What Inflation Means

Contra the FT and the QE defenders...

 

BACK in April 2014, Martin Wolf at the Financial Times issued one of his tiresomely regular defences of quantitative easing and arguing for the direct state control of money, writes Tim Price at Price Value Partners.

 

The last nine years have not been kind to this article. One respondent on the Financial Times' website made the following comments:

 

"The headline should read, 'Only the EXPERIENCED fear hyperinflation'. Unlike Martin Wolf's theorising, the Germans – and others – know only too well from first-hand experience exactly what hyperinflation is and how it can be triggered by a combination of unforeseen circumstances.

 

"The reality, not a hypothesis, almost destroyed Germany. The Bank of England and clever economists can say what they like from their ivory towers, but meanwhile down here in the real world, as anyone who has to live on a budget can tell you, every visit to the supermarket is more expensive than it was even a few weeks ago, gas and electricity prices have risen, transport costs have risen, rents have risen while at the same time incomes remain static and the little amounts put aside for a rainy day in the bank are losing value daily.

 

"Purchasing power is demonstrably being eroded and yet clever – well paid – people would have us believe that there is no inflation to speak of. It was following theories and forgetting reality that got us into this appalling financial mess in the first place. Somewhere, no doubt, there's even an excel spreadsheet and a powerpoint presentation with umpteen graphs by economists proving how markets regulate themselves which was very convincing up to the point where the markets departed from the theory and reality took over. I'd rather trust the Germans with their firm grip on reality any day."

 

As for what "inflation" means, the question hinges on semantics. As James Turk and John Rubino point out in the context of official US data, the inflation rate is massaged through hedonic quality modelling, substitution, geometric weighting and something called the Homeowners' equivalent rent.

 

"If new cars have airbags and new computers are faster, statisticians shave a bit from their actual prices to reflect the perception that they offer more for the money than previous versions…If [the price of ] steak is rising, government statisticians replace it with chicken, on the assumption that this is how consumers operate in the real world…rising price components are given less relative weight…homeowners' equivalent rent replaces what it actually costs to buy a house with an estimate of what homeowners would have to pay to rent their homes – adjusted hedonically for quality improvements."

 

In short, the official inflation rate – in the US, and elsewhere – can be manipulated to look like whatever the authorities want it to seem.

 

But people are not so easily fooled. Another angry respondent to Martin Wolf's article cited the "young buck" earning £30,000 who wanted to buy a house in Barnet. Having saved for 12 months to amass a deposit for a studio flat priced at £140,000 he goes into the estate agency and finds that the type of flat he wanted now costs £182,000 – a 30% price increase in a year. Now he needs to save for another 9 years, just to make up for last year's gain in property prices.

 

So inflation is quiescent, other than in the prices of houses, shares, bonds, food, energy, school fees and a wide variety of other types of assets.

 

The business of rational investment and capital preservation becomes unimaginably difficult when central banks overextend their reach in financial markets and become captive to those same animal spirits. Just as economies and markets are playing a gigantic tug of war between the forces of debt deflation and monetary inflation, they are being pulled in opposite directions as they try desperately to anticipate whether and when central bank monetary stimulus will subside, stop or increase.

 

Central bank 'forward guidance' has made the outlook less clear, not more. Doug Noland cites a paper by former IMF economist and Reserve Bank of India Governor Raghuram Rajan titled 'Competitive Monetary Easing: Is It Yesterday Once More?' The paper addresses the threat of what looks disturbingly like a modern retread of the trade tariffs and import wars that worsened the 1930s Great Depression – only this time round, as exercised by competitive currency devaluations by the larger trading economies.

 

"Conclusion: The current non-system [a polite term for non-consensual, non-cooperative chaos] in international monetary policy [competitive currency devaluation] is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing. If I use terminology reminiscent of the Depression era non-system, it is because I fear that in a world with weak aggregate demand, we may be engaged in a futile competition for a greater share of it. In the process, unlike Depression- era policies, we are also creating financial sector and cross-border risks that exhibit themselves when unconventional policies come to an end."

 

There is no use saying that everyone should have anticipated the consequences. As the former BIS General Manager Andrew Crockett put it:

 

"Financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle.' A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have."

 

The Fed repeats its 2% inflation target mantra as if it were some kind of holy writ. 2% is an entirely arbitrary figure, subject to state distortion in any event, that merely allows the US government to live beyond its means for a little longer and meanwhile to depreciate the currency and the debt load in real terms. The same problem in essence holds for the UK, the Euro zone and Japan. Savers are being boiled alive in the liquid hubris of neo-Keynesian economists explicitly in the service of the State.

 

Doug Noland:

 

"While I don't expect market volatility is going away anytime soon, I do see an unfolding backdrop conducive to one tough bear market. Everyone got silly bullish in the face of very serious domestic and global issues. Global securities markets are a problematic 'crowded trade'..

 

"To be sure, today's incredible backdrop with Trillions upon Trillions of hedge funds, ETFs, derivatives and the like make 1987 portfolio insurance look like itsy bitsy little peanuts. So there are at this point rather conspicuous reasons why Financial Stability has always been and must remain a central bank's number one priority. Just how in the devil was this ever lost on contemporary central bankers?"

 

Meanwhile, the global trend towards dedollarisation rolls on. Got gold?