It’s time to debunk two myths about inflation. The first myth is that growth causes inflation. The second myth is that debt causes inflation. Neither is true.

“The capital-intensive process of training and equipping a new generation of innovators causes inflation. It’s the down payment on the next economic boom.” - Harry S. Dent, Jr.

The idea that growth causes inflation has only proven true in some short-term economic booms where a scarcity in capacity, materials and labor has temporarily caused inflationary pressures. In many boom periods, for instance 1982 to 1986 and 1992 to 1998, inflation rates fell dramatically. In fact, if we look at the course of history for the last 400 years, it is clear that economic boom periods do not tend to be inflationary.

The idea that debt causes inflation is also easy to refute. For instance, from 1980 to 1992 government debt and deficits accelerated more than at any other time in U.S. history yet inflation fell dramatically. Inflation rates continued to fall into 1998 and HS Dent predicts that they will remain low and flat through the end of this boom period and well into the bust (where they have actually gone negative), which started in late 2007. So what does cause inflation? Well, ask yourself one simple question: is raising kids expensive? The obvious answer is yes, but parents aren’t the only ones bearing the expense. Government invests in the education of our children from primary school through college, and then the companies who hire them assume an expense for the initial investment in office space, equipment and training new workers require. That’s why HS Dent has discovered that the best leading indicator of inflation, outside of war periods, is the growth of the labor force on a two-year lag. We call this the “Inflation Indicator,” and it is shown in the chart below.

Click chart for larger view

The Inflation Indicator makes plain what logic suggests. Labor force entry is the crescendo of the very expensive cycle of raising and educating our kids. As the labor force grows through an influx of young workers into the economy, capital is needed to pay for their training and to support the innovative companies, services and products that these young workers create. If capital were widely available, this would not necessarily create inflationary pressure. However, the high demand for capital typically occurs when the supply of available capital is low because the influx of an innovative generation of workers surges just when the productivity of a maturing economy reduces corporate profits.

For centuries, from the invention of the printing press to the microprocessor, inflation and innovation have gone hand-in-hand.

Inflationary pressures are particularly great when labor force growth coincides with one of the long-term revolutionary cycles in the economy, which occur every 80 years and every 500 years. At such times, inflation pays for the new technologies and infrastructures that will utterly transform the way we live and work. We saw it five hundred years ago, with the introduction of the printing press. We saw this happening into the 1970s, with the advent of the microprocessor. If we take the long view, it is evident that inflation is our economy’s means of financing an economic revolution and a healthy sign of progress in the making.