by oil and more fascinated by this "all liquids" catagory, crude oil, LNG, pipeline nat gas, gas to liquids, Diesel and bio Diesel, alcohols, propane, etc.  It seems like these are and will be even more so in the future, interchangable, and that "light sweet crude" is becoming just one sliver ofa broader spectrum of fuel switching...once coal to liquid comes on (and GHG be dammed, it will!), and you end up using coal to make Diesel and GTL to make fertilizer to make corn or soybeans to make fuel...the mix and match will be become extraordinarily confusing!  The greatest inflation is going to be in processing/refining equipment, pumps, pipes, valves and cookers and boilers, already racing upward in price.

The whole definition of inflation is a very contentious issue. The goldbug camp swears there are significant efforts made to conceal the true inflation that people feel in the wallet. Of particular concern is this practice of replacing steak with hamburger and hamburger with dogfood - the actual items in a consumer basket are not really constant. Seems like comparing apples to oranges. Personally, I feel like life is getting way more expensive compared to the 1-2% posted rates, but I don't have any hard calculations to back it up.

Here is an interesting link on the government stats that we are expected to take a gospel

It is not just the gold bugs.  It is also accountants!  CPI calculated in the "old" way used before Clinton is running about 8%:

Williams is associated with the Gillespie site you posted.


They are already telegraphing the hoodwinking!  Network-level
TV commercials for a popular dollar store chain are advertising
specials for their brand authentic 'Meat Flavored" Marinara Sauce.

Watch "Repo Man" again.  Soon we may be allowed to stand in
queues for Fresh, Generic brand 'CANNED FOOD'.

Best get your real food act together while you still can.

Hi Stuart and All

I have been thinking about this for a while and I keep coming back to the same conclusions...

In order to put the whole issue on a proper footing I first considered that money is not the base currency, energy is...

Whit that in mind it strikes me that both inflation and deflation are likely depending on the subjects exposure to energy imports...

Let me explain my thinking...

If you are a net energy importer then the pressure of inflation is from the price you have to pay to get access to the energy that is required for everything... Thus you suffer inflationary effects...

On the other hand if you are a net exporter your internal energy costs are largely down to the cost of production and as such the HARD limiting factor of energy cost falls to that base. In the previous case you would have to pay the full market value which would be much higher the the extraction costs due to supply and demand... In this case the withdrawal of credit, if it oocurred would more likely cause local deflation...

Does this make any sense and if so does this then mean that a widening gap of prosperity will appear between energy importers and energy exporters... Obviously this is a relative concept in that the ratio of exported to imported energy for the subject will lessen or wrosen the effect in the appropriate direction...

I guess what I am trying to say is that I think both inflation and deflation will take place in different areas or jurisdictions according to their energy wealth, the only real wealth...



I've argued in the past on other boards that what we are likely to see is what I call depressionflation and some have called biflation, that is, high prices in the energy sector coupled with increasing home ownership costs due to ARMs significantly reducing consumer spending.  The result will be extremely high energy inflation rates coincident to deflation in consumer products as retailers attempt to generate sales by reducing prices.

The question in my mind is whether it is possible for the US economy to survive as consumer spending drops - regardless of price cuts.

We call it 'Stagflation': Inflation in a stagnant or reducing economy. But yes, the inflation is due to an external source such as energy costs. Increased energy costs act as tax on discretionary spending. At the same time, 'inflation' appears to be going up, so the traditional government response is to hike up interest rates
The assumption being that the interest hikes will 'cool the inflation'. So joe public takes it in the nuts twice.

Also, re further up this thread, I too am sure that true inflation is in fact nothing like the posted official rate.

This is a neat way for TPTB can extract wealth.


I am well aware of stagflation since I lived through it. FWIW, I also lived through rationing during WWII.  Although I wasn't that old, I saw how it impacted my family.

I believe that we will have hyper increases in costs (therby avoiding the debate about the definition of inflation) in all areas that involve energy with a true depression in most other areas.  This is nothing like stagflation.

In very simplified terms, the service industries will die and the result will be massive unemployment, the financial sector will tank due to defaults and government activities will shrink dramaticly due to a lack of tax funds.

I agree and sorry, I wasnt trying to be clever. I did not know if you had the term 'stagflation' in your part of the world at the time.
If you lived through rationing then you must be from this side of the pond.

What is your take on the current method on the measure of UK inflation? I assume you got the same kind of council tax bill I just got...



Actually, I'm in the US so I can't comment on the UK. The US had significant rationing during the war.  Besides the booklet of stamps for various foods and gasoline, one of my "fondest" rememberances is "margarine" (which by the way was also rationed).  You got this brick of white grease sort of stuff with a little packet of coloring that you mixed into it to make it not look like white grease but rather, yellow grease.

In driving, my dad tried to coast down any hill (in neutral) to save gas.  At home, we heated with coal but I don't remember whether it was rationed - probably was.  We were never short of food but we never had much food in the house.

During the stagflation period, I was the manager of a process development group and wages and prices were controlled.  The only way to get a "raise" was for the company to offer rationales for additional reponsibilities or a title change.  It was a strange time.  My only real rememberance of that period was President Jerry Ford trying to intoduce his WIN program - Whip Inflation Now.

I didnt know you guys had rationing!

You learn something new everyday!

My Mum says thanks for the Spam. You can keep the margerine though


US society went through a significant change during WWII.  My mom who had been an elementary school teacher had to quit when she got married because schools did not permit married teachers to, well, teach.  She got a call after the war started from a principal saying she had to go back to teaching because it was her patriotic duty (since men teachers had been drafted)!

This kind of historical perspective is why I'm pretty gloomy about the future.  My maternal grandmother grew up in a cabin in Ohio in the late 1800's.  The local Indians came in after they went to bed to sleep by the fire - and this is a story by itself.  My parents had no electricty as kids; only gas lights and "real" ice boxes.  Electricity was a big deal.  One of the things that speaks toward the future was something my great grandmother used to tell my mom and her sisters once they got "radio", "Watch what you say because they'll hear your comments."

My point regarding WWII and the past is that people accepted life as it was.  You couldn't over consume because you were lucky to have food and a roof over your head.  During WWII, there was a shared societal consciousness to do whatever it took to "bring the boys home."

I cannot conceive of this kind of, I'm at a loss for words here, action in a post peak energy world.  Especially one with rampant financial problems.  The real issue as I indicated in a post above, is whether this is still possible,

Another more recent change along those lines is clotheslines.  As recently as my childhood (1970's) most Amercians still hung their laundry out to dry (at least where I grew up).  I think my family even had an automatic dryer and we probably could have afforded the electricity, but hanging clothes out to dry was just normal back then.  Now the practice is all but completely forgotten.
Not only that, it's often illegal.  People think it looks tacky to see underwear hanging on a line, so communities pass rules banning hanging clothing outside, at least if it's in view.

My mom still prefers to line-dry her clothes, but she has a sort of hideaway clothesline in a courtyard of the the neighbors can't complain.


 The historian Christopher Lasch wrote a book The Culture of Narcissism which explores in depth the point you make about the contrast between the WWII era and the present.

 I agree that from WWII up to the 1960s there was a strong sense of community cohesion. That has now been replaced by a "Me" mentality that is incomprehensible and will likely increase the social breakdown associated with PO.

Goddamn margerine. That stuff is teh shit and not in a good way. We could not afford butter in the 70s. And fucking powdered milk, YUK! Teeny tiny portions, chicken maybe once a month. I still can't look macaroni and cheese er, "cheese" in the eye.

When I saw myself in the mirror and saw a kid with a bulging stomach (NOT because it had food in it) and skinny arms/legs I knew I had to do something, I'd seen that in National Geographic. And I started working on foraging skills.

You seem to be right on the money Stuart, what you wrote makes great sense. I don't think many people get it that past rates hikes have been caused by oil shocks and nothing else.

As an addendum to your post here's the last work of Andre Gunder Frank:


I believe it's not finished, Frank died soon after. It has a strong political content but it's worth reading all the way.

I think it's slightly more complex than that. The Fed attempts to manage the economy of the US, and due to the size of the US economy, by extension it is managing the world economy to some degree. When an oil shock hits, I believe that the Fed inflates. It would be interesting to see M3 plotted against those oil shocks since it is supposedly through M3 that the Fed introduces new money into the economy in large volumes when necessary. I may look for that data later. Anyway, in order to control the resulting inflation from the cash injection necessary to soften the impact of the oil shock, the Fed then raises interest rates. What the Fed has done in response to 9/11 and peak oil is the same thing only if this is really peak, then the crisis won't just go away as it did before. Thus I suspect the Fed's tactics may no longer work and that the results may not be what they expect.

I'll see if I can find the historical M3 data somewhere and see if this train of thought bears any fruit.

I was also wondering why the M3 growth rate wasn't outlined in the graph.
That would surely be valuable.

I found the historical M3 data but some quick (and crude, compared to Stuart's) graphing didn't show any relationship so my prior thoughts are not backed by the data. I am going to look at it more but no longer expect to find such a relationship though there may be something else there. I had to convert the ASCII version of the file to a CSV file, then import that into OpenOffice and try graphing it. I tried charting the month to month rate of change as well as the change over the preceding 12 months but as I said, it didn't seem to show any relationship to Stuart's inflation data.

There is much of interest on his website.

"One resulting scenario is that this situation offers an opportunity for more productive and competitive Europeans to step in and replace the dollar with the euro and/or another as the world's reserve currency. However, the Europeans lack a strong state to do so. But a major step would be for Russia, OPEC and other oil exporters to price their oil in euros instead of dollars, thus increasing demand for the euro and sending the dollar crashing down. Iraq priced its oil in euros, and an important reason for the U.S. war against it was to keep others from doing the same."

Another great piece from Frank, he was realy one of the greatest economist of his time.

In this particaluar article I believe he ignores that fact that Asia has 60% of the population for 10% of oil reserves. No way this century will be Asian.

Still a very sound macro-economic analysis.

The economic pressures that are arising as our growth based economy hits the wall of finite resources will only be increasing from now on. What happens when an economy that is based on the assumption of perpetual growth is faced with declining energy resources? My paper, The Organic Economy is an investigation into this question as well as providing some suggestions of how an economy could operate in a more balanced (organic) manner.

I think that the inflation/deflation question is perhpas not the most important one. It is more important just to understand the massive pressures coming bear on our economy. With the Fed's recent decision to no longer track the M3, which tracks the total supply of money and is beginning to show a serious level on inflation, there are rumors on the net that a huge money printing campaign has begun. The reaction of economic policy setter to the immense pressures that are forming will (at first) dictate whether we have inflation or deflation. It seems they are implimenting an inflationary strategy. However, I think that this strategy will only allow the pressure to build a little longer, and periods of deflation are completely possible.

I think the most important thing is that it will be chaotic, unpredictable, and small perturbations may have the potential to swing the market and the money supply in drastic ways.
I wrote the post above in a hurry and wanted to elaborate.

The point that MicroHydro makes below is a good one. Inflation is really a growth in the money supply (which was until recently best measured by the M3). The "inflation" caused by high energy prices that translate into higher prices throughout an economy is a different beast. But look at it from the point of view of the banksters:
1) high energy prices = higher prices on consumer goods
2) higher prices on consumer goods = people buy less
3) people buy less = economic slowdown
4) with the economy on such shaky footing with the housing bubble, massive trade deficit etc - economic slowdown may = economic crash
5) solution? "print" money like crazy

More money in the system means that higher prices can be offset by the fact that there is more money in circulation to pay those high prices. Of course, it is unlikely to work in the long run, if by "work" we mean that it keeps the economy operating in the way we have come to expect. More money supply means more "real" inflation, causing prices to rise even more, creating the necessity of printing more money to maintain the illusion of economic growth. This is really playing with fire, because if the currency massively inflates, it may lose its value completely. Thus, hide the M3 figure, cross your fingers, and hope for the best!

From The Organic Economy:
Money is created and issued by banks in the form of loans. These loans are the source of the money that circulates in our economy. The interest charged on loans is a key part of the growth economy.

Imagine a situation in which 10 people each borrow $10 from a bank. These 10 people form their own closed economy and money system. The terms of the loan are that each person has to repay the $10 at the end of one year, plus one extra dollar in interest, for a total of $11. Since there is only $100 in the system (10 people x $10), it will be impossible for 10 people to pay back $11 each - that would equal $110, more money than exists. The ten people must compete fiercely for money to repay the bank, and at least on of them will not be able to repay her loan. If 9 people each pay back the $11 they owe, that would equal $99 and there would only be $1 left for the last unfortunate person, who would become bankrupt.

