A "Real" Inflation/Deflation Indicator

There are several metrics used to reveal levels of economic activity. Some of the more accurate are said to be consumed levels of the fuel and construction commodities, in particular crude oil, copper, steel, aluminium, lumber and the like. Of these, consumed levels of crude oil is said to be the most telling.


Aggregate global consumption of any commodity is difficult to calculate, so economists like to use price as an indicator, since rising and falling price will directly reflect demand.


But first I think we have to ask and answer the questions, what gives an indicator it's value, and what makes it accurate?


Obviously, for it to have value, it has to measure something of relevance. Less obviously perhaps, for it to be accurate, it has to make that measure using a method of the highest signal to noise ratio possible. The less relevance or accuracy of the indicator, the lower it's value.


I'm going to stipulate that crude oil priced in gold is the most relevant and accurate price based indicator of aggregate global economic activity we currently have at our disposal. We don't want to use crude priced in US Dollars because USD has become very problematic as a measure of any fundamental economic condition. USD has a very low S/N ratio, caused by a lack of "anchor": since it can and is being printed with no regard to underlying economic activity, it is very "noisy" as a measure of said activity.


To digress a bit, I would say the dollar's only useful measures are twofold: how quickly it multiplies against itself, ie how fast is it being printed, and whether it can mount anything more than "snapback" (reaction) rallies as it continues a secular decline in value (purchasing power). In other words, it's most useful measure is now only whether we have entered into a run-away spiral (hyper) phase in the economy in either the direction of inflation or deflation. Other than those gross (but potentially useful) measures, it is mostly "noise".


To get back to the main point, the case for using crude priced in gold as a measure of aggregate economic activity has multiple elements: 1. the aggregate use of crude is thought to be the most accurate measure of activity, 2. price is thought to be the most accurate measure of demand, and 3. gold has become, by virtue of the incredibly high "noise" levels in USD (in particular since the onset of the "long crisis"), the most trusted functional currency.


And since oil and gold are both priced in USD, by pricing either in the other we completely eliminate whatever "noise" the dollar would contribute to the final measure.


In addition, a secondary but not insignificant point, is that both crude and gold are considered "alternate" currencies to USD, because of the noise issue with USD. This cancels the potential for gross out of phase characteristics. In other words we are comparing variations on a theme, or apples to apples.


So what we are left with is perhaps the best single measure of true savings vs true spending on the global aggregate scale. And since the impulse to "save" is the key deflationary force, and impulse to "spend" is the key inflationary force, we have a true measure of direction of inflation/deflation on the global aggregate level.


Bottom line: if price of crude in gold is moving up we have a condition of aggregate global inflation, and vice versa. Here is a an example chart (click for larger) of what that looks like on a monthly time frame.