Question: Has anyone ever measured the “true” inflation rate? I am referring to the insidious rate experienced by a person trying to buy J & J adhesive tape at CVS. They only offer the store brand contracted by CVS. Or how about the rate of increase of dairy and beef prices, or the overpackaging of chicken? We have been duped, as you know, by the fair and impartial government BLS.

Answer: As I suggested in last week's conversation, there is no “true” rate of price inflation. A good bit of mushiness in the figures is unavoidable, because there is a good bit of mushiness in the concept.

(i) Whatever goods and services you decide to include in an index of consumer prices, some things will be left out.

(ii) People don't all consume the same things, so a given price index calculated for a given month will do a better job of indicating the level of prices for some people than for others. For some people, the price of yogurt doesn't matter. It could triple in price, and their cost of living wouldn't change. I'd say the same for broccoli, but in my case the price of salmon does matter.

(iii) No consumer good or service is a static thing. The level of quality changes in ways that are important but impossible to measure accurately. Cars have been getting better and better… but by 2% per year or 5% per year, or at some other rate? Movies have been getting worse and worse, although I can't attach any numbers to the deterioration. When the cellphone and the personal computer converge as a single device selling for, say, $500, will that mean that PCs have gotten cheaper or that cell phones have gotten more expensive?

(iv) There are unsolved conceptual puzzles about how to weight each good in a consumer price index. You could assign weights equal to the quantity of the good people are consuming when the index starts. But later, as prices change, people will tend to shift consumption out of the goods that have become more expensive and into the goods that have gotten comparatively cheaper. That makes the original weights obsolete. You could adjust the weights from time to time, to reflect changes in spending patterns, but that can lead to anomalous results. For example, if prices change and then return to where they started, shifting weights could leave you with a change in the price index.

Question: Inflation will start taking off within 12 months of people saying that the economy has fully recovered. That is potentially many years away, given our current state. It took the best part of two decades and a world war to fully recover from 1929. Can current policy insanity go on that long?

Answer: During those two decades, the dollar was still on a gold standard, so the Federal Reserve did not have the freedom to print that it has now. US economic history before 1971 (the year President Nixon told foreign governments trying to redeem dollars for gold to drop dead) is not a good guide to what is happening now.

Question: Neither the Fed nor the US government can afford a spike in interest rates. UK, Japan, and much of the developed world are in a similar position. I have read a ton of speculation that the massive market in derivatives has a major interest-rate component that could put the banking industry at serious risk were rates to spike. Thus it would seem that there are massive survival pressures keeping interest rates artificially low.

Answer: Yes, there is an enormous and powerful constituency for keeping interest rates low. It includes most members of Congress. But no amount of political will can alter facts. When they make buy and sell decisions about bonds, investors do not ignore inflation, and they cannot be made to ignore inflation. The Fed might fight a rise in interest rates by buying still more bonds, but that buying would feed the expectation of even higher inflation, which would add to the pressure for higher interest rates.

Question: Can there be significant inflation in a low-interest-rate environment? John Williams would argue that we are there now, but in your interview we are talking about inflation levels hugely greater than what we have today.

Answer: Temporarily, maybe. Fear of a coming economic downturn would lead the public to save and not borrow (and thus keep interest rates low), even though the currency is losing value. But such a situation would be transient. If the feared downturn fails to materialize, fear abates and savers insist on an interest rate that compensates for inflation. If the downturn does materialize, it dampens the rate of inflation.

Question: It would seem that we are talking about a collapse of faith in fiat money, driving an inflationary reaction and a strong move towards tangibles like precious metals (what they can't print, as Mauldin says). While there are indications of fraying around the edges (e.g., central bank bullion purchases), I don't see anything that will drive this to happen anytime soon. Social unrest, sure. Look at Greece—but it still has not forced a change. What could be the/a trigger event?

Answer: There needn't be an identifiable, triggering event. With so much cash in the system, a recovered economy will overheat, and one by one, businesses will start raising prices. A collapse in faith in fiat money, if it occurs, won't come any time soon. It would come after years of experience with rising inflation rates. I have precious metals and mining stocks and have internationalized (I live in Manila). In spite of the fact that our situation is blindingly obvious to me, the vast majority of the world lives in an alternate universe, and things keep just moving along. This has caused me to question my assumptions as to how long we can continue down the path we are on and what could trigger a “come to Jesus” moment. I still haven't figured it out, but it appears to be significantly longer than I thought possible.

Question: The Fed seems very confident that it can engineer a “soft landing,” i.e., avoid serious price inflation. What is the basis, theoretical or otherwise, of this confidence? Assuming you don't share it, why not?

Answer: A talent for looking confident is part of the requirement for getting a job as a central banker (as it is for most high-level political positions). Only a dunce could oversee what the Fed has been doing and be genuinely confident that it won't end in an inflationary disaster—and the people running the Federal Reserve are not dunces. They are hoping to get lucky and eventually put QE into reverse by just the right amount at just the right time. But they know that what they have been doing has no precedent, that it is a giant science experiment, and that before it is finished all the test tubes may get broken.

Question: I would like to get an explanation of why the government and Fed want to avoid deflation at all costs. Is it somehow linked to the fact that they're in debt up to their eyeballs?

Answer: As you suggest, deflation would make the government's debt more of a problem than it already is. But I don't believe that troubles the politicians, since the effects of deflation in one year could be more than offset by inflation in later years.

What does worry them is the turmoil that comes with the transition from a regime of stable or rising prices to an environment of falling prices. What drives such a transition is each person's discovery that he can't sell his services or the goods he produces at the prices he was expecting. That leads to price cutting. But there is more to it than a dispassionate exercise in decision-making.

The one-word term for “discovering you can't sell your services at the price you were expecting” is “unemployment.” And “discovering that you can't sell the goods you produce at the prices you were expecting” means overstocked stores and warehouses, businesses in trouble, and lay-offs all up and down the chain of production and distribution. It's not deflation per se that worries politicians: it's the depression that it would take to get there.

Question: Is the Fed really, actually printing money or just making journal entries? If they are in fact printing, how will it find its way into the economy?

Answer: As you suspect, the Federal Reserve does not actually print money. When it buys something, such as a Treasury bond, a Federal Reserve Bank (usually the one in New York) credits an account maintained by the commercial bank where the seller of the bond keeps his money. The commercial bank can at any time draw on that account to transfer money to another commercial bank, or it can withdraw money in the form of hand-to-hand currency (e.g., hundred-dollar bills) and use that currency to satisfy withdrawal requests by its own customers. The actual printing is done by the Bureau of Engraving, which is part of the US Treasury Department.

Question: How will we be able to track the billions that are tied up in the banks, so that we know that increasing inflation is imminent? M2?

Answer: We won't know that increasing inflation is imminent. If you or I could predict inflation rates with precision, so could the Fed, in which case it wouldn't be in such a pickle.