Where's the Inflation? (It's in the Asset Markets)

“The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements, or a disease that comes like the plague. Inflation is a policy.” - Ludwig von Mises, “Economic Policy”

The Federal Reserve has a publicly-stated goal of achieving a 2 percent inflation rate. However, the US is running an annual inflation rate of just 1.7 percent through the 12 months ended in August 2014.

Many economists and analysts expected soaring inflation when the Fed initiated its quantitative easing (QE) program. Creating all that excess money in the absence of an equal expansion of goods and services in the economy was supposed to trigger price inflation.

But continued weakness in the US economy has thwarted any prospects of the runaway inflation that was expected in coincidence with the nearly $4 trillion dollars created out of thin air by the Federal Reserve (the Fed’s balance sheet has expanded from about $850 billion to more than $4.4 trillion since the 2008 financial crisis).

To be sure, there has been inflation -- it just hasn’t been in the consumer price index (CPI). Instead it's been manifested in assets. All that money had to go somewhere, and it has flowed into -- and distorted -- the markets.

Look at the stunning rise of the stock markets, not to mention the housing market, since the lows of 2009. Each of the Fed’s three QE programs have caused the stock market to surge as more liquidity was pumped into the financial system.

Before the recent turmoil, the stock market had tripled in value since the bull run started in early-2009. That is not reflective of the weak US economy, diminished household incomes, or reduced consumer spending.

During the throes of the financial crisis and subsequent Great Recession, the stock markets reached stomach-churning lows.

In March of 2009, the Dow fell to a 12-year low of 6,547; the S&P slumped to a 13-year low 676; and the NASDAQ dropped to a seven-year low of 1,268.

Yet, even after this week's market upheaval, the Dow now stands at 16,380; the S&P at 1,887; and the NASDAQ at 4,258.

This surging bubble in U.S. stock markets was created by the Federal Reserve through its record low interest rates.

So, in reality there's been plenty of inflation — it's all been in asset prices and, in many markets, housing. Home prices have once again reached 2005 levels.

Ultra-low interest rates have discouraged saving and instead encouraged massive speculation in volatile asset markets.

As history has shown repeatedly, this never ends well.

Looking for the highest possible returns, investors have forgotten the recent crashes of 2000 & 2008. Shunning savings accounts, CDs, money market accounts and Treasuries, investors have instead piled into stocks and high-yeild bonds, which are historically volatile.

Since the start of 2009, funds invested in junk bonds have returned an average of 14 percent each year. That's been very alluring.

For comparison, the yield on the benchmark 10-year Treasury note recently fell below 2 percent for the first time in more than a year. Moreover, the yield on the 10-year Treasury note hasn't consistently traded above 4 percent since shortly before the financial crisis of 2008.

U.S. Treasuries are viewed as the safest of all investments. In other words, investors are spurning safety in favor of high-risk yields. The alarm bells are ringing!

Less than ten years after the dot-com bubble burst, there was a housing bubble that inevitably burst. Money that drained out of stock markets during the dot-com panic instead flowed into housing markets and the now infamous mortgage-backed securities.

One form of massive speculation was simply traded for another.

Yet, we now find ourselves in the midst of concurrent equity and bond bubbles throughout the world's financial markets.

Most incredibly, we are now faced with our third asset bubble in less than 15 years. Will investors never learn? This is like the film Groundhog Day. Yes, history repeats, but three times in 15 years? This is the height of recklessness and delusion.

Former Fed Chaairman Alan Greenspan famously referred to it as "irrational exuberance."

Somehow, it's returned, and it seems to be a sign of the times.

So, the next time you hear someone (particularly some talking head news pundit) say there's little or no inflation, ask yourself how they can so blindly miss the absolutely massive level of inflation in the asset markets.