Brad Zigler: Your Bookie’s Take On Inflation

January 06, 2011

Brad Zigler considers the path of the HAI Monetary Inflation Index in 2010 and looks forward to 2011.

Six months ago, we sharpened our pencils, pulled the green eyeshade snug on our brow and  laid down the odds on inflation for various time horizons stretching into 2011(“The Latest Odds On Inflation Vs. Deflation”).  The top of the year then represented an intermediate prospect, so it’s now time to check up on our forecast and cast our eyes further into the future.

First, though, we need to re-establish our definition of inflation. At HAI, we make a distinction between price inflation, such as that described by the Consumer Price Index (CPI) and the Producer Price Index (PPI), and the measurement of currency erosion known as monetary inflation.

CPI and PPI measure the domestic prices of goods. HAI’s Monetary Inflation Index (MII), in contrast, tracks the gold purchasing power of the U.S. dollar relative to the world’s second reserve currency, the euro. As disparate as the concept of price and monetary inflation may seem, they’re actually linked.

Figure 1 tracks one-year inflation rates. As you can see, the monetary inflation trend tends to presage changes in the price metrics.

Figure 1: 12-Month Inflation Rates

MMI tends to be predictive, but the essential difference between price and monetary inflation is transparency. Monetary inflation can—and is—calculated in real time. CPI and PPI are refreshed monthly, but MMI is updated daily. MMI, then, can provide more immediate feedback to investors and so, enhance their hedging or trading ideas.

Since the greenback’s value is compared to that of the euro, the MII’s base (100.00) is set at the common currency’s launch date in January 1999. Currently, the MII’s at 161.44, but the index didn’t get to that level by following a smooth arc. There’s been a whopping bit of volatility that’s pitched and rolled the index over the past couple of years.  The index reached 195.88 in December 2009 while the dollar took a drubbing from the euro but fell to 109.82 six months later when the U.S. currency’s recovery strength finally peaked. (See Figure 2.)

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