I think so many people are arguing about inflation, especially after the CPI report, that I need to drop my inflation-adjusted 3 cents.

If you really want to understand inflation, just go to Mish blog, it’s all there.  Just open it in another window, finish reading this post to the end and read it.

There are many scientific definitions of inflation. As I’m not an economist, I’ll give my own, not scientific:

Inflation is the expansion of money and credit divided by the expansion of economy and produced goods. When economy is doing very well, more goods to purchase is produced and more of public business and assets to purchase is available. But usually the credit is growing even faster, so there are more and more money for goods produced, so the sticker price of assets and goods is growing. It is impossible to properly measure the expansion of credit and goods, so instead economists are watching just the price level to understand how big the inflation is

So inflation has nothing to do with price level, but it can be partially measured  by price levels

Some prices are unrelated to inflation, as they depend on politics, wars and weather. So those prices must be ignored

For example, corn price is unrelated to the inflation, because it is affected by new ethanol policies. So corn prices must be ignored.

Price of oil are unrelated to inflation, too. They are affected by tensions with Iran, wars in Africa and the fear of Middle East that they are running out of oil (maybe they are). So the prices of oil and gasoline are unrelated to inflation and must be ignored.

What is important is the level of outstanding credit in the mortgage market and the junk bond market. The quality of this credit is so low and the risk premium is so low, too, that there is a danger that massive defaults will eventually trigger the contraction of the credit. And defaults usually produce cross-defaults, so the credit contraction will spread.

Eventually the reduction in money supply will go so far that there will be much more goods than money. Much more homes than mortgages. Much more cars than car loans. Much more stuff in the malls than shoppers. The prices will decline, as a result of deflation.

Remember – price decline is not deflation, it is a result of deflation. Deflation is when there is no money in the system and there is no enough helicopters to throw more money.

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