Now imagine that six months into the year, 10 more people join the economy, each with a $10 loan. Suddenly there is $200 in the economy and only $110 of it will be due at the end of the first year. There is enough money to satisfy short term requirements, but still not enough in the long run. The amount of debt still exceeds the supply of money.

The money system of a growth economy is based on credit that is issued under the assumption that tomorrow's economic expansion will be able to repay today's loans. But what if tomorrow does not bring expansion?

In the inital stages of a growth economy, money that is borrowed can easily be used to increase the overall value present in the economy. It can be put to good use. When this occurs, the investement makes money, and the loan can be repaid. However, as we reach the limits of growth, money that is loaned can no longer be used with such a good effect. It is much harder to create "real" value. Thus, we have super-inflation of housing prices etc. This money is not creating real value, it is going into feeding a bubble.

The problem is that money must be issued at an ever increasing pace, as illustrated in the quote above. If it is not, when debts become due, there will not be enough money in the system to repay them. Thus inflation (in the real sense of an increase in money supply) is a necessity to maintain our growth economy. This is not a problem as long as this inflation approximately matches the growth of real value in the economy. But when real value does not increase with the pace of inflation, it is only a matter of time before the whole house of cards collapses. Inflation is the necessary policy of the banksters, but it is an open question as to how long this strategy will keep this illusory economy afloat.

This is obviously a huge and quite complex topic. I'd love to hear any thoughts or questions from the people in the TOD community about the possibility of an Organic Economy that does not base itself on the assumption of perpetual growth.
Here I was not buying a house at bubble prices because I thought that was the finacially intelligent course of action. If the government is going to radically devalue our currency by going into a money printing frenzy, though, obviously I'm the sucker, as that reduces the value of debt. Clearly I'm not cynical enough.
The future is unknowable; that is the one and only thing we know for sure about the future;-)

Note that multiple scenarios can all be correct if they happen in sequence. For example:

  1. Crash in housing prices leads to stock-market crash, severe recession, greatly increased unemployment, reduced demand for oil and hence lower oil and gasoline prices for a few years, to be followed by
  2. Extremely expansive fiscal monetary and fiscal policy to reduce unemployment which, with a time lag of a year or two, which then leads to
  3. An abrupt shift in expectations for increasing inflation that fuels another borrowing binge and tight monetary policy with skyrocketing interest rates to combat the inflation and
  4. A 1980 type of situation, with inflation in double digits and the prime rate above 20% which causes
  5. an even more serious recession/depression with unemployment rising to 15% and beyond, which triggers
  6. Deficits in the multitrillion dollar range financed by the Federal Reserve giving up the battle against inflation by montetizing the national debt in a despairing attempt to prevent a spiralling downwards into depression and deflation.
  7. Then TSHTF.

We live in inreasingly uncertain times. Rather than obsess on "What is going to happen????" be flexible and ready for inflation or deflation (even though I think deflation is extremely unlikely), oil at $200 per barrel or oil at $20 per barrel (for a few recession years), and the collapse of the real estate market over the next couple of years which will have enormous financial repercussions.

One topic that I think has received insufficient attention is that the financial collapse of residential real estate in the U.S. could lead to a crash in the stock market of 1929 proportions. Note: I do not assert that this WILL happen, but I do believe that it is not especially unlikely.

IMO the Fed will do whatever is needed to prevent a deflation that could result from financial collapse--and that means that Ben and the rest of the Board of Governors will load up the helicopters with cash to "bomb" the cities if necessary. (Compared to other wasteful programs of the federal government, dropping cash from helicopters is a both effiecient and effective way to redistribute income and stimulate the economy. It probably will not come to that, however.)

Don, I basically agree - my comment was mostly sarcastic. Of course, you can't hear my voice when reading what I write.
We live in inreasingly uncertain times. Rather than obsess on "What is going to happen????" be flexible and ready for inflation or deflation (even though I think deflation is extremely unlikely), oil at $200 per barrel or oil at $20 per barrel (for a few recession years), and the collapse of the real estate market over the next couple of years which will have enormous financial repercussions.

I agree completely that meeting uncertainty with flexibility is very good advice. Minimizing the consequences of being wrong is a good idea as well. If you take either an inflationary of a deflationary strategy to it's logical  conclusion (for inflation max out debts on purchase of real goods, for deflation sell everything and hold liquidity in preparation for asset price collapse across the board) you would be in very serious trouble if you turned out to be wrong. You could even be in trouble if you turn out to be right if reality ends up being more complicated than you expected (and reality is almost always more complicated than humans expect).

For instance, if you hoarded gold in anticipation of hyperinflation and did end up in a hyperinflationary scenario, gold ownership could be declared illegal and being caught trading it for the necessities of life could incur severe penalites. If you had bought a large amount of real estate, your property could be confiscated or made the subject of punitive taxation which you might no longer have the uncommitted cash to cover.

If you were sitting on a lake of liquidity in anticipation of deflation and deflation did in fact occur, holding on to your collection of uncommitted choices for long enough to use them as prices bottomed out could prove to be as difficult as holding on to a handful of water for a long time. It would almost certainly attract the unwelcome attention of cash strapped governments unable to meet their obligations who would probably find a means of taxing it out of existence. You might also find that the things you were waiting to buy until prices fell are no longer available due to the collapse of the companies that made them.

Either way, you would be trying to maintain a disparity of material wealth in comparison with the general population, which is as difficult as trying to hold on to a concentration of heat in a sea of cold. In other words, you would be fighting entropy, which requires constant vigilance as to impending changes in relative value and an ability to switch between stores of value without sacrificing too high a percentage of that value in transaction costs. The risks are far higher at every turn than most people in developed societies are accustomed to.

Given the difficulties of maintining a disparity of material wealth, I would argue that knowledge, specifically knowledge as to how to provide for oneself from one's surroundings and make do with very little, is the one of the best investments one can make. Knowledge can be shared without being diluted and can't be confiscated. I would also recommend being debt-free (I'm expecting deflation), having the equipment necessary to provide for the essentials of one's own existence and having emergency supplies of essentials. A crisis of any kind could mean having to look after oneself and one's family without the usual regular inputs for a significant period of time.

One topic that I think has received insufficient attention is that the financial collapse of residential real estate in the U.S. could lead to a crash in the stock market of 1929 proportions. Note: I do not assert that this WILL happen, but I do believe that it is not especially unlikely.

Personally, I think this is very likely.

I agree with this...skills and as much diversification of your assets as you can manage will serve you well.
A friend of mine who lived in Argentina (during hyper inflation years) likes to tell the story of how he was able to pay off the balance of the fixed rate loan of his condo with ONE paycheck.

Buying a lower-priced house now for no money down might be a way of hedging this bet - I did it.  I still can't believe that lenders are currently willing to allow things like 80% primary and 20% second loans with large amounts of closing expenses allowable for rolling over into the loans as a "seller contribution."  Just be prepared to hold on to it during some weird times, and make sure that it doesn't have a "call" provision (these days a call provision is rare, except for sub prime).  

Historically, this is nuts!  But hey, I used it and I would like to say something to the "system,"  "Thanks!  And don't worry, our payments will always be on time - no defaults from these campers."

I sure hope that none of the retirement plans and IRAs that are holding these (super safe, they say) securitized loans don't get hurt...

Stuart, you have fallen prey to a consensus fallacy.  These are common.  For example, the words decimated and enormity are almost never used correctly.  The word inflation has been deliberately misused for decades to mislead.

Inflation, classically means one thing only: the expansion of money supply.  In modern times the broadest measure of money supply, M3, would be the correct metric.  Note there are many ways to grow the money supply now, including monetization of treasury debt created by defict spending.

Inflation does NOT refer to increases in wages, consumer prices, the Dow, or housing prices.  All of these things are symptoms of an expanded money supply.  If the money supply were not being inflated, it would be impossible for the aggregate value of these metrics and assets to increase.

The Greenspan era was NOT a low inflation period, despite the tame CPI.  Instead the increase in money supply was funneled into asset bubbles (bonds, stocks, housing) and to growing the dollar reserves of Asian nations.

There has NEVER been a deflationary (negative money growth) period in the past 60 years despite several recessions and cyclical bear markets in various real and paper assets.

What happens in oil shocks is that many paper assets decline and consumer prices rise, but that has nothing to due with monetary inflation, that is simply a reallocation of the pool of money.  However, the happy periods of asset bubbles with low consumer prices are experienced differently by the masses than expensive commodity eras.  When the Dow goes from 1000 to 10,000, everyone with a 401K is happy, so that is not called inflation on TV.  When the house you bought in Ohio for 80,000 in 1981 is valued at 240,000 in 2006, you are happy, and the media doesn't call that inflation either.  When your stock portfollio declines and petrol, bread, and butter cost more, then you are unhappy, and the guy on TV will tell you that is inflation.  But it is all the same.

There is an overwhelming case that monetary inflation will continue to accelerate even if unlimited supplies of oil appear tomorrow.  This is due to the need to inflate to devalue debt, a Ponzi scheme that is reaching endgame independently of resource issues.  This is too complex for a post, but there is a law of diminishing returns for debt fueled economic growth.  As the end stage is approached, the ratio of debt created/GDP increase goes parabolic, and this is seen in the record of recent decades in the US.

Rescouces: Anything from the Austrian School of Economics, founded by Ludwig Von Mises
The numerous essays by Jim Puplava's group

Micro:   "As the end stage is approached, the ratio of debt created/GDP increase goes parabolic, and this is seen in the record of recent decades in the US."

IMO, we are going to see relative price increases for food and energy with relative price decreases for almost everything else, independent of the money supply (unless we go into German style hyperinflation I suppose). The debt load is going to have a powerful deflationary effect on prices as people try to liquidate assets to pay off debts--and to pay their energy and food bills.  

To put it in simplest terms, you want to be affiliated with food and energy producers; you do not want to be affiliated with (most) housing and auto companies.

Also, our GDP is very "soft" in the sense that a majority of Americans live off the discretionary income of other Americans.  We are witnessing the beginnings of a very painful transition from an economy focused on meeting "wants" to an economy focused on meeting "needs."

One piece of advice for high school and college students looking for summer jobs:  send them to a farm.

IMO, American consumers are standing at a four way intersection with four speeding eighteen wheelers headed their way:

Rising food and energy costs;

Rising health care costs;

Rising taxes, especially property taxes;

Increasing competition for jobs, i.e., deflationary pressure on hourly labor rates.

The only logical response is to cut spending as fast as possible.  Economize, Localize and try to become a net Food or Net Energy Producer.

Yesterdays thread had an interesting conversation.  IMO the biggest question is what will the masses do.  More income gets taken to drive, eat, and heat thier houses, what will they spend thier remaining $ on?.  I agree that most jobs are off of the disposable imcome of others.  My wife historically has her feet all to firmly on the ground.  She believes the main indicator is these stupid coffee shacks.  When they go we are in trouble.  If they stay we are going good shape.  You can buy how many pounds of coffee for $10.00 and this will make how many gallons of coffee?  These coffee shacks are the biggest luxury ever IHO.
Even though the Fed will continue creating more money - meaning on the M2 level inflation will continue - Deflation could certainly rear its ugly head:
In terms of M3.

If the banks start tightening their own lending practices, there will be less money on the market. Less money supply is (in your definition) deflation. A very possible/probable future.

As Micro notes, as the end game approaches both a deflationary crash and a following hyperinflation become more likely. As the debt/GDP ratio increases, your economy becomes more unstable and difficult to control. So the answer quite possibly could be both. A future hyperinflation period would be very hard on the US middle class (workers) as the % of unionized workers is much lower than in the 70s. Thirty years ago a high % of workers could get negotiated wage increases that matched the rate of inflation (which also was more accurately recorded at that time).Those days are gone.
I agree with you. The growth in promises of goods, running ahead of the growth in supplies of goods, is a much better definition of inflation than whatever index we construct to reflect the relation of prices to merchandise.
And this growth in money supply is larger, the more realistically we define money.
Characteristically, the more important the statistic the less we are encouraged to know about it. The Fed will no longer publish M3. Estimates of inflation which would be still more informative, taking into account all the ramifications of the derivatives industry, are not even collected.
The problem with the Austrian school is that too often,their economists prefer the world of apriori theory too engaging with the facts of our predicament. As Cicero would say, they live in the Republic of Plato, not the dungheap of Romulus.
Thank you.  That makes a lot of sense, and fits well with I what I see in the world around me.
The public has "de facto" re-defined inflation to be a nominal increase in prices.  People such as yourself, economists, myself, and others will be forever frustrated until we change our terminology.  I try to avoid the word altogether.
I mostly agree with Micro.  But the accurate definition of inflation is "the expansion of money supply in excess of the expansion of the quantity of available goods and services".

