As we expressed in our new book Inflation, the Consumer Price Index can be influenced by a wide variety of factors, which we characterized as “non-monetary” and “monetary.” “Non-monetary” factors are all those supply/demand-related factors which may influence prices, even with a currency of theoretically perfect stable value. “Monetary” factors are those that arise specifically from changes in currency value, independent of any supply/demand-related issues.
The 1970s were a time dominated by Monetary factors. Non-Monetary factors did exist, and were mostly toward lower prices — for example, broad recession, or “demand destruction” brought upon by higher nominal prices.
However, there have been other times in US history when Non-Monetary factors dominated. Mostly, this was during wartime. Let’s look:
As we can see, there were times when the Consumer Price Index hit double-digit levels (YoY% change), in the 1940s and also the 1914-1916 period. There was a minor jump related to the Korean War in the early 1950s. None of these were Monetary in nature.
Here is the value of the USD against gold, the benchmark of currency value during the pre-1971 Gold Standard Era:
As we can see, the USD remained basically linked to gold during WWI. Actually, there was some floating after the US entered the war in April 1917, but prior to that the USD remained “as good as gold.” There was a little bit of floating during WWII, but not that much.
We can also see that bond yields did not react to these mostly Non-Monetary spikes in the CPI very much.
Unfortunately, we now have a strange mishmash of interest rates and the CPI together, called “real interest rates.” This is not very helpful, particularly when price rises are being driven mostly by Non-Monetary factors.
So far, there has certainly been some decline in USD value (i.e., a Monetary factor), but I estimate that more than half of recent reported CPI numbers are due to Non-Monetary factors. Usually, in the past, these have resolved themselves pretty quickly, but instead, today, they seem poised to get worse. This is especially true of Food and Energy commodities, which have their own supply/demand factors that seem to be intensifying, while existing “supply chain”-type issues remain slow to resolve.
One of the interesting things here is that, when you adopt a Fixed Value policy, whether linked to gold (common in the past), or perhaps linked to the USD or EUR (common today), the CPI becomes largely irrelevant. The US got by for a long time without it — the modern CPI dates from 1940 — and was very successful.