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The past 20 or 25 years has seen a great increase in the number of economic bubbles, beginning in Japan circa 1986. Since then real estate prices have seen huge appreciations, not only here in the United States but in Europe, Africa, the Middle East and Asia. Even Iraq has had a real estate boom. Stocks have bubbled forward around the world. And not just stocks but commodities. And not just commodities but bonds, which have rallied for 30 years. And even the most obscure things, such as rare painting and quality violins, have seen their prices skyrocket.

Meanwhile, traditional inflation measures, such as consumer prices, have come down. For example, the IMF finds that CPI (broad price index) inflation has been falling among both developed and developing markets steadily since the 1970s.

What the numbers tell us is a huge divergence between two different kinds of inflation - asset price inflation, which has been skyrocketing, and goods and labor inflation, which has come to a virtual standstill.

Asset price inflation is when the price of investment goods rises-- that is, things that people don't normally use but find useful to hold large quantities of, from which they can extract rents. It's the kind of thing you want as an owner. It's not necessarily something that can't be used, rather it's something were a lot of the buyers for that thing want it only to have it, not use it.

One of these would be precious metals, like gold and silver. Gold and silver can be used in jewelry, but many people also purchase them as investments to hedge against declining currency values. Real estate and land is another-- people use them to live, but property owners also hold them for the sake of appreciation and income. Financial instruments like stocks and bonds are investment goods. You can't eat them. Other commodities like oil and copper are certainly used a lot, but there's been much talk of increasing speculation (hoarding) in these markets.

Goods and labor inflation is when the price of immediately useful goods or labor rise. That is, things that aren't hoarded or owned for owning's sake, but things that are used. For example, most manufactured goods-- cars, computers, cars, airplanes-- fall into this category. You don't see groups of investors hoarding large groups of cars because they are hoping for a speculative gain. That's because next year, these cars will be worth less, not more, as a newer model comes out. Cars just aren't a good investment. But they're useful if you want to get around.

Labor is another example. When labor is purchased, it is generally put to use right away doing something--making something useful, or providing some useful service. Labor isn't "invested in" -- that is, you don't see rich people hoarding large quantities of contracts that entitle them to someone else's future efforts. That's because your efforts tomorrow are worth no more than your efforts today. If you aren't working and your skills atrophy, or you are aging in a way that hinders your ability to do what you do best, they may be worth even less.

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The latter kind of inflation, is generally well measured by price indexes such as the Consumer Price Index (CPI) which measure the final value of goods and services sold.

There is no general measure in our economy for a price index of assets.

Policymakers such as those at the Federal Reserve generally look to things such as CPI, and therefore they may miss important inflation. For example, had the Federal Reserve included housing in 1997-2006, they would have found a much higher inflation rate than they did.

The divergence between these two types of inflation-- especially lack of labor price inflation, or wage gains, combined with massive asset price inflation, has played the main role in increasing inequality in the United States. It may also be a symptom of inequality.

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Consumer Price Inflation (CPI) is a symptom, to some extent, of the power of labor, particularly organized labor and unions. It is also a sign of what in the old days used to be known as Demand-Side economics or Demand-pull inflation. What in the olden days used to be called the "wage-price" inflation spiral. It goes like this: governments used to make a big effort to improve the living standards of the middle class. Governments would pursue policies that maximized Demand, and pushed the plants and mines and factories to produce the most they possibly could to make this happen. Workers and unions would demand (and receive) regular wage hikes. At some point, the demand for more goods and higher wages would push the productive capabilities of the economy to the limit, and so prices would start to go up.

That is goods or labor inflation.

Asset price inflation, on the other hand, is a symptom of wealth inequality. Wealth inequality is far more profound than income inequality. Income inequality might be the difference between a person "making" $25,000/year and a person "making" $250,000/year, a 10x difference. At the end of the day both persons are working, and if the latter person lost their job, if they were in debt and had a family to support, they might be in real trouble. Wealth inequality, on the other hand, is the difference between a person worth $50,000 in net assets and a person worth $50 million in net assets. A 1,000x difference. The latter person doesn't have to work. He or she and their family can live off their income from the things they own. This is being truly rich.

When a great deal of wealth is concentrated in the hands of a very few, what do the few ultra wealthy do with the money? There are only so many big mansions, jets, golf courses, and cruise boats one can buy. The rest of the money must go somewhere. As it happens, the rest of the money goes towards investments -- big housing developments that are then rented out to other people, stocks, bonds, pieces of famous artwork, rare violins, hoarding of gold and silver. In other words, assets.

This leads to asset price inflation.

What we have then, is a world and nation of asset price inflation, because literally trillions of dollars are sitting in unproductive assets just so the rich can be owners of more, while productive labor in the form of tens of millions of unemployed goes unused because of lack of final demand for goods and services.

Originally posted to randomfacts on Thu Dec 09, 2010 at 06:04 PM PST.

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