If the amount of available goods and services goes up by 5%, money supply should also go up by 5% in order to achieve a stable general price level.  Easy to see in a simplified economy where only bread is transacted.  If you have 10 breads and 10 $ in circulation, 1 bread = 1 $.  If you have 20 breads and still 10 $, 2 breads = 1 $, i.e. 1 bread = 0.5 $ (deflation).

This assumes the velocity of circulation of money remains constant, which is a reasonable assumption for normal situations.  All this is summarized by the Fisher Equation of the Quantity Theory of Money, which in its old form is:

M = Money Supply
V = Velocity of Circulation (the number of times money changes hands)
P = Average Price Level
T = Volume of Transactions of Goods and Services

For Austrian followers - of von Mises, not Arnold i.e. - I know Rothbard bashed the Fisher Equation here:
He is right in that the "Average" price level is not a rigorous definition and that V is not an independently defined variable.  But I still find the equation useful.  BTW, its modern version from Friedman is:
MV = Py

where y = real NNI = Net National Income in constant dollars

From good old GDP:
NNI  = GDP + NR - CC - IT
NR = Net income from assets abroad (net income receipts)
CC = Consumption of fixed capital (aka D = Depreciation)
IT = Indirect taxes

By the way, the Money Supply in the equation is M1 except in countries where people can buy through direct electronic debit to their savings accounts, in which case M2 is the relevant one.  It should be noted that Mn definitions vary by country.  Notably for the US, dollars abroad (eurodollars) are only in M3, the cesation of reporting of which lends support to the notion that the game is to pay for the US debt (mostly in the hands of foreigners) and for the US trade deficit by happily printing dollars and sending them abroad to creditors and producers of real things (particularly oil).

Back to energy issues, a reduced availability of energy will result in the availability of less goods and services.  In this case, even a constant money supply will be inflationary (less breads, same dollars).  So, the conclusion of Stuart is right:

"What it looks like is the oil shock causes inflation, and then the fed raises interest rates to rein it in again."

Now to the deflation scenario, it's amazing that people with awareness of real issues like TOD'ers still consider it.  Ask yourself the following:

Are the vast majority of Americans net debtors or net creditors? (Answer: net debtors)

How deep in debt are they in average?

How much of that debt is of adjustable rate?

Are Americans going to be hurt by rising energy costs (which will happen in real terms whether there is nominal inflation of deflation)? (Answer: yes)

Will it be in the best interest of the government/ruling elite/deep politics/whatever-you-want-to-call-them to add insult to injury to the majority of the people, already hurt by energy costs, by raising interest rates?  (Answer: No)

Does it mean the US will have hyperinflation, defined as monthly inflation rate above 50 (fifty) %? (Answer: No.  I suggested how it can play out here: )

Is inflation good for people in debt? (Answer: Yes.  I quantified it here: )

Is inflation bad for creditors? (Answer: Yes)

Where are the majority of US creditors? (Answer: abroad)

Do foreign creditors vote? (Answer: in any case, in their countries ;-)

Will foreign creditors turn to the streets?  (Answer: in any case, to their streets ;-)

Will the dollar drop in value relative to other currencies? (Answer: yes, but only relative to some currencies.  Japan e.g. has fiscal and demographic problems much worse than those of the US, so they will probably print yen massively.)

What does that imply? All of the following:
a. that holders of US dollars and bonds will face untold losses
b. that Americans will be able to import much less
c. that China, etc. will produce much less unless they start producing for themselves at long last.
(Note that b. and c. above are in line with "balancing" a Peak Oil scenario.)

When financial players realize this, where will all the liquidity start going? (Answer: to commodities, related stocks, and currencies that cannot be printed: gold and silver)

The last question and the rest of the post is for gold bugs only.

Will Peak Oil bring about a new gold confiscation, a la FDR in 1933?

Answer: No, contrary to what Roland Watson ( says.


Because the 1933 gold confiscation, and the subsequent more civilized ways of keeping the public away from precious metals (the London Gold Pool of the 60's and the more recent ongoing covert manipulation denounced by GATA and recently publicly acknowledged by the BIS (see Appendix) had all one objective in common: to ensure the effectiveness of central banks' monetary policies to stimulate aggregate demand (consumption plus investment) and thus "foster maximum sustainable growth in output and employment" Bernanke, February 07, 2006, as quoted in.  That sounds like quite a good endeavour, and it would certainly be if the Earth were flat and infinite.  But it is spherical, and after Peak Oil, the "limits to growth" will be imposed by Nature, not by lack of demand.  Therefore there will be no use in stimulating it, and so in fighting the shifting of assets to gold (and silver, though heretofore I will refer only to gold for brevity).

To see why you have to keep the public away from gold in order to ensure the effectiveness of monetary policy to stimulate demand, you have to know the concept of "dollarization".  To non-economists: dollarization is the substitution of a country's currency by that of another country (usually the US dollar, more recently also the Euro) for one or more of the functions of money (first for store of value, then also for medium of exchange).  Basically, as a Latin American (or Balkan, or FSU) government started to irresponsibly print pesos (or whatever), the public started to shift their savings to dollars (or Marks, in the case of Croatia e.g.), kept mostly outside the financial system ("under the mattress"). Then they started using dollars for big transactions (like buying houses or cars).  That process advanced to different degrees in different countries, and exhibits hysteresis.  With a high degree of dollarization, monetary policy loses all effectiveness in stimulating demand: additional injected liquidity just serves to raise the exchange rate.  In other words, any excess peso people have in their pocket is used to buy dollars (or euros).  In a very dollarized economy, Fisher's V depends not only on the interest rate, but also, and mainly, on the expected devaluation, the degree of dollarization of the economy, and the elasticity of substitution between currencies.  It can become a very volatile variable.

Now, the key concept is: gold is to the dollar what the dollar is to the peso.  If Americans started shifting their savings to gold, the Fed would no longer be able to stimulate demand by monetary policy.  That's why letting US investors (who were financially smarter than those in other countries) shift their savings to gold was a no-no in 1933 (when lack of demand was the cause of the Depression), hence the gold confiscation.  This can be deduced even from books for laymen like Krugman's "The return of depression economics".  There he says something in the line of "Recessions are caused by people chasing too little scrip.  The solution is to print more scrip."  It follows that, if people are chasing a currency that cannot be printed, there is no solution.  (Actually there is no fast solution.  Even without any stimulus the US would have gotten out of the Great Depression in the long run.  The problem was that for FDR any run longer than 4 years was just too long.)

Summarizing, "metallization" (coining that word for the shifting of savings to metal-denominated assets, metallization being to OECD fiat currencies what dollarization is to pesos) was unacceptable, because it meant monetary policy would be useless to fight recessions, which up to now were always caused by lack of demand.  So, if governments and central bankers did not try to keep the public away from gold, they were not Keynesians.  And, after the miserable failure of the London Gold Pool, if they did not do it in a covert way, they were incompetent.  So GATA has been right all the way in that a manipulation was taking place, they just didn't know why.

But after PO the "limits to growth" (actually the "enforcement of negative growth rates") in economic output will not be the consequence of insufficient demand but of a relentless physical constraint from Nature, namely the decline in the production rate of fossil fuels.  Stimulating aggregate demand with monetary policy will not be able to increase output at all, as no monetary stimulus can reverse the decline of an oil field, and no monetary stimulus will be necessary to increase exploration efforts since the price of fossil fuels will be high enough to do the job by itself.  (The only investments that must be stimulated are those related to renewable energy sources, for whose financing the Central Banks should lend to the commercial banks at preferential low rates.)  Therefore, there will be no harm to the system in allowing the investing public to escape from fiat currencies and park their savings in gold or silver, since there will be no benefit to the system in stimulating their consumption of goods (and there could possibly be some harm in that: when a pub is running short of beer, they wouldn't turn on the heater to make people more thirsty).  That means:

a) that there will be no future gold confiscation.  Even in the worst case (OPEC countries demanding gold for their oil) there will still be no need for confiscation: people will surrender voluntarily their gold at the service station, and Exxon will transfer it to Aramco.  Why forcing (already discontent) people to do what they can do voluntarily?

b) that the manipulation of the gold price is bound to end.  So, GATA was also right about that, again they did not know why.  The only problem I see about that is how to communicate it to the public.  Imagine a BIS/IMF/Fed/ECB/BOJ/etc. joint declaration stating:

"Up to know we have been carrying on worldwide monetary policies conducive to stimulating demand, in order to achieve maximum sustainable growth in economic output and thus in employment.  But the relentless decline on the extraction rate of fossil fuels that was confirmed to start five years ago has rendered that endeavour completely futile, because, regardless of monetary policy, economic output will decrease year after year for several decades until we reach a really sustainable steady state.  By the way, we have now realized that any activity that consumes fossil fuels is not really sustainable, therefore the economic growth we helped achieved while the extraction rate of fossil fuels was rising was not sustainable at all.  We just hope you enjoyed it, and wish you all a happy transition to the brave new world.

Since the referred monetary policies involved as an essential component a covert manipulation of the price of gold (and collaterally of silver) intended to suppress it, we apologize to all people involved in gold and silver mining for the inconvenience."

Appendix: "The" acknowledgment of the "management" of the price of gold:
"The intermediate objectives of central bank cooperation are more varied. ...
And last, the provision of international credits and joint efforts to influence asset prices (especially gold and foreign exchange) in circumstances where this might be thought useful."
William R. White, Head of Monetary and Economic Department, BIS, on June 28, 2005 at the opening remarks of the Forth BIS Annual Conference - Past and future of central bank cooperation.
Bank for International Settlements (2006), "BIS Papers No 27 - Past and future of central bank cooperation - policy panel discussion.  Fourth BIS Annual Conference, 27-29 June 2005".

Brillian post, BeachBoy!
I mostly agree with Micro.  But the accurate definition of inflation is "the expansion of money supply in excess of the expansion of the quantity of available goods and services".

Great post. It seems obvious that inflation and deflation must be defined with reference to the relative supplies of money vs goods/services. We will have less oil vs demand for oil, hence inflation of oil prices. We will have more human labor vs demand for human labor, hence deflation of the price of human labor. This could easily extend to goods/services where the human labor component is a greater share of the finished product/service than the energy cost.

I remember a friend of mine who visits India often telling me how they would have two laborers operating one shovel. One holding the handle in normal fashion, the other holding a rope tied to the blade to pull on when the blade was filled with dirt. I expect to see adjustments analagous to this in the US. It may easily become cheaper to hire twelve laborers to dig a ditch than to hire a backhoe.

"I mostly agree with Micro.  But the accurate definition of inflation is "the expansion of money supply in excess of the expansion of the quantity of available goods and services"."

Thank you for taking the time to type the full story in more detail.  Beach Boy is of course correct.  In the 19th century US, the increase in the extraction of coal, timber, iron, etc., was fairly well tracked by gold/silver mining so despite economic growth and population increase, price levels remained fairly stable the entire century.

On the subject of money supply and available goods and services:

"U.S. ringtone sales totaled $500 million last year"

That must fit into the picture somehow, maybe just as a curiosity (virtual money for virtual products), but to the extend we create a non-physical economy certainly we are less energy dependant.

"to the extent we create a non-physical economy certainly we are less energy dependant."

While it's worth considering that our 'virtual' universe is essentially nothing BUT energy.

  I read the 'Cyberspace Declaration of Independence' some years ago, with its statements like 'ours is a world entirely of the mind/  pure thought/  those tied to the physical world don't fit, don't belong here, and never will! ' [!]  It was grandiose and belligerent, and seemed to take for granted the VERY physical reality of millions of miles of copper-wire, of hot little CPU's, of Appalachian Hills frying away in Coal-fired power-plants to keep the whole thing running.. and of course of the countless corporations, governments, deals, standards and ongoing creations that daily have brought the virtual plane out from the busy ovens of the physical world.

So go ahead, figure your blog-posts per gallon ;-)
The above was my first post of the morning.  I didn't really have the energy to spell it out further.

Many of those scifi things (and some science) go off on a rift about the univers (and life) being information.  They do not disignate the lowest energy required to transmit (or build a market out of) that information.

Consider a hybrid car (with some honking 300V batteries) and then a cellphone (with maybe 3V batteries).  Each one can move that scifi life/energy ... but with significantly different efficiencies.

If we are goint to ultimately make a renewable energy economy work (maybe 100 years from now, after the coal is gone/illegal), I think it will be a lot easier to to build it out of 3V devices (or even lower power) rather than 3000lb 300V monsters.

