Current price inflation data confirm all trends and expectations associated with monetary inflation. In recent years, both the official and the alternative indicators of consumer price inflation point steadily towards stagflation.
 

The price inflation chart above clearly indicates that since 2002 inflation has been steadily accelerating.

At the same time, as you can see in the chart below, economic growth has been steadily slowing since the beginning of 2004. The last three years represent a period of accelerating price inflation and slowing economic growth, irrespective of whether one uses doctored government statistics or the SGS-adjusted numbers.
 

Compelling evidence of stagflation has emerged from the statistics so far this year. A sequence of weak jobs reports have convinced many renowned economists that the U.S. economy slipped into a recession either in December of 2007 or in January of 2008, even though the mainstream continued to opinionate even in August of 2008 whether the U.S. will slip into a recession. Most likely, the U.S. economy has been in recession over the last 5-6 months, while at the same time inflation has been steadily rising and approaching levels uncomfortable even for Wall Street and FOMC members.

While many openly dispute the recession hypothesis by claiming that the U.S. can dodge a recession, at this point pretty much everyone agrees -- even Fed Chairman Ben Bernanke -- that the U.S. economy is stagnant, growing close to zero percent. At the same time, observers across the board have acknowledged rising consumer price pressures.

Literally every meaningful indicator is pointing to continuous price inflation in coming years. The most obvious indicator is inflation’s momentum. Despite macroeconomic stagnation (or outright recession), inflation has continued to accelerate.

The second obvious driver of price inflation is a steadily weakening dollar against all other currencies, despite the dollar bear market rally during the last 3-4 months driven most likely by Wall Street deleveraging. Since the beginning of the Credit Crunch, the dollar has fallen between 10 and 20% against a wide basket of currencies, suggesting steadily rising prices of imports, while the recent relief rally will most like prove to be an intermediate correction. More importantly, many exporting countries, like China and India, are reporting accelerating inflationary pressures in their economies, indicating rising prices in their own currencies, which in turn will translates into even higher prices in U.S. dollars.

The third driver is the rising price of energy on international markets. Rising crude and gas prices will filter eventually through consumer prices as production costs rise. In a sense, the “Third Oil Crisis” is unfolding in slow motion as the price of crude has doubled during the last year. Such a 12-month increase in the price of crude has always resulted in a recession coupled with rising price inflation, even though the price of oil eased after the price spike. In other words, spiking oil prices are highly stagflationary. While it is true that the oil has corrected almost 50% in few short months, the price of oil will resume its upward move; we have seen similar corrections many times before, most notably in January of 2007.

The fourth driver is the evolving “Food Crisis”. In my opinion, there is no food crisis and there is no shortage of food. There has been a small decrease of output in highly inelastic agricultural goods coupled with steadily rising demand that has resulted in food prices almost doubling in a very short period of time. This is a classic textbook example of basic Econ 101 that we typically teach freshmen in their third week of the semester.

For example, in my home country Bulgaria, there is no shortage of any agricultural commodity – any can be had, albeit for a lot higher price than a year ago. Similarly, during the last month I have been living in Saudi Arabia and I have never heard once anyone mention anything about food “shortages”. It seems to me that the journalists’ quest for sensationalism naively associates rising food prices with “Food Shortages” or with a “Food Crisis”. They show us images of emaciated children in poor countries caused by the Food Crisis, while the simple truth is that these poor are starving because their parents have low incomes and cannot afford the rising price of food. The root of the problem is not the lack of food, but the lack of income.

In reality, what has happened is that after so many years, food prices are finally beginning to catch up with other prices in the economy – with real estate prices and with stock market indexes, for example. Essentially, the whole commodity complex is making up for lost time during the 1980s and 1990s. Commodities still have a lot to rise in order to realign their values to stocks, bonds, and real estate; or alternatively, stocks, bonds and real estate prices must collapse relative to commodity prices. Here, I prefer a monetary argument: given that the Fed has been flooding the markets with liquidity over the last 9-12 months, it is unlikely that stocks, bonds, and real estate will adjust significantly downward, but much more likely that commodities will adjust upward, which spells even more consumer price inflation down the line. Rising commodity prices, just like rising oil prices, spell stagflation. Do not be fooled by the recent fall in commodity prices.

The fifth driver is the rapidly rising inflationary expectations. As an illustration, consumers feel that rice will be more expensive next month or next year, so they decide to stock up on rice, which drives its price much higher. Suddenly rice is hard to find, so consumers begin stocking up on all sorts of foods. That makes all food prices react violently upward, which in turn triggers governments across the world to impose export quotas, which in turn further feeds the buying frenzy. Now, consumers seeing all sorts of prices rising (such as imported underwear and apparel or necessities such as toothpaste and toilet paper) will rationally decide to purchase many of them in advance, in anticipation of more rising prices. The obvious result: even more price inflation.

The sixth driver is the government’s stimulus packages. This summer the consumer benefited from a few hundred billion dollar stimulus package and Ben Bernanke testified again in front of Congress in October 2008 that yet another fiscal stimulus is necessary. The consumer has plenty of options, like paying down debt and investing the money in stocks and bonds, but the most likely outcome is that the majority of money will be spent of food and energy, thus further driving their prices higher and further exacerbating an already acute inflationary problem.

The above is sufficiently important to warrant a detailed explanation. In essence, the current price inflation has squeezed the consumer to the point where a much larger portion of his income goes to food and energy. Demand for these two critical items is very inelastic, so most extra income will be directed towards them. The key to understanding the outcome is the fact that food and energy supply is also very inelastic– consumers can willingly pay higher prices, yet businesses cannot respond with increased supply of food and energy. The nature of providing (supplying/producing) food and energy is such that it entails significant lags in time, often three, five, seven or more years. Thus, increased demand for food and energy driven by the Bush stimulus package(s) will likely result in significant price inflation and little economic growth. As a counter-example, consider that if consumers were to decide to spend their stimulus package cash on massages and fitness trainers, it would result in booming massage and fitness industries hiring more massage therapists and fitness trainers to expand their services; with food and energy this won’t happen—it won’t translate into jobs or growth.

A host of other factors contributing to exacerbating stagflation can be offered here, but the overall message should be clear. Price inflation has strong, long-term drivers that are here to stay for many more years. Unless another Great Depression truly chokes consumer demand, inflation is only going to get worse.