Inflation? Deflation?

BarroMetrics Views:  Inflation? Deflation?

For the rest of this week, I’ll answer a number of questions raised by readers.

In the first one……

Irene asked: “I wonder if you would like to share your views as to whether the world is heading towards inflation or deflation in the next 12-18 months.  Or any other scenarios?
The various asset classes (equities, bonds, commodities) seem to be saying deflation from their current price actions.

I recall that you had been inflation-biased since 2010 or so.  Has that view changed?”

My view has not changed although your recollection needs a little jogging.

Inflation will be a problem in the US only when the funds presently held by the St Louis FED are released into Main Street. The longer this takes, the greater the eventual problem because the greater amount that will have to be accommodated.

Right now, the trillions created by the FED has done Main Street (as distinct from Wall Street) little good – because the banks have preferred to deposit the funds with the FED. And, who can blame them? The FED is paying close enough to commercial interest rates so banks can ‘lend’ for virtually no risk. Why lend to SME’s, with all their accompanying risk, when you can have the same rate of interest for no risk? I wouldn’t and neither are the banks.

The problem is without the release of the St Louis deposits, it is unlikely that the economy can start the process of real recovery – as distinct from the shenanigans perpetuated by Bureau of Labour Statistics (see http://www.shadowstats.com/).

Once the deposits are released, then the risk of a hyper-inflation led depression raises its head. The FED will have to act, and act quickly, to prevent inflation turning into hyper-inflation. Failing to do so, will bring about not only an initial hype-inflation; it will be followed by a massive depression (Weimar Republic type scenario).  But, here’s the bind facing the FED: acting quickly will bring about a whale of a recession – in other words, the FED will be damned if they do, damned if they don’t.

Unfortunately I can’t see Yellen taking the timely action that will be needed when these events unfold. Summers would have been a better FED chief for this era.

Right now, world Central Banks are posing the issue as one of inflation versus deflation; whereas, in reality, it’s one of  misallocation, and the needed correction of that misallocation. Greenspan began the misallocation, and so far the FED has refused to allow the correction. Instead it has preferred to kick the problem down the road; thus ensuring the resulting pain, when taken, will be so much more.

Consider this:

  • From Sept 7 2002 to Sept 9 2008 (2195 days), the Asset Monetary Base increased 24.74%.
  • From Sept 10 2008 to September 14 2014 (2195 days), it increased  374.36%!!

Think of it this way. Let’s say your personal debt (mortgage etc) was $24,740.00 in September 7 2002. Six years later it stands at $30860.62 (an increase of $6120 – about $1000.00 pa). This is a rate of increase most of us could manage.We would probably be able to reverse the debt.

But, if our  debt, in six years, increased from $24,740 to $117, 356.62 (i.e. increased by $92,617, about $15, 436 pa), we may not be able to manage the increase.

So, the question facing us now is: will we be able to take the timely action to pare down the debt once rates start to rise? That would depend on our willingness to suffer the pain of massively lowering our living standards.

I have attached two charts that may help you visualise the challenge facing the FED.

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FIGURE 1 FRED Asset Monetary Base, 2008 to date

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FIGURE 2 FRED Asset Monetary Base, 1995 to date