Ringtones, as much as they are meaningless luxuries, show that folks are out there putting food on the table by pushing around low-power bits.

I would say the real problem is that far too many of us are putting food on the table by pushing meaningless luxuries.  

And we'll find out just how much a luxury the Internet is, when TSHTF.

Well, why is that a problem and not an opportunity?

Let's remember that luxuries are not bad, it is rather the subset of energy-wasting, polluting, chid-killing, luxuries that we should oppose.

I have never bought a ringtone in my life, but I'm impressed that those guys can make something out of nothing.  (no new energy wased or pollution created, they are just reorganizing the bits already in the system.)

I am not anti-luxury.  I love 'em myself.  But I don't think we'll be able to afford many of them in the post-carbon age.  It will be back to basics for most Americans: food, shelter, clothing.  And we won't be getting them off the Internet.

Indeed, I expect Internet use to drop off sharply as the economy worsens.  There will be more and more people who can't or won't pay $10-$40 a month for Internet service.  That will put the ISPs in a bind; they may have to raise rates for their remaining customers, or go out of business.  At the same time, content on the net will also decrease.  People who don't have ISP connections at home will find it more difficult to post to blogs or maintain Web sites. People who don't have jobs won't be able to pay for webhosting for their personal sites.  Companies will also be forced to cut back on the content they provide, as the ad revenue they get for it will be dropping.  So the Internet will become less valuable, at the same time it's becoming less affordable.  

Well, like those monty python magic appartment flats, the economy holds itself up by belief.  I think belief in the most sustainable buisinesses (even if those are luxuries) is a very positive thing.
BTW, it would be interesting to know how the total energy of an amazon order and UPS delivery compares to a drive to a shopping center.
It seems obvious to me.  

Amazon: Truck goes from warehouse to house.

Shopping center: Truck goes from warehouse to shopping center.  Customer drives car to shopping center.  Even if it's an SUV, it gets better mileage than a big delivery truck.

As I've mentioned before, this has become a serious problem for highway engineers.  eBay and Amazon mean we now have huge trucks going through residential neighborhoods, on roads that were designed for passenger vehicles.  It's causing traffic and wear and tear that designers did not anticipate.

How many packages does each truck carry, and how does the energy consumption divide down?

(I notice that when I (rarely) buy something from Amazon, the truck has other deliveries, even just in my condo complex)

Dunno, but I would bet it's not as good as delivering a bunch of stuff to a central location, and letting people go get it.  

Remember, there's room for improvement on the customer side of the equation, too.  You can combine trips.  Ride into town with a neighbor.  Bike, take public transportation, walk.  That's how it used to be in the old days (and still is, in very small towns).    

My mother never learned to drive. She went to shop (insisted on freshest produce and meat and bread) almost every day, walking and taking me and my sister along--even when I was in a baby buggy. Lots of women shopped for food each day, carrying reusable shopping bags, and of course it offered good opportunities to meet people and socialize.

Typically I bike or walk to the store, except in the foulest of weather.

Everything tends to run in families. She hung wash out on a line to dry, and so do I, except in the winter, when indoor drying racks work well to humidify dry air and to save money.

BTW, line-dried wash, IMO smells much better than the probably toxic scents put on Bounce and competing brands.

On the other hand, in 1900 we had mail order and deliveries, but we didn't have Walmarts.  The only real difference I can see between and the old Sears mail order catalog is the time delay in delivery.  They both had tremendous selection distributed from warehouses and sold by catalog.

I haven't seen any analysis of goods delivery systems nearly rigorous enough to decide whether Amazon's or Walmart's distribution systems will be more likely to survive an expensive transportation fuels world.  I'm inclined to use the past as prologue and believe that it's Walmart that will go away, as people decide they would rather pay more in delivery time than in personal fuel expenses to go to big-box stores.  It wouldn't surprise me a bit in 20 years to make an order through the internet for a book on the collapse of big-box retail and to have the book delivered by train to my post office, and from there to my mailbox.

Put another way, which takes more energy, moving a boxcar full of 1000 books, or moving the cars of 1000 people to buy one book each?

BTW, there would be plenty of time to switch over to low power mesh networks, if that became the thing:

... it might take a day for TOD posts to echo around the world, but that might not be so bad, from a productivity standpoint ;-)

I think it was about 1947 that corn prices exceeded $2.00 /Bushel, that's about equal to $25.00 in today's dollars. A farmer could buy a new tractor for $1500 now a new tractor is about $150,000. 1947 the beginning of the end of the 160 acre farm. Can you imagine making ethanol from $2.00 corn when gas was 28 cents a gallon including taxes. I know my Father enjoyed life much more than my brothers-in-law farmers do. I suspect that sometime in the future corn will again be $25.00 in today's dollars, and the one man farm will return and not exceed 160 acres or maybe less. The knowledge base to survive that life style has been lost and will only return through trial and error, with much pain and suffering.
25/2 = 12.5
$150 000 / 12.5 = $12 000
12 000 / 1500 = 8 times as exensive.
This should mean that the cost per tractor work equivalent has been nearly constant, nowdays tractors are bigger, more capable and more comfortable to drive.
Yes but now he is selling 16 cent corn with a $12000 tractor vs $2.00 corn with a $1500 tractor. How big does the farm have to be?
You can still buy a tractor equivalent to the $1,500 one of 1947 for around $12,000 (if you compare to something like the Ford 8N, etc.) - maybe a little more.  It will be made in Korea or China, and it would not be considered suitable for a 160 acre farm these days, much less a bigger one, but it's still largely the same design.  So there is a difference in expectations as well.  But if the alternative were no tractor, it would start to look pretty appealing!
In 1947 my Father's farm included 6 draft horses and no tractor. Fossil fuel was used for lighting lamps, grease bearings  and fabricate farm equipment. Gas use seldom exceeded 5 gallons /month.
dipchip -

A little tractor trivia to round out this rather esoteric economic thread:

I was quite surprised to recently learn that the first John Deere tractor (after it had acquired the Waterloo Boy Tractor Co in 1918) had a sturdy low-revving two cylinder engine.  The engine had a distictive popping sound, and soon this tractor acquired the nickname 'Johnny Popper' or 'Popping Johnny'.

 The interesting thing about this engine was that it ran on both gasoline and kerosene, fed from separate partitions in a common fuel tank. The engine was started on gasoline, and once warmed up  was switched over to kerosene. A heat exchanger around the exhaust manifold vaporized the kerosene before it entered the engine.

The rationale for this set-up was that in rural areas gasoline at the time was  much more expensive and harder to come by than kerosene, which had been used for decades in kerosene lamps. So what we have here is a very early example of a means of conserving a precious form of energy (gasoline) for a less valuable and more plentiful form (kerosene). An exercise in energy 'form value', if you will.

While I very much doubt one could pull off the same sort of thing with today's high-output, high-compression engines, it is a good example American ingenuity applied to an early energy problem.

The small tractor/dozer that my father bought around 1958 is a gas/diesel.  You pull out the decompression lever, start on gasoline, let it warm up for a few minutes, and then throw in the decompression lever and switch to diesel. I don't know if any current models of equipment do this.
Sorry, not a good comparison at all. Most farmers of 1947 did not consider the Fords and Fergusons to be real tractors. The typical farm tractors of that period on small farms were much heavier models like the John Deere 'A', Oliver 77, Farmall 'H' and 'M', Case 'SC' and their counterparts from other manufacturers. These tractors went into the fields generally weighing about 5000 pounds. Weight is what determines traction and traction is what matters. The $12000 tractors you mention just wouldn't do the same work. A comparable tractor today will cost more in the neighborhood of $25-35k. The little tractors can do some very useful things, however.
Depends on where and what kind of farming.  A tremendous number of Ford 8Ns and Ferguson TO20s (and their various descendants) were sold.  And while today they may just pull brush hogs, that was not always so.  For some types of farming, a tall Farmall H (which weighs 3175lbs dry, about 50% more than an 8N) with limited to no hydraulics and a drawbar was fine.  For others, not so much.  The Ford-sized tractors were used quite a bit in some areas - mostly on smaller farms.  They would probably be a bit out of place out in the Midwest on giant farms.  

You can get a 2wd tractor heavier and more powerful than either for less than $10k.

Those interested in the corn/ farm thread may want to consider the following book which is on my list to read:

Michael Pollan, The Omnivore's Dilemma

which devotes a large part to the growth of corn in America and all the resultant problems such as pollution, obesity (secondary to cheap corn syrup in every grocery store and fast food product), the loss of the family farm, etc.  This author was interviewed on Terri Gross's Fresh Air show on NPR last evening.  There was no discussion of peak oil per se, but this author clearly gets the big picture of the non-sustainability of large-scale mechanized farming.

I liked Richard Manning's Against the Grain, after you get past the rather overwritten introductory pages. Much information, and at least one really good question: why did/do people switch from hunting and gathering to agriculture? Agriculture is a lot less fun, more work, the risk of famine is larger, and the food often sucks.
Assuming there is enough game to hunt and plants to gather. Cheating this set of limitations and random risk for another by getting more plants by farming seems reasonable for me since I rather would work hard then pray to the gods for game or run around longer and longer to search in vain.
Based on my readings of various anthropologists and their guesses (and it can only be conjecture, because nobody was taking notes 10,000 years ago), what probably happened is that people were gradually forced into societies based on horticulture because of technological advances in hunting.
  1. The spear thrower (or atlatl increases the effectiveness and efficiency of hunting medium-size and large game a great deal. Thus these game animals would become more sparse over time.
  2. The bow and arrow increases the effectiveness of hunting (over ordinary spears) very significantly for all sizes of game--and thus game would tend to become scarcer and scarcer over time, along with population increase based on this big technological advance.

Based on personal experience with profesionally made bows and arrows vs. homemade spears, harpoons, and spear throwers, you have to get very close to an animal with an old-fashioned spear, but with a bow and arrow, especially if you have a small team of people shooting many arrows, you can consistently bring down game of various sizes at a reasonable distance--perhaps 30 meters or even more, depending on expertise and quality of equipment. Personally, I have never mastered the atlatl, but I know other who have and who hunt effectively with this simple extension of the arm.

For fun, try shooting arrows with barbs at the head and lines attached at the back part (like a small harpoon) at huge fish, maybe through the ice in winter. This is a big sport in Minnesota.

Stuart, and anyone else who is interested, I recommend for further personal research into inflation/deflation that you listen to the following discussions from Financial Sense Online.  Both are free MP3 files.

The Great Inflation - Part 1 (approx first 20 minutes of the broadcast)

Interview titled "Inflation, deflation" with Dr. Marc Faber on Financial Sense Online.

As someone above pointed you, you have fallen into a common misconception that inflation is increases in price, wages, commodities, real estate, etc.  True inflation always is, and always will be an increase in the money supply; the result of which is higher prices in commodities, real estate, wages, etc.

You can also not measure an increase in money supply by only looking at M1 and M2.  You need M3 (which was no longer being published by the Fed starting last month), which includes the most popular way that the Fed injects money into the economy; repurchase agreements with banks.

I am going to stop here because the above two links to the MP3 files are so comprehensive on the topic that I can not do it justice by only typing a few paragraphs.

After you are brought up to speed on the "classical" economic definition of inflation and how it plays out in an economy, then we can move the discussion forward to the question "does high oil prices cause inflation or deflation?"

Repo agreements are used by the Fed in open market operations to affect the available amount of bank reserves.  That affects M1, but since M2 and M3 contain components that have no reserve requirement, it would appear to me to have proportionately less impact on M2 and M3.

In a fractional banking system, bank repos are a "turbo charged" way of adding money to the economy.  So a one million dollar Fed injection using repos may turn into ten million dollars worth of loans.

I do not quite understand what you are saying how bank repos would have less impact on M2 and M3.  Repos increase bank loans, but unless those loans are turned into cash and deposited in a form that would show up in M1 or M2, you would not see it in those numbers.  Those loans may be used to purchase real estate or sent overseas to buy plasma and LCD TVs.

M1: M0 + the amount in demand accounts ("checking" or "current" accounts).
M2: M1 + most savings accounts, money market accounts, and certificate of deposit accounts (CDs) of under $100,000.
M3: M2 + all other CDs, deposits of eurodollars and repurchase agreements.

Thanks dbarberic, valuable information indeed.
Can someone point me to some sources where the 'true' or 'classical' definitions of inflation/deflation are an expansion/contraction of the money supply?

Or is this just something folks have picked up from Jim Puplava and the Austrian Economics sites?

