The Latest Odds On Inflation Vs. Deflation

June 24, 2010

Is an inflationary breakout in the cards, or a deflationary breakdown? We run the numbers to make the call.



It's been almost a year since we took to our green eyeshades and made book on inflation (see "Laying Odds On Inflation"). In that feature, we projected the probabilities of a standard deviation's worth of increase or decrease in our real-time monetary inflation index over three horizons: 100 days, 200 days and 500 days.

If you're not familiar with the monetary inflation index, it measures the U.S. dollar's gold purchasing power versus the world's second reserve currency, the euro. We update it daily in our Desktop columns.

The connection between monetary inflation and the price inflation reflected by the Consumer Price Index is direct. That is, monetary and price inflation trend together, though monetary inflation tends to lead the CPI. Changes in the direction of monetary inflation can often precede CPI shifts by weeks. You can see this in the chart of rolling one-year inflation rates below.


One-Year Inflation Rates

One-Year Inflation Rates


 Inflation's been a real roller-coaster ride recently. Over the past two years, the one-year monetary inflation rate's vacillated between -5.3 percent (February 2009) and 4.7 percent (November 2009).

Since the index's inception in January 1999, monetary inflation's run at an average compound annual rate of 1.8 percent. An average rate doesn't tell the whole tale, as it tends to mask the often-extreme gyrations in the index. You can get a better idea of the index's volatility in the longer-term chart below.


Monetary Inflation Index

Monetary Inflation Index


 In last year's feature, we gave higher odds on an inflationary breakout in the near term. That breakout occurred. But then inflation stalled and headed southward again. Presently, the monetary inflation index looks like it's attempting a bottom.

So, given the volatility of the past year, what are inflation's odds now? Does the monetary inflation chart reflect the much-feared "double-dip" recession?

Again, we turn to probability theory for the answers.

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