Inflation: The Real Reason the Fed Raised Interest Rates?

InflationMy theory on why the Federal Reserve raised interest rates this past Wednesday is one of those “I didn’t see anyone look at it from that angle” points of view. So here it goes…

We all know that, according to the Bureau of Labor Statistics, the Consumer Price Index (CPI), the official measure of inflation in the U.S. economy, rose by just 0.5% in the first 11 months of 2015. (Source: Bureau of Labor Statistics, last accessed December 16, 2015.). But we also know inflation is running at a much faster pace than that.

Let’s look at the “official” predictions of inflation from the Fed: it expects inflation to be 0.4% in 2015, increasing to 2.0% by 2018. And in the long run, the Fed expects inflation to remain around 2.0%. (Source: Federal Reserve, December 16, 2015.).

Alternative Measure Says Inflation Obnoxiously Higher Than Reported

To examine real inflation, I look at alternative measures of inflation, one of them being the Chapwood Index. This alternative measure looks at 500 things that actually matter to average Americans in the 50 largest cities in the U.S. economy.

According to the Chapwood Index, all of the largest 50 cities in the U.S. had much higher inflation over the trailing 12 months (June 30) than the CPI reports. The lowest inflation was registered in Kansas City, Missouri: 7.2%. (Source: Chapwood Index, last accessed December 16, 2015.) That’s 1,300% greater than the official inflation figures!

Dear reader, could the Federal Reserve have raised interest rates this week because it sees real inflation getting out of hand? (Higher interest rates have historically worked to curb inflation.) Why else would the Fed have raised interest rates? After all, the performance of the U.S. economy was pathetic in 2015 when measured by a slew of economic gauges.

One Chart Suggests Inflation Could Skyrocket Going Forward

There are two types of inflation and they are interconnected; meaning that if one occurs, the other follows. Those two types of inflation are monetary and price inflation.

Monetary inflation is when the money supply increases. With more currency in an economy chasing the same amount of goods, you get price inflation.

Since 2010, we have seen full-blown monetary inflation in the U.S. economy, as the chart below illustrates. This is a chart of the monetary base in the U.S. economy. This is basic currency: notes, coins, and deposits of commercial banks held at the Federal Reserve.

Monetary Base in the U.S. Economy

Monetary Base in US Economy Chart

(Source: Federal Reserve Bank of St. Louis, last accessed December 16, 2015.)

In 2008, the monetary base of the U.S. economy was around $850 billion. Today it sits at $4.0 trillion—an increase of 370% in a matter of a few years.

Inflation Outlook for 2016

As it stands, investors are ignoring inflation. We hear more about deflation than inflation these days mostly because of falling oil prices, and I question if that is right. If we look at oil prices, crude oil has fallen 42% in price this year. But gasoline prices have fallen a lot less than that: only 20%. And we know the price of buying, maintaining, or servicing a car certainly hasn’t gone down.

Maybe the Fed is also worried about inflation. Maybe the Fed is looking at different measures of inflation than just the CPI. And maybe investors have it all wrong about inflation. That’s why I continue to like gold.

Investors are shunning gold right now while the U.S. dollar reigns as the “flight to safety” asset. As gold prices fall, I’m taking the contrarian play and adding to my positions, because I believe I’m getting into the metal at a bargain-basement price. Rising government debt and the threat of rapid inflation make it valuable to me.

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