Fed Chairman Bernanke defines deflation as:

...a general decline in prices, with emphasis on the word 'general'."
As far as I'm aware, that's the same definition that the Fed had in the 1920's. And the distinguished Austrian school economist Murray Rothbard doesn't seem confused either. From the introduction to the third edition of his book "America's Great Depression" (1975, page xxviii) he says:
The Austrian view holds that persistent inflation is brought about by continuing and chronic increases in the supply of money, engineered by the federal government.
i.e. he separates the symptom from its cause.

I'm not disputing the general thrust of the monetary argument for inflation, just the notion that the definition is wrong. Dual definitions make it very hard to debate the matter without having to constantly qualify what we mean.

And be careful - an expansion in the money supply does not necessarily lead to price inflation.

Just emphasizing the word "general" does not solve the problems with defining its meaning in this context.
You make a good point, though, that "inflation" is too well established in its accepted meaning for a change to be feasible.
So the question at issue is whether the concept itself retains its former importance under today's conditions.
The schools that define inflation are the Keynesian theory of economics and the Austrian theory of economics.

Economists of the Austrian school (which Dr. Marc Faber and Jim Puplava of Financial Sense Online subscribe to) see inflation to mean an increase in the money supply and that everything else is just a symptom of the increase in money supply.  This would be considered the more "classical" definition that has existed through many centuries of economic writings.

The Keynesian theory (which is more widely held now and is the primary theory now taught in most business schools) is that inflation is broken down by three types:

Demand pull inflation - inflation due to high demand for GDP and low unemployment, also known as Phillips Curve inflation.

"Cost push inflation - nowadays termed "supply shock inflation", due to an event such as a sudden increase in the price of oil.

Built-in inflation - induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle". Built-in inflation reflects events in the past, and so might be seen as hangover inflation. It is also known as "inertial" inflation, "inflationary momentum", and even "structural inflation".

A fair number of people believe that government support of Keynesian economists through appointment of critical federal posts and grants is an effort to shift economic thinking to Keynesian and neglect to teach opposing view points, such as Austrian economics.  The purpose of this effort is to obfuscate that the true source of inflation is money creation by the Fed.  It also happens that Keynesian economics supports fiat currency by a central bank, as opposed to gold back currency or gold itself as currency.

All this inflation/deflation, peak oil, global warming, local living is a touch depressing. (Aging populations, pensions..)

So on a lighter note I'd like to refer you the Bordeaux vintage chart, where you will see the quality of the wine vintages has improved vastly over the last couple of years.

I don't know if global warming can claim the credit, but I feel reassured that at least some aspects of fine dining in the future will be greatly improved.

Have a good Easter!

Mish has some interesting comments on the definition of inflation.
If I understand correctly, he calls inflation an increase in the total money supply, which includes both money AND credit.  Which is why he forecasts a deflationary end to this current bubble cycle.  We simply have so many people and institutions so far overleveraged that before any re-inflation can take place, many of these bad loans have to get liquidated.  And during the period of liquidation, people will not be taking on new debt, not even at an interest rate of zero.  This is also understood by Keynesians, who called it a "liquidity trap"

Note that this was pretty much the way Japan's post-real estate bubble played out--even tho the central bank reduced interest rates to zero (they are still at zero today, BTW), they still suffered 10 years of deflation because no one was willing to take on new debt.

As a result, the total money supply contracted, because the fall in the amount of credit exceeded the amount of fiscal stimulous the government pumped into the economy (in the form of bridges to nowhere, etc)

My best guess for our future is that he the collapse of the housing bubble (now under way) leads to a rash of bankruptcies and foreclosures that becomes self-feeding (throwing more houses onto a saturated market), and we will see derivatives cause some "innovative" financial implosions.  Deflation will be the dominant economic theme, but with rising energy costs as the icing on the cake.


Talk about depressing.  However, this makes sense to me, more than any other comments in this thread.

 Someone better ask Prof Goose and the others to make the next thread a study of lyrics in the Sound of Music or something equally saccharine. "Some dough, a beer, a tank of potted sun. These are a few of my favorite things."

 Or perhaps we could transition from a PO board to one reviewing the finer points of good Bordeaux.

So, what is an investor to do? If you believe the inflation first, then deflation arguement, then it's hard to consider which investments will do best. At first everything will go higher and higher with inflation, but then you will have to cash out in someway before the crash. IMHO this seems to point to investments in highly liquid assets since you will want to cash out quickly in a crisis.
I am trying to figure out a business idea around building and owning equipment and infrastructure that will be needed during and especially post peak oil. The aim with the idea is to attract investors who are content with long term low precentage but inflation proof dividends compared with how the rest of the "non financial" economy performs. I cant do and dont like financial ju-jitsu, I like to have assets as pysical as possible and providing customers with something they have to buy. This would mean building mutual long term security between me and those who like my ideas, investors and future employees. I only need to formulate it better, finish more of my own and copied ideas for investments and see if I can find people believing in it that would like to work more for reinvesting then to get rich fast. The social part is the realy hard part, I am not good at selling myself. :-(
As a good engineer, it is not to be expected that you are also a good salesman/fast-talking promoter. You may need to find an entrepreneurial partner--brother, sister, wife, uncle, friend of 10 years or more--somebody who you can trust and who is on the same wavelength you are. Here are some thoughts:

Land is good. Land can be used for trees, for a junk yard, place for storage buildings, to grow things to eat, and perhaps also for hunting and trapping.

Tools and equipment you know how to use are good, especially if you enjoy using them.

Services (for example, well digging, welding, cutting wood, carpentry, plumbing, wiring, pouring concrete, fixing broken things) are good.

The best kind of advertising is word-of-mouth advertising. Start small, with a very small investment and part time, and then gradually expand. Keep your prices low and quality high, and that way you will always have a backlog of customers waiting for your services.

The rule I was told for computer start-ups is that you need three people - the engineer, the BS artist (sales), and the numbers guy.  With one missing balance is not achieved ;-)
Engineers can do book-keeping; that skill is easy to acquire. Raising money and sales promotion are skills related to optimism, "animal spirits," ability to read people, and it helps to be able to believe one's own optimistic projections.

A big problem with engineers is that they know what will not work; they tend to be rational and conservative--traits that interfere with successfully starting an innovative business.

Most innovation fails.

I think it makes more sense to do what is proven to work in bad times and good times--working as a handy-man, for example. Most important, IMO, is to follow your bliss: Do what you truly enjoy doing. For example, I'm pretty good at fixing boats but do not enjoy it nearly as much as teaching others to sail; hence I specialize in the latter activity.

Some of the best businesses you just stumble into. When I was a graduate student I used to help my foreign-student friends to edit their papers, because their writing skills in English were limited. It never occurred to me to take money for this, until one of my profs offered me some to help his new trophy wife with her thesis, and hence I discovered a silver mine: I charged $4 per hour, cash in advance, satisfaction guaranteed or money back for editing services. I had a good backlog and worked as many hours as I felt like--never did ghost writing, and if a project was very bad I recommended euthanasia as opposed to surgery. This was back in the days when fees at the U. of Calif., Berkeley, were $42.50 per semester, and my apartment north of campus was $72.50 per month. That same apartment now rents for $1,200 per month, and the last time I looked tuition fees were up to several thousand dollars per semester.  

Partly because I was quick and proficient at it I enjoyed editing academic papers, but I also helped seriously distressed people, and that made me feel good too. Perfect job: No overhead, no advertising, no partners, and I forgot to keep records or report income to IRS;-)

The old computer software salesman joke is "what's the difference between a software saleman and a used car salesman?" .... "the used car salesman knows when he's lying."

The problem/opportunity is that you need the BS artist to push the envelope.  And if the engineer and that guy are peers in a partnership it's iffy who will dominate.  Or if energy will just be wasted by deadlock.  So, the working solution was often three guys.

'' I told the customer you would have that time machine ready by next Friday. And they want it in beige.''
Sometimes it felt that way. ;-)

I should mention that joke is the one the salesmen told, not something we engineers made up.

I thinking about things such as small scale district heating systems, pellet stoves with refilling contracts for dummies, carpooling dispatchment software, biomass electricity production combined with industrial heat needs, etc. Lots and lots of things are possible, I only need to focus and find people to work with or a company that needs me.

Nuclear powerplants, railways, etc, are a thousand times more expensive then what is reasonable to find investors for. Such businesses is for states and giants.

Playing survivalist on a farm could be a fun hobby but I hope to be more useful then that. Something that scales upwards and grows reasonably fast with a high upper limit  must be a business idea that can utilize an inflow of capital and preferably customer money. Nothing is better then customer money.

I am a fairly good salesman and promoter, as long as I have a good product and dont try to sell myself...

Your first two ideas (which would work well in combination) look like almost sure winners to me. But the problem I see for you is that you would need years to develop such a business to the point where you could draw a reasonable income out of it.

As a young man, you quite rightly want and need income based on productive activities NOW, as opposed to five or ten years from now. For this to happen, you will probably have to go to work for somebody--corporation, city government, public utility, something like that. An alternative would be to go into a profession such as teaching: That is what I did, even though my earnings potential in finance were four to ten times what I could get working 180 days per year in a congenial job, where my days off corresponded to time off that my children had from school.

A big problem with starting a business and working to make it grow is that for success it becomes a total commitment: All your time and energy must go into the business, with almost none left for fun, wife, children, reading books, continuing your education, etc.

One of your skills is expressing your thoughts concisely and with great clarity in writing; this skill is rare. Is there much money to be made as an engineering consultant or technical writer in Sweden?

Re: "what is an investor to do?"

I'll let you know. I am reviewing The Coming Economic Collapse: How You Can Thrive When Oil Costs $200 a Barrel by Stephen Leeb who runs Leeb Capital Management, Inc.

Of course, in the vast majority of cases, one should bear in mind the truth of the old adage it takes money to make money.

Gratuituous picture.


Note here a "typical" weighting means for an inflationary environment; "aggressive" weighting means deflationary circumstances. These are the percentages from Stephen Leeb's THE COMING ECONOMIC COLLAPSE, page 194.

To position your portfolio to survive and thrive over the next few years, you should consider the following model:

Typical weighting (oil rising or falling moderately)

Inflation hedges
25% Precious metals (gold, silver and platinum stocks and bullion)
25% Energy (oil service, energy funds and alternative energy)

"Chindia" (China-India)
30% (Large cap American companies expanding into China-India)

Deflation hedges
20% Zero coupon bonds

Aggressive weighting (oil rising or falling rapidly)

Inflation hedges
10% Precious metals (gold, silver and platinum stocks and bullion)
10% Energy (oil service, energy funds and alternative energy)

"Chindia" (China-India)
30% (Large cap American companies expanding into China-India)

Deflation hedges
50% Zero coupon bonds

One more from elsewhere:

33% short U.S. Treasuries (90 day- 2 year)
33% Gold (bullion and stocks)
33% Energy

Looks like the economy can go in any direction and you are still "safe".

To get back to price rises, which I think was the worry..

If economic structures are intact then I think price rises due to energy costs is inevitable with many cyclical time lags reverberating.

Consider a modern retailer:

Day 1, fuel increases 10% therefore:-

transport costs increase [1%] = price rise

glass/plastic increases [1%] = price rise

price index increases [1.5%], therefore minimum wage increase [1.5%] = price rise

price rise [2%] means price index increases [1%] - means 'real job wages' eg the oil industry or retail management [not minimum wage workers] get private sector rises [3%] = price rise [1%]

and so on in an endless loop of compounding into an exponential growth.

Let us give thanks for minimum wage regulations, otherwise workers really would be stuffed. Anyone above minimum wage but without wage bargaining power will see erosion in wealth.

* Many economists would argue that the absence of big inflation peaks since the early 1980s means that inflation expectations have been conquered, and that things are fundamentally different now. *

Prices have been generally falling in practical terms for 20 years at least in the UK.
We now get dirt cheap food, shoddy service, short life goods made abroad etc. This enables us to spend the remainder on housing costs, things we don't need
and taxes.

When retail prices rise I think there could be serious unrest

Agreed.  Some comments above are worried about the best kind of investments, but most people are (or will be) most concerned about making ends meet.  Thus prices (relative to income) will be the real issue, not abstract  notions such as "money supply".  Notice I said "relative to income".  With the peaking of oil and many other essential resources, we are facing scarcity of resources.  That is a simple physical concept, not subject to monetary policy and such.  There will be less "stuff" per capita.  Thus most of us will be "stuffed" in the sense that Pondlife meant.  This can be brought about by higher nominal prices (call it inflation if you want), or lower incomes (call it deflation if you want), they're one and the same to most people.  I suppose monetary policy will have some impact on the path between those two.

