Von Aldo

How to Really Measure (and Project) Inflation

Brad Zigler, our exchange traded product/alternative strategies columnist, has a quibble (or five) with the way the gub'ment (pronounce with your best Michigan Militia accent) measures inflation. Zigler, managing editor of Hard Assets Investor (www.HardAssetsInvestor.com), used to head up marketing, research and education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange-traded funds. Brad measures daily monetary inflation (the purchasing power of the U.S. dollar globally) as opposed to the gub'ment's CPI, which can mask inflation's true impact. By his calculations, inflation is around the corner, but perhaps not as bad as many fear.

In a note to me this morning, Brad wrote: It's important to remember that the Monetary Inflation Index (MII) measures inflation in a different way than the Consumer Price Index (CPI). MII measures the global purchasing power of the US dollar, not the cost of a basket of domestic goods.

That said, MII is predictive of changes in the Producer Price Index (PPI) and CPI. Shifts in the MII's direction and volatility preceded those in PPI and CPI by months back in 2009 and 2010. That timing gap has narrowed considerably in 2011.

I last performed a study of MII's likely course in April (http://www.hardassetsinvestor.com/columns-a-opinions/2681-setting-the-odds-for-new-inflation-highs.html), when I projected short-(100-days, out to July 2011), intermediate- (200-days, out to November 2011) and long-term (500-days, out to September 2012) odds of new inflation highs and lows.

In April, the MII reached a new high at 199.03 (the MII's base is 100 as of January 1999). In the April article, I figured there were 4-in-5 odds of a new high being posted by July. A new high at 215.03 was indeed notched in May, corresponding to a then-365-day inflation rate of 3.7%.

Longer-term, the odds still favor, albeit at diminished odds, increased inflation.

Rate volatility has certainly increased in the past month. There's been day-after-day new highs in the MII's 200-day moving average since July 2.

If you're asking where monetary inflation might end up in the long term, you've first got to state a context. Over what time horizon?

I calculate a 365-day monetary inflation rate on each trading day. The rate fluctuates based not only on the current Monetary Inflation Index reading, but also the MII a year ago. Sometimes, when the current MII holds steady following a disinflationary episode a year back, an investor gets with the impression that dollar purchasing power is eroding more dramatically than is actually the case. That's where the 200-day moving average comes in.

In this case, however, the MII's 200-day average has broken into new high territory, so there's real "oomph" to this move. Does that mean a challenge to the 5% annual inflation rate level seen in June?

In all likelihood, yes.

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