Oct 072011

The graph above depicts the supply of US dollars from January 1975 through September 2011. The gray bars represent periods recognized by US government statisticians as recessions. Note the swell in the 1990s, during the Clinton Administration, when the supply of US dollars fell. Ah… the good ol’ days!

Now, come over to 2008 or so, and hold onto your hat!

In general, and all other things held constant (or, as we say in the business, ceteris paribus), prices can rise for three reasons: demand increases (e.g., an auction or a popular restaurant), supply decreases (e.g., lower efficiency, war, or natural disaster), or the number of units of currency increases faster than the rate of increase of goods and services (inflation).

Today, we are witnessing a lack of consumer confidence bordering on panic (demand down; prices down), increasing efficiency (supply up; prices down), and a massive increase of the currency base (inflation; prices up). In other words, sagging consumer confidence and increasing productive efficiency are putting a lid on inflationary price increases.

However, efficiency can increase at a high rate for only so long before leveling off (supply stops increasing), and eventually people will go shopping again (demand stops decreasing). When that happens, the downward pressure on prices will weaken. Use your favorite analogy here: a pressure cooker, a plunger, a spring, whatever.

It is reasonable to expect that the downward pressure eventually will be released. Coupled with the inflation depicted in the graph above, this could lead to a period of large and swift price increases.

Invest accordingly.

Prof. Evans

  2 Responses to “Supply, Demand, and Inflation”

Comments (2)
  1. Amazingly, on NPR this morning there were some people who really ought to know better calling on the Fed to kickstart the economy by purposefully setting 5% annual inflation as a target.