Here in the USA the minimum wage is NOT linked to the prices of essentials, thus minimum wage slaves are doubly stuffed.  Anybody who does their own grocery shopping can plainly see that prices have been rising far faster than the official CPI.  The problem with the CPI (or other offical stats on prices) is that the "basket" of items used for the calculation reflects some sort of current average lifestyle.  The true impact on people varies with their actual personal "basket" of purchases.  If food prices go up, the poor suffer more of an overall impact than the rich who spend a smaller percentage of their income on food.  And as the economy slowly collapses, the old "basket" becomes less and less relevant.  The claims that in our "new" economy energy is a smaller percentage of the total and thus less important are based on many errors, one of which is that that percentage can change (and has been changing) rapidly as energy prices rise, and spending on frivolous junk declines.

People who still have savings (other than in temporarily overvalued houses) do need to worry about how to maintain at least some of the value of those savings in terms of their power to purchase essentials.  Buying durable essentials in advance may be good.  Unless you are convinced that their nominal prices will fall.  I doubt that will happen, except for housing.  But if your house is mortgaged with a fixed rate of interest, then savings in the bank (a fixed nominal amount, even without returning any interest) that can pay X months of the mortgage now will pay X months of it later just as well, despite inflation.

Re: "Anybody who does their own grocery shopping can plainly see that prices have been rising far faster than the official CPI...."

Damn right. Instead of doing it myself, I'll let this guy do the usual rant about the CPI.

The core CPI rate is defined as the CPI less food and energy costs. Each time some news organization mentions the core rate, I have to shake my head slowly back and forth in awe.

Now what good is a CONSUMER inflation indicator without food and energy? I guess I am a prima donna, as I have always lived under the assumption that without food and energy, I am dead. As someone who eats several times a day, needs to drive, and enjoys sleeping in a climate controlled environment, I find it odd that increases in food and energy prices are not relevant enough to inflation to be considered "core". It is great to know the BLS feels non-essentials like food and energy can be divorced from the core inflation rate, as maybe one won't starve to death without food, and won't freeze to death without energy. (Interestingly enough, Alan Greenspan in a June 13 speech accused those who question the Labor Departments statistics as being "cynics".) Enough of the cynical "core CPI" rant, and back to the CPI.

Now, what is priceless (no pun intended) is that the linked-in commentary is old (from the year 2000). So check this out.
Cheaper gasoline in May [2000]? Hmmm... This assertion is easy enough to test. On May 1, the wholesale price for unleaded gasoline was 81 cents per gallon. On May 31, a gallon of wholesale unleaded cost 98 cents, yielding a blistering 21% monthly increase! (Annualized, this is over 250%!) On June 16, unleaded gasoline traded at record levels of $1.08 per gallon. Granted, the CPI is a backward looking report and is not focused on wholesale numbers, but if "lower gasoline prices" fueled the benign number, should the stock market look at the data as anti-inflationary given the HUGE rise in the wholesale gasoline price in May?
I rest my case.
My graphs above are the CPI-U, not the "core" rate (which I agree - the core rate looks to me like leaving out key pieces of the data).
Jim Puplava wrote about this last year:

The Core Rate

He argues that one reason the government has so much incentive to fudge the numbers is the COLA on entitlements.  If that's the case, they will only have more reason to fudge the numbers in the future.

When retail prices rise I think there could be serious unrest

I'm not at all sure we'll see retail prices rise:  the customers who have to fill their gas tanks and heat their houses won't have enough money to buy all the junk they're used to buying.

Of course, faced with higer costs, the manufacturers and retailers will try to raise prices.  I just don't think they'll be able to make price increases stick.

The result will be a very tough profit squeeze on manufacturers and retailers.

I don't expect unrest, either.  There might be political action (windfall profit taxes, etc.), but most Americans have very much bought into free market ideas.  They'll grumble and complain, but I wouldn't expect unrest from that quarter.

Nobel Laureate and professor Milton Friedman says, "Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output".

Most people don't catch the subtlety of this concept, and simply think that "printing money" is inflation.  It's really about the comparison of two growth rates -- the economy and the money supply.

Now, on to the issue of "inflation" and peak oil, I believe it's important to avoid the word "inflation" in economic discussions because of mis-interpretations of its meaning.

How about:

  1. As the amount of energy supplied to the economy contracts, economic activity will contract.
  2. The Federal reserve will reduce interest rates in an attempt to remedy the decrease in the economy (the economy may have a negative "real" rate of growth at this point but the nominal measure may be flat or even rising).
  3. If the economy doesn't respond to the cheaper rates and typical increase in the money supply, then the fed will take more dramatic measures to keep the nominal size of the economy from decreasing.

It's this third step that is widely debated.  Bernanke knows that a nominal decrease in the economy is very bad because it makes debt very hard to repay within the whole economy.  This is also the crux of the "inflation / deflation" debate.  Will the fed allow (can it prevent?) a nominal decrease in the economy after peak oil?  Some suspect that step #2 above will not do it.  

History says the value of the currency will be destroyed.  And the economy will tend toward a barter system -- exchange of goods on a relative value basis.  After the currency is destroyed then people will demand a "hard money" system (I hope it's not gold, it's too "hoardable").


My belief is that the economy will adjust by eliminating wasteful economic activity at a rate that equals the energy decline rate.  Here are some things that I think will suffer in making these adjustments (brainstorming here):

  1. interscholastic sports
  2. movie theaters
  3. pets
  4. non-major league sports
  5. travel
  6. entertainment (which requires any travel)
  7. frame shops
  8. "the arts" -- symphony, theatre, art galleries
  9. knick-knack shops
  10. concerts
  11. Nascar attendance
  12. leisure motorboating, jet skiis
  13. monster truck rallies
  14. theme parks
  15. home remodeling
  16. Chuck E Cheese's (go play outside Junior!)
  17. County fairs

The mind can go wild thinking of things that people do that are not economically necessary for the participant (the vendors may think otherwise).

What might increase?

  1. sailing
  2. biking - both bicycle and motorcycle
  3. cable TV
  4. gardening (although this is more wasteful than people believe)
  5. any type of entertainment on the internet
  6. musical intruments
  7. board games, chess, checkers, etc.
  8. sex
There is a photo from the 1929 crash, with a well dressed man in spats, with his foot resting on the running board of a very fine car, with a sign on it reading "for sale, $100." He was surrounded by a crowd of people, smiling for the camera. It was obvious that none of them had $100.

After the crash, cash is king.

Robert Shiller has been saying that the present real estate boom is the biggest financial bubble in human history, and recently the Economist has said the same thing (sorry, no link).

It is not difficult to imagine a wave of mortgage defaults, followed by desperate selling by Fannie Mae and the hedge funds -- suddenly holding vast amounts of unsellable real estate, instead of interest bearing securities.

It is easy to imagine that in five years, anyone with cash (not credit) could buy properties for pennies on the dollar. But of course, the reason for this is that few people would have cash -- and those who do will be fearfully holding onto it.  

If you hold gold, you will have to sell it for cash to buy these cheap houses (or pay for your own food, or your own mortgage); but other gold holders would also be selling to do the same thing.

If we experience something like a 1929 crash (or something even worse), then demand for commodities like oil will decline faster than the natural depletion we have been discussing, and it is conceivable that we could experience a good deal of the decline curve without ever noticing it; because demand destruction would lower prices faster than depletion would raise them.

I agree with Stuart that peak oil is inflationary; but a crashing bubble (whether post 1929, or post 1989 Japan) is strongly deflationary.

This is essentially the way I see things playing out for the next few years. I would argue a deflationary spiral is likely to culminate in a liquidity crunch.
Unlike the post 1929 period, the dollar is currently tied to nothing and as Bernanke says, money could figuratively  be dropped from helicopters. Comparisons to Japan are not useful as Japan's strong trade surplus made devaluing the yen extremely difficult (rates were basically at 0%). The US economy is in more of a South American situation-devaluing the dollar will be the easiest thing in the world to do-but the result won't be much fun.
I've been thinking about this a lot lately too.

First of all, there are two types of inflation; cost-push inflation and demand-pull inflation. Cost-push inflation is the type of immediate concern, and it has different dynamics.

Clearly the price of oil is largely beyond the ability of the US to control, and so long as the world economy is robust, the price of oil will be bid up, or stay high, and we in the US will have to follow along and pay it. Much of the soft demand has already been squeezed out by high fuel prices, but we'll probably pay whatever is needed to commute to work. Likewise, all the truck traffic that delivers the stuff to Walmart and everywhere else will have to pay it too.

Since all the businesses that see their costs rise must pay for fuel or go broke, or reduce profits, it means that this type of inflation will ripple through the economy with a certain lag period of six months to a year.

If the money supply is constant, the price of necessities like grocery store food delivered by truck will increase at the expense of other sectors. Demand for consumer luxuries like pizza deliveries and tourist travel will suffer. It will rearrange the economy as consumers shift their buying toward necessities. This shift has a big effect on low income consumers in particular, and concerned Walmart last year since their cost-conscious customers made less shopping trips.

Since the cost of necessities will be pushed up by inflation, this means an increase in the consumer price index. Interest rates will tend to rise to keep lenders lending; they want a positive return on their capital. Domestic consumers will get squeezed and the housing bubble (which is the main thing propping up domestic consumer spending now) will tend to deflate.

But the federal government is hugely in debt (more than a $300,000 per US worker working to pay off the federal debt) and it needs either taxes from these increasingly hard-pressed domestic taxpayers or more importantly foreign lenders willing to buy treasury bonds to keep interest rates down despite our trade imbalance, which is now increasing at about about $2 billion per day. Domestic consumers already have about $7,000 in debt per household.

Here is the best economic modeling on the web that I know about to explain the interaction of these various factors, even if their analysis is pretty much blind to peak oil.

"Are Housing Prices, Household Debt, and Growth Sustainable?"

There have been many economically sophisticated warnings in the last year that US consumer demand is in trouble; kind of a house of cards based on the housing bubble and the willingness of foreign lenders to keep lending.

The bottom line is that if massive foreigners like China ever decide to cash in their treasury bonds on a large scale, if South Korea panics and decides to cash in their treasuries, then a huge amount of dollars will be injected into the internation economy and this will cause the other kind of inflation; demand-pull inflation; lots of dollars but not so many goods to buy.

Here is the best analysis I know about to explain this big picture:

"It's time to take seriously a US-led global recession"  by Lau Nai-keung
2005-10-06 07:37

I think it is time that we should take a serious look at the possibility that the US is going to take us down towards a worldwide recession in one or two year's time... How would a government, which depends on the taxes of a strong economy to operate, keep all its promises?...  One thing is for sure, some time in the not too distant future, every central bank and institutional investor is going to dump US dollar and US Treasury bonds. Once, when a country like South Korea dumps the dollar, the still unsold US Treasuries in the asset column of Asian central banks - US$2,000 billion according to some estimates - will collapse. The cheapened dollar will cause a sudden jump in the US inflation, which forces the Fed to jack up interest rates. A giant leap in inflation will cause a severe recession, or perhaps a depression, in the US. These countries' exports to America will dry up, which in turn will spread the global economic downturn like wildfire...

My view of US economic history is that economic contractions are the result of lack of regulation of an ivestment sector. 19th century "panics" followed attempts to corner the gold market, the silver market, the creation of commodity trusts and interlocking directorates, etc. The 1929 crash was preceded my to much borrowing for stock market investing. The Enron debacle and current recession (by using pre 1980 methods)was set up by deregulation of utilities. Now we have unregulated hedge funds and speculation in fuel futures.
That's the problem though, isn't it? These countries know that if they dump the dollar, their own economies are toast too. This keeps them holding dollars and still doing business with the US. This is also why moves towards currencies other than the dollar to use for world trade cause such a stir - if there was an alternative, many of the holders of US dollars would bolt for the door. So long as these other countries have no alternative, they have tended to continue with the dollar and for now, despite the euro situation, I don't see another alternative ready to replace the dollar. Outside of the euro, the closest I could think of would be the Chinese yuan, much like the dollar replaced the British pound as the world currency in the first half of the 20th century.
But don't the other fiat currencies all have to follow the dollar down? Otherwise all the production would rush back to the US, no?
Others have already covered the money supply / inflation link well enough.  But I think some have missed the central banker logic that feeds into these issues in the face of an oil supply shock.

