Inflation Update
1. Thanks to Scott Grannis for this thoughtful response on his Calafia Beach Pundit blog to this CD post about annual M2 growth falling recently to 4.5%, the lowest growth since late 2005, and what that means for future inflation. Scott makes the supply-side case for rising inflation:
One of the key insights of supply-side economics is that free markets are excellent sources of real-time indicators that can be used to tell, for example, whether monetary policy is inflationary or not. It's rather simple: if there are too many dollars in the system, then we would expect to see some or preferably all of the following: a) the value of the dollar falling relative to other currencies, b) gold prices rising, c) commodity prices rising, d) the yield curve steep or steepening, e) credit spreads tightening (since easy money is great for debtors and should reduce default risk), f) inflation expectations as embodied in TIPS prices rising, and g) currency growth falling (currency becomes a hot potato when inflation rises, so the demand for currency should fall). All of these are symptomatic of a situation in which the supply of money exceeds the market's demand for money.
Since we have been seeing most or all of these rising inflation symptoms for the past year or so, that's why most supply-siders have been predicting rising inflation even though M2 growth has slowed down rather remarkably (M2 growth is essentially zero over the past six months). Caveat: this is a highly contentious issue about which reasonable men can and do disagree.
2. Speaking of reasonable men/economists disagreeing, the consensus forecast from the most recent (Dec. 4-7) WSJ survey of 52 professional economists seems to disagree that rising inflation will be a problem in 2010 (see chart below). The consensus forecast is for CPI inflation to be about 2% through next year, falling to 1.8% by the end of 2010.
If that is the case, annual inflation in 2010 would be the lowest since the 2.04% inflation in 2003 (December 2002 to December 2003), except for 2008, which experienced almost no inflation (-0.08%). Even Brian Wesbury and Bob Stein are predicting inflation of "only" 3.5% by December 2010, just slightly above the 2.8% average since 1990.
Bottom Line: The case for rising inflation in 2010 still seems somewhat unconvincing to me, and I guess I'll go on record as an "inflation skeptic."
11 Comments:
Bill Gross may believe 3.5% inflation (predicted by Brian Wesbury and Bob Stein) and 2% real growth (predicted by UCLA) are needed:
Bill Gross January 2007 partial interview:
Bloomberg's Tom Keene: "Bill [Gross], your note every month is always interesting. This last one is one of my favorites. As you know, I'm a big fan of nominal GDP - this, folks, is real GDP plus inflation. It's the 'animal spirits' that's out there. You say be careful, Bill Gross. It looks real good to me, Bill. I see 6% year-over-year nominal. You say that's going to end?"
Pimco's Bill Gross: "I think almost assuredly, because of oil prices. I'm not suggesting it end because of real growth going down - that's the Goldilocks scenario in which we have 2% plus or minus real growth. With oil prices doing what they're doing - if they hold in the $55 range - gosh, we're going to see CPI prints y-o-y over the next three or four months of 0.5% or 1.0% and that means nominal GDP is down in the 3% range. "Ultimately, the inflation component affects the real growth component. To the extend that you have nominal GDP - in my forecast 3 to 3.5%, that's really not enough growth in terms of the economy itself to support asset prices at existing levels. And so, declining assets prices ultimately factor into eventually lower real growth. But that's not for mid-2007 but perhaps for later in the year."
Tom Keene: "When we look at six months of low nominal GDP, is that enough to link directly into the 'animal spirits" of the business investment component of GDP - the "animal spirits" of business men and women?"
Bill Gross: "Well sure it is. When you realize that the average cost of debt in the bond market - and therefore in the economy and this includes mortgages - it is about 5.5%. If you can only grow your wealth and service that debt at 3.5% rate, then that has serious implications. When you go back to 1965, Merrill [Lynch] did this study - in terms of asset prices during periods of time when nominal growth grew less than 4%. Risk assets have been negative in terms of their appreciation and actually bonds have done pretty well. The question becomes why hasn't that happened yet, and I think we're simply in a period of time where there are leads and lags that are much like the leads and lags of Federal Reserve policy."
mjperry wrote: "I'll go on record as an "inflation skeptic." "
Well, as long as you don't become an "inflation denier"! :-)
Bret:
How in the world can one be an Inflation Skeptic or Inflation Denier when Al Gore says the Inflation Rate at The Center of the Earth is 1000%. Somehow thought that 1000% was the inflation rate on the surface of the sun?!?
I am not a reasonable man, and I still disagree.
Ain't no inflation out there.
Wages (60+ percent of prices)? No.
Housing? No, on sale.
Any gadgetry? No, gets cheaper every year.
Cars? Nope.
Food? Nope, cheaper all the time.
I get a $2 frozen burrito at Walgreens with 1000 calories in it. That is my new "lunch" and it a record low for me. I was paying $3 for burritoes from food trucks back in the 1980s.
Medical services and education? Yes, real inflation in these sectors.
Upshot?
Gold hit $900-something waaaaayyyy back in 1980-something.
It was Fool's Gold then, and it is Fool's Gold now.
Asia booming baby. Investor look West. We are entering another 20-year global boom in GDP.
Only Islamic Asia, Africa and maybe the USA will not participate, although I think we will.
Invest accordingly.
M2 is falling because of declining demand so does that mean another lost decade like Japan has been having? The S&P 500 is about even with the year 2000 mark, so some will say the U.S. has had a lost decade already.
The velocity of money is the frequency of money changing hands and so it is probably a good true indicator of economic activity grwoth.
Here is a chart via Jesse's Cafe American that shows the veloicty of M2 over the last couple of decades. Note how veolicty started to slow in the mid 1990s. This is when trade deficits started to really grow. Add to the U.S. federal deficits accelerating starting to grow in the early 2000s.
The decreasing of the velocity of money is a cul-de-sac for the U.S. that strong and determined leadership could overcome if it was present. When money leaves the country veolicity is pretty much stopped (becomes M3?)
Mr. Grannis, I would like your opinion of my punditry here, if possible.
So slow M2 growth suggest low inflation, but commodity prices and other market indicators are suggesting higher inflation. Perhaps the problem is that M2 growth is only slow relative to the existing money stock. But the real issue is the rate of M2 growth relative to economic activity. Could it be that economic activity has declined so much that even a moderate level of M2 growth is inflationary?
One definition of inflation is too much money chasing too few goods. Right now, much money is sitting in reasonably safe investments. Banks are making few loans because businesses are too worried to expand and because interest rates are so low than only adjustable rate loans make sense (to the lenders). If a large proportion of these monies get dumped into the economy, then inflation will rise well beyond 2%. If the economy picks up markedly with businesses expanding and consumers consuming, then inflation could quickly rise above 5%.
I would like to hear thoughts about what is going to happen to the huge expansion in the monetary base. Doesn't that flow out and impact m2 and other inflation indicators at some point.
It appears Bernanke intends to keep the monetary base from hitting M2 by paying interest on bank reserves. I understand how that would work, but it seems to me there would be ever-increasing bank reserves and less lending. I don't understand what the exit strategy will be.
Yeah, I figured that the interest would keep the reserves in the bank, for awhile, but it also seems to me that those reserves have to create some kind of lending leverage at some point. So I don't understand what the exit strategy is either. It would seem like the increase in the monetary base has to have some kind of impact at some point, and the increase has been HUGE.
Since March, import prices (all items) are up about 10%. Foreigners want more dollars for the same items because they are worried about our deficits and the dollar ($1.4 trillion budget deficit, $300B monetized debt, $900B in created money to buy mortgage debt). Inflation is coming!
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