Inflation, consumer prices, house prices, stock prices and gold

The following are titles of recent articles appearing at Zero Hedge:

5 Reasons The Fed's New Policy Won't Create Inflation

and

Inflation - Running Out Of Road

The first contends that however much money the US Federal Reserve prints it will not succeed in creating a substantial rise in the consumer price index. The second asserts that far from there being no price inflation, an honest consumer price index would show inflation running at an annual rate of 10%.

So how to resolve the contradiction? First, it is necessary to be clear as to what inflation is. As Milton Friedman put it shortly:

Inflation is a monetary phenomenon -- always. 

This of course was not an original insight. Adam Smith wrote at length of the process whereby monetary inflation was achieved by re-minting gold and silver coinage in increased quantities through the addition of base metal.

But the supply of money is not unrelated to prices. As Samuel Johnson observed in 1775, during a visit to the Western Isles of Scotland, eggs were a half-pence a dozen not because eggs were abundant but because pence were scarce.

But the effect of monetary inflation on prices is not necessarily uniform. Thus, inflation does not necessarily affect the consumer price index directly or even at all. In Western economies today, money is chiefly created by banks, central or private, that create money out of thin air by making loans.

These loans are, in the case of the commercial banks, made primarily to facilitate the purchase of big-ticket items, particularly houses and cars, to support speculative stock investments, or to allow corporate stock buy-backs.

Such lending has little effect on the consumer price index, since it does nothing to increase consumption of items, the price of which determine the level of the price index.

Rather, mortgage debt and car loans will tend to suppress the consumer price index by forcing borrowers to divert an increased share of income to interest and capital repayments.

What such loans do affect is the price of houses, cars and stocks that are bid up by the loan-based spending. Thus, if we want to gauge the effect of monetary inflation on prices, we need to look at home prices and stock prices as well as the prices of bread or milk. 

When we take that broader view, we see that the US and many other countries are in the midst of a rapid money-printing-induced price inflation, which greatly enriches the already rich, i.e., the owners of stocks and real estate, while making the poor, relatively speaking, much poorer.

As for gold, the price reflects fear of the consequences of monetary inflation--which is to say fear of the loss of purchasing power of the unit of currency--among those with money but no desire to invest it in stocks or real estate.