When a supply shock leads to high oil prices, the result is a drop in the standard of living (for everyone who uses energy--i.e. everyone).  It is also very hard on businesses, which see costs go up, but are unable to raise prices (because all their customers are cutting back on non-energy purchases so they can heat their homes and fill their gas tanks).  This squeeze cuts corporate profits (resulting in a drop in the return to capital), as well as layoffs (resulting in a drop in the return to labor).  The result is inevitably a recession.

In the 1970s, central banks responded to this scenario by creating excess money, leading to inflation.  If they had created too little money, the result would likely have been that the recession would have become a depression.

In between, there's some perfect amount of money creation that would preserve the value of the money.  We still would have had a recession (as businesses and households adjusted to the lower standard of living), but things would have been better, because the price signals would have given people the information they needed to make the best decisions.

As a practical matter, though, it's a hard call for the central bank. All they have to go on are statistics--prices, interest rates, money supply numbers--that are at best a picture of the recent past, and never completely accurate.

I think next time the central banks will try to keep the inflation rate lower, even in the face of a recession--they remember how bad the inflation of the late 1970s was, and how much pain was necessary to work it back down during the 1980s.  But what the central banks try to do and what they actually achieve are not necessarily the same thing.

So, we're still stuck.  The next oil shock could be followed by either inflation or deflation--or even a stable value of the money.  (Relative prices, of course, will shift, with energy becoming more expensive and other things becoming less expensive.)  The only thing that is certain is that there will be a recession (or worse).

I think that we are headed for a deflationary recession, even according to the Austrian definition, because I think that there will be a contraction in the money supply.

Eventually, and maybe soon as interest rates are rising, there will be a snowballing liquidity and solvency crisis as US consumers and mortgage holders are unable to meet rising monthly payments (in a context of rising interest rates, rising fuel prices, and falling real wages).  Banks and other credit issuers (e.g. Fannie Mae) will have to write off trillions of dollars on their balance sheets.  This will happen even if the Fed keeps interest rates low and monetizes the mounting government deficits.  Its money creation will not exceed the money destruction due to the credit collapse.

I also disagree that the Fed will want to inflate the money supply to eliminate debt.  The Federal Reserve is the agent and the instrument of the creditor class, and I don't think it will allow debtors to escape from their debt by inflation.  I think that the creditor class learned a painful lesson in the danger that inflation poses to their wealth during the 1970s, and they are determined never to let that happen again.  

So interest rates will rise in response to rising energy prices, even if it brings a recession or depression.  If this happened in the near future, it would play into the hands of the creditor class, as it would allow them to dispossess the middle class by foreclosing on mortgage holders and buying their foreclosed properties at discount prices.  The resulting depression, by the way, would push oil consumption levels well below current supply and would cause energy prices to crash as well, reinforcing deflation.

Of course the government debt will mount and will have to be repudiated eventually (most likely when baby boomers start claiming entitlements).   I think that they will do this simply by repudiating the claims of foreign US bondholders and declaring Social Security bankrupt.  This would cause the dollar to crash on foreign exchange markets.  This makes it all the more imperative, from the point of view of the US power elite, to secure physical control of oil reserves before the dollar has to be repudiated.  (This would also be necessary if the endgame were to inflate the dollar into oblivion.)  Hence the current fun and games in the Middle East.

The Fed was created by the U.S. Congress and answers to Congress, which can abolish it or take away its powers.

The Board of Governors of the Fed know that.

Thus U.S. House of Representatives in particular and to some extent the U.S. Senate represent the interest of debtors more than the interest of creditors.
Corporations often are huge debtors, for example. Farmers are deeply in debt. Homeowners are drowning in home-equity and credit-card debt. Recently graduated students often have extremely burdensome student loans.

The political clout of creditors--such as old people with savings in retirement accounts--is far, far inferior to the political power of debtors.

Thus I conclude, the odds against deflation are about nine to one.

Economists advise.

Politics rules.

I mostly agree, but most congress folks are creditors and not debtors. Their money is in the long haul more important than their job.
The Federal Reserve is the agent and the instrument of the creditor class, and I don't think it will allow debtors to escape from their debt by inflation.

"A banker is a guy that lands someone else's money and profits from the interest rate difference". In case of inflation it is almost irrelevant for a bank that its credits will melt - so will their liabilities. Their only loss will be their exposed net position, but I'm sure the rich guys know how to hedge it.

The opposite scenario will be much more disastrous for them. If FED overshoots interest rates, banks risk massive defaults and they will be pressed both by decreasing assets (bancrupt borrowers) and increasing in real term liabilities towards their own creditors.

Don and LevinK have addressed most of what I would have pointed out already in an excellent manner, so I'll add only one more caveat of note against a deflationary scenario (as opposed to inflationary):

With oil supplies unable to meet demand, energy prices rise (and trail the shortfall). These energy costs trickle through the economy, from transportation costs (be it road, air, or sea) to manufacturing costs (plastics, refined metals, fertilizers) to labor costs (commuting, food, machinery, etc), and compound each other in a self-reinforcing loop, resulting in the need to pass these higher costs on to consumers.  In return, workers try to keep their pay on par with the rising prices, which in turn leads to higher costs.

Keynesian economists refer to this as "built-in" inflation, or the price-wage spiral, with ever-increasing energy costs as the driving impetus.  

All else aside, that alone will give you an inflationary scenario, unless energy used (demanded) can be cut at a rate equal to or greater than the energy cost increase (resulting in a net neutral cost coefficient).

FWIW, I don't buy this theory that inflation should be defined as increase in the money supply.  It seems to me to put a theory (and one that does not appear well supported by the data to me) about what causes inflation in place of the thing itself.  My definition of inflation is a general increase in the level of prices, which is also (more-or-less) what the CPI and the GDP deflator are trying to measure.  If you'd like inflation to mean something else, please explain how to calculate the inflation rate from the quantities you believe are more important.


At any rate, price inflation is the thing I'm discussin in this post, and as I outlined above, it seems to have far more to do with oil shocks than it does with changes in the money supply.

For those of you who are big fans of the M3 Fed conspiracy theory, please explain to me exactly how the Fed controls the quantity of M3.  Also, what's your view for how the Federal Reserve Board makes decisions about the M3 supply?  Where are these decisions noted in their minutes?  If the matter isn't discussed at FRB meetings, what's your theory of how these decisions are getting made?

(I agree that asset price inflation is different than inflation in prices of goods and services).

What is Inflation?

"Economists wake up in the morning hoping for a chance to debate the causes of inflation." :-)

I will try. There are much better people out there to do it(as others have pointed out), but for me, as an engineer - this is how the world of the FED works:

  1. Our money is debt-based, instead of asset (gold) based, and hence infinite money can be created by the FED by making loans to consumers, to the goverment (by buying treasury notes) and injecting it into the stockmarket throuh REPO operations.

  2. The FED does not control the actual loans banks make - instead they throttle the loans by managing the reserve ratio (i.e. how much a bank can lend based on it's capital) and interest rates.

  3. To much money chasing too few goods leads to price rises, and this would normally place a limit on how much "free" money the FED will create and allow to enter the economy. But they have a neat trick - where they "mop up" dollars, and park them in special treasury accounts for foreign banks, and pay those banks interest. I.e. our oil dollars flows to (say) Saudi Arabia, who would then accumulate a lot of excess dollars, and send them right back to America to be parked in these special accounts to earn interest. Since these dollars are not entering the mainstream economy, they do not contribute to price rises. (Even though there was money supply inflation).

So - it is not as simple as to merely monitor "how much money" is being created - you also need to look at how much money is being withheld from circulation in order to judge price pressures.

The whole dollar hedgemony game is based on (a) forcing everyone to use dollars, (b) mopping up and immobilizing the used dollars to prevent price rises as much as possible (we have "only" lost 95% of the dollar since 1913), and (c) of course keeping the ability for the US FED to create new dollars to fund our deficit spending and whatever else they fancy to spend it on.

This game is now in it's final inning, and will shortly fall apart, either because foreign goverments will no longer send their money back to be "parked" (through buying treasury notes), or they will stop using dollars to buy and sell stuff, or because the accelerating rate at which the FED is now creating new money will overwhelm these mechanisms for containing the excess dollars.

Every time a loan is paid back, the "capital money" that was created originally out of thin air is cancelled out and that money dissappears from the economy.

The question of dollar inflation / deflation is then simply up to what you think the FED will do. If they allow dollars to become scarce (by curtailing loaning so much new money) they can force deflation. If they keep printing more money and finding willing lenders, they will force inflation.

EVERY GOVERMENT IN HISTORY, faced with this situation, chose to create more money.

All of this is talking about the dollar world.

If instead, you convert your money to gold, then you dont care about the dollar inflation /deflation thing. (House prices have actually DECLINED the last five years in house/ounce terms.

My point is that the amount of money supply growth (at least for M1 which is the thing the Fed controls via open market operations) looks fairly uncorrelated with the CPI).  The theory you are espousing looks like a poor explanation of that data.
Yes - well the CPI we all know and love may not be for real either - see

I only told part of the story here - the reality of how our money works and is manipulated is worse than you can possibly imagine.  Another one of my heros is Douglas Gnazzo - you should look him up on

In the long run, there is a high (almost unity) correlation in the rate of growth in the money supply and the rate of inflation.

In the long run, possibly.  For countries with hyperinflation, no doubt.  But, if you actually look at the data in the post above, you'll see that it completely sucks as a putative main explanation of changes in the measured inflation rate in the US over the last 45 years.  By contrast, a big oil shock never fails to bring an immediate spike in inflation.  All the largest features in the inflation curve are closely synchronized with the largest oil shocks.

In monetary matters I'm a big fan of Milton Friedman, though I disagree with his belief that the velocity of money is a stable or a predictable function. In a nutshell, and leaving out a whole bunch of qualifications, here is what he said:
  1. The rate of growth in the money supply compared to the rate of growth in the real economy determines the rate of inflation (because the velocity of money is a stable or at least predictable).

  2. The link between rate of growth in supply of money and the rate of inflation is hard to see because of long and variable time lags (varying from six to thirty months).

  3. The best monetary policy is to maintain a steady rate of growth in the supply of money (measured as M2) about the same as the rate of growth in real GDP. Thus if long-term real GDP grows at about 3%, then the Fed should aim for a rate of growth in M2 between 2% and 4%.

  4. Following point #3. will substantially reduce the severity of business fluctuations.

  5. Fiscal policy only matters insofar as it works through monetary policy. For examples, if fiscal policy is expansionary, it only works because cutting taxes or increasing government spending creates a deficit that puts pressure on the Fed to increase the rate of growth in the money supply.

The key element here is the long and unpredictable time lags: It is because they are long and unpredictable that Friedman believes that discretionary monetary policy is worse than useless.

Now, is he right? In large part, I think he is. The reason, in my opinion, that lags between rates of growth in M2 and the rate of inflation are so long and variable is because expectations are usually adaptive (a weighted average of recent history) but sometimes abruptly become "rational," i.e. based on all available information, including probable future events, outcomes, trends, and also expectations of what other people think expectations will become.

Expansionary monetary policy works to stimulate the economy only when it is a surprise.

The Fed knows this.

The latest oil shock where prices quintupled in 6 years did not lead to a spike in inflation in contrast to your position that a big oil shock never fails to bring an immediate spike in inflation. Something has changed post 1980.

This Letter argues that oil shocks are sometimes assigned too large a role in the run-up in inflation during the 1970s because analysts tend to ignore the part played by inflation expectations and by monetary policy during this period. The implication is that the recent oil shock should not lead to as much inflation as the 1970s would suggest. Financial markets provide confirming evidence.



Money is a complex subject. While the FED produces inflation, China the new world power in manufacturing exports inexpensive goods back, which cause falling prices for stuff, i.e. deflation. So you don't see inflation in much of the stuff the CPI covers. Exceptions are things energy related, which is why talking heads happily relate the CPI figures with food and energy increases removed.

Someone here touched on how the Fed has feed asset bubbles. Used to be if money and credit increased, consumer prices would too. But not if most of the increases are going into financial assets. The NASDAQ bubble had little effect on the price of goods sold in the U.S., except from the psychological "wealth effect" increase in consumer spending.

Stuart. Sorry
You don't have to claim that the Fed controls M3 to be suspicious about their decision to stop publishing M3 statistics.
Nor does the redefinition of inflation as a rise in the money supply, beyond the rise in the supply of goods, imply a commitment to the theory that the growth in M1, or M2, or M3, is the only or most important variable that explains the change in consumer prices.
It simply ties the word to a philosophically more fundamental concept.
That an alteration in the definition would be confusing - I agree with this, as I said above.
It's not at all obvious that it's philosophically more fundamental.  Prices changes are the observable thing that everyone in society experiences, and that most inflation measument effort goes into.

