Inflation: Fact or Fear?
Chicago Tribune columnist Steve Chapman claims that fears of coming inflation are “unfounded.” His main arguments:
- Gold has been rising since 2000, while CPI inflation averaged under 3% per year since then—suggesting gold has been a poor predictor of inflation.
- Price increases for other commodities are driven largely by surging demand from developing countries (this explains the 10% increase in the PPI “all commodities” index over the past year)
- “Core inflation [not counting food and energy prices] is currently low” at a mere 1.2% annual rate of increase
- In the 1970s all prices rose; today it is only commodities
- The dollar has been declining against the Euro for the last 10 years (therefore no need for special worry now about Dollar depreciation in FOREX markets)
- People are still lapping up 3 year T Bills at low low 1% yields, suggesting that the bond market is not worried about inflation
- All of the Fed’s newly printed trillions are just sitting on banks’ books as extra reserves—low M2 growth indicates banks aren’t in a rush to lend and thereby create more spending money
Chapman’s points are standard fare for inflation doves. They are all either true or at least plausible, and thus should be carefully considered by inflation hawks. I’d like to challenge a few of them head on, but I need to begin by addressing the big, forest-level argument that Chapman seems to be missing on account of his detailed rendition of several individual trees.
What stokes us hawks’ fear of inflation is not so much the massive, unprecedented money printing that has occurred since 2008, but the prospect that it won’t stop nor even slow down. We’ve reached a new normal where an increasingly acceptable solution to every little crisis is to print more money.
The bailouts are pretty much over (unless you count the monetization of US debt by the Fed), but the printing continues. What’s driving it now is the unquenchable fiscal