For those of you who want to argue that money or money and credit supply changes are really inflation, I'd ask this: what's the inflation rate right now?  How do I compare 2006 dollars to 1996 dollars?  How do we actually put any numbers to the idea?

The idea that monetary changes are the main driver of inflation depends on the assumption that the velocity of money is fairly stable.  It comes from the Fisher equation that MV = PY.  However, the velocity of money is at best a very strange beast.  I won't claim to understand it, but it certainly isn't particularly stable.  V(M2) has been somewhat stable, V(M1) has been increasing steadily (and V(M3) would have to have been declining because M3 has grown faster than M2 and V1M1 = V2M2 = V3M3).  None of them are very stable in the short term - at least the percentage changes are of the same order of magnitude as the size of percentage changes in the money supply itself.

Here's the data for velocities of M1 and M2:

and here's the year on year changes in velocity.  I have no idea what to make of this.

My view is that velocity of money, like productivity, is not an interesting statistic. Not only does it depend entirely on more important variables, but to define and tracce the growth of money itself is vastly more cogent.
For those of you who want to argue that money or money and credit supply changes are really inflation, I'd ask this: what's the inflation rate right now?  How do I compare 2006 dollars to 1996 dollars?  How do we actually put any numbers to the idea?

It depends, do you want to buy a house, a meal, or a computer?

That may sound glib, but that is the problem here.  We have asymmetrical changes in the prices we experience.  Any number that collapses those changes must make a huge pile of assumptions.  Even if we leave the nefarious stuff out of it, it is not surprising to me that the gov would make assumptions that are consistent with their concept of "living."  They mantain a model of a certain (or small set of) lifetyles, and tally changes to it.

That number is not going to have a direct correlation to my life, or any particular business.  Instead, it's major impact is that we all agree to use it as our point of reference.  We use it to build our outlook and confidence ... which is sill when you think about it.

It makes a big difference whether you have your house, or want one.

I would suggest that we already have deflationary pressures at work: Cheap labor, etc.

The question that has to be asked is: How much play is in the pricing of imported goods?

Many exports from developing countries have enormous mark-ups; consequently, we have seen consistent profit reports from TNC's.  (The economic boom without increases in labor costs.)

Notice that despite the last spike in oil prices, inflationary was weak as far as goods are concerned--not gas and energy.  

I suggest that we will first have a flood of goods--with a slowdown in retail.  

As Odograph pointed out, fuel prices will eat away at disposable income.  As energy prices escalate, prices will fall until the slack disappears.

Or, to put it another way, in order for retailers to capture the vanishing buck of consumers, they will have to lower prices.  And they have the slack to do it.  Any gains developing countries have seen in wages will be eaten away.

High ticket items will continue to do ok.  Watch Walmart.

Deflation first. After all the fat has been wrung out of the system and wages can go no lower...your guess.  The wild card will be those consumers who have overextended themselves.  Personal bankruptcies continue to climb.  Business bankruptcies have stayed constant in absolute terms.  That alone says a great deal.

There is nothing in past history that will prepare us for what will happen. We have never had aworld economy on this scale or with these forces.  

Until the final, all-encompassing crunch, I see a "bifurcated" price structure. Prices continue to go up for those with money, the "haves", while prices may go down for the ever-earning-less "have nots".

So, prices go up at Restoration Hardware in Palo Alto, whose customers just giggle about it anyway, after all, they have money. And prices go down at the supermercado/carneceria on the other side of 101, for those who clean the houses of those who shop at Restoration Hardware.

Inflation is
    always and everywhere
a monetary phenomenon.

In 1970 Friedman recognized it, said it, and rocked people's worlds. It was heretical in a world of palm-readers. We now have thirty years of evidence to support it.

A word of caution in your analysis, Stuart - M1 and M2 are crude, at best, measures of money.

Also, Friedman pointed out that it's not just money being printed, but a difference of money supply relative to the actual growth of the economy.

You might argue that the oil shocks restricted the economy so that money supply growth became relatively more significant thus inflationary.

I'd caution coincidence versus causation. For example, (oohhh I'm going to get lynched for this next statement...) maybe the Carter-era forced conservation on top of lingering nixonian wage controls were the effective stiflers of the underlying economy so that excessive monetary policy resulted in long-term inflation.

Under this explanation, one can conceive that the oil shocks were indeed shocks because the economy was already in its inflationary throes. (Just as 2005 was the oil shock that wasn't.)

Further, one could argue that it was the economic conditions that created opportunity for the crises that created the shocks themselves! That is, if the US was barreling mightily through the '70s and would the embargoers have seen an opportunity to get us?

I may be the only regular reader of this site who differs with you here, Stuart. But I'm seeing effect, not cause.

My impression of this thread is that almost no-one has actually looked at the graphs I posted.  We mostly have large numbers of gold bugs who are completely locked up in their theory of what's happening, and then a handful of monetarists locked in theirs.  Data and evidence seem to be at a very low premium.

I agree that M1 and M2 are crude, but they are what economists mainly use.  So which other ones do you believe provide the thirty years of evidence?  (I would also point out that when the 30 years haven't had any decent-sized oil shocks in, there hasn't been much of a test.)

I am actually trying to figure out what is a reasonable metric for the total amount of money and credit in the economy, but it is non-trivial as far as I can see (if someone else knows, please enlighten me.  And it's not at all obvious to me that the Fed really controls the supply of money and credit any more.  As far as I understand it, 30 years ago, a mortgage was bank lending and the amount of it the bank could do was constrained by their reserves.  Today that mortgage will be securitized and sold off into the credit markets where many of the players are completely unregulated.  The only control the Fed has is short term rates, AFAICS, and as we've seen through the recent rate rise, long term rates didn't respond much to what the Fed was doing.

You might argue that the oil shocks restricted the economy so that money supply growth became relatively more significant thus inflationary.

Well, exactly.  The data suggest to me that the bigger the oil shock, the higher you'd better raise interest rates afterward if you want to control inflation (as long as you don't mind the resulting economic carnage).

Well, I at any rate much appreciate your empiricism, Stuart.
And, as I said, I also think it is far too simplistic to say that the Fed controls the money supply.
But I do claim that the Austrian definition of inflation is the only one suited to be a conceptual building-block.
Incidentally, you must have noticed in your own graphs how much more monetarist policy was in the Keynesian era :-)
"But I do claim that the Austrian definition of inflation".

So let me ask again.  What is the inflation rate now according to that method?  How do I compare 2006 dollars to 1996 dollars using that method?

No-one ever promised the most important things would also be the easiest to measure.
My definition is really a whole range of them, and I understand why you're unhappy with that.
I will refrain from the various verbal coup-de-graces that occur to me :-)
Occam's Razor demands that we consider the simplest solution - and in my opinion that is that these figures (M1, M2, etc etc, and the various graphs fails to convey expected information because there is none - the underlying economic model and it's associated assumptions that we are using is mostly wrong.

Going back to 1913, when private banks were allowed to "become" the FED, and knowing that for almost 100 years now they have had access to the best and brightest minds, and assuming that they have had a profit motive, is it any surpise that the statistics and explanations they dish up for us about what really is going on does not stand up to a first order examination?

Would the fox give an honest account of what is going on in the henhouse?

My impression of this thread is that almost no-one has actually looked at the graphs I posted.

What I'm trying to figure out is how do your graphs show anything beyond coincidence?
Your conclusion in your last paragraph is correct, in my opinion.

Now, does the Fed still control the supply of money, as measured (say) by M2.

Yes, it does, and it does it the old-fashioned way, through open-market operations.

Interest rates are a rough measure of the ease or tightness of money, but the rate of growth in the money supply--over a period of twenty to thirty months--is a better measure. Note that interest rates are stated in "nominal" terms. There is an inflation premium built into nominal rates that is based on expected (not past) rates of inflation. Thus high nominal rates, such as we saw in 1980 can be zero or negative, because the expectation of inflation might be 12% when the interest rate is 10%.

Due to political pressure not to trigger a recession or make an existing downturn worse, the Federal Reserve System tends to make almost all its mistakes in the direction of excessive ease, excessively rapid rate of growth in the supply of money.

Note that an excessively rapid rate of growth in the money supply will eventually trigger higher nominal interest rates (the Fisher Effect) because it will cause expectations of inflation to increase and thereby increase inflation premiums on interest rates--especially on long-term rates. Thus, there is no simple relationship between interest rates and rate of growth in M2.

"Well, exactly.  The data suggest to me that the bigger the oil shock, the higher you'd better raise interest rates afterward if you want to control inflation (as long as you don't mind the resulting economic carnage)."

You have neglected to recognize that the Fed often speaks out of both sides of their mouth.  They are currently raising interest rates to "fight inflation" but are also injecting money into the economy at the same time to keep it from crashing.

See charts of M1, M2, and M3 up to the point in March in which it ceased publication.

How does M1 ever exceed M2, if as stated, M2 = M1 plus savings accounts and small CD's?
No, it's the rate of growth in M1 that sometimes exceeds the rate of growth of M2.
I've listened to both sides of the argument, but in the end I've come to the conclusion the mirrors what Jim Puplava (Financial Sense Online) and Dr. Marc Faber believe.  Monetary inflation will be the way that the United States gets itself out of the massive liabilities it has.  It literally has no other choice.

There is to much at stake to allow deflation to occur.  Deflation wrecks asset values (stocks, commodities, real estate, etc.) and destroys the credit/loan servicing for both the bank and the borrower.  Cash is horded (by businesses and consumers) and no one wants to spend because they know that prices will continue to drop.

Monetary inflation allows for the subtle "erasing" of fixed rate debt over the life of the loan.  As wages increase, the real cost of the monthly loan payment is reduced.  For example, a person may have purchased a house in 1970 for $50K and had payments of $500/mo.  In 1970, $500/mo may be a significant amount of money, but by time the final payments are made near the end of the 30 year loan, a $500 month payment is nearly nothing once you factor in how much your wages and cost of other goods have increased.

Inflation also plays the same role in "erasing" the debt of our country for the holders of  treasury bonds.  It also allows the US to meet its obligations (Medicare, Social Security, etc).  It is a subtle tax in that everyone pays because you currency is worth less and less and the difference is used to support debt payments and Federal obligations.  When politics is involved, which is more likely to happen: a politician will tell voters that benefits will need to be eliminated or cut and taxes will be increased to get the US out of debt, or let the people keep their benefits, but debase the currency to pay for those obligations?  

Our current Fed Chairman, Ben Bernanke, has come out and said in so many words that he be damned if he'd allow deflation to occur on his watch.  He is quoted as saying that if necessary he'd drop money out of helicopters (inject cash into the system) to prevent deflation.

The United States is far into debt (once the on the books and off the books liabilities are added together) that I heard a stat which said that even if Federal income taxes were raised to 100% for one year, it still not resolve the financial imbalances.  At this point, the US has only one choice, and it is to inflate our way out.  Inflation is like a tread mill that keeps moving faster and faster, once money is injected it takes increasing amounts of money to keep the whole thing going (keep the current economy from crashing and driving GDP growth).  This is where I personally believe that the United States will eventually go the way of hyper inflation which is probably many years or perhaps a decade out.

How Peak Oil is linked to this, I do not have a theory for.  However, perhaps the damping effects on the economy of high oil prices will be a driver for increasing amounts of Fed money injection into the economy to keep it from crashing.  If your from the Austrian school of economy theory, all this will accomplish is more inflation which will manifest itself all or some parts of the economy (real estate prices, stock market bubbles, commodity prices, food and energy prices, etc).  Sounds like a never ending feedback loop to me: high oil prices = decline in economic growth = Fed injects money to change decline to economic growth = inflation in prices (which also includes energy prices) = decline in economic growth = ........

Recommended reading: Empire of Debt.

Stuart, the issue you are going to find in comparing changes in money supply and CPI is that your baseline CPI has had fundamental changes made to it throughout the years.

There is a guy who has built a consulting business around backing out methodology changes to key government statistics so that businesses can have an accurate measure with a consistent baseline for analysis going back decades.

This guy actually estimates that the real unemployment rate is currently running around 12% and that the real CPI is around 7-8%.

I have always considered higher unemployment to be worse than higher inflation. Higher unemployment is caused by recessions. History tells me that recessions are triggered by unethical and illegal behavior by the rich. We have a government controlled by the rich and which cheated its way into office, lied its way into a war, lies about key economic stats, and kisses the butt of corrupt arab monarchs. If we don't get the foxes out of the henhouse soon there won't be chicken in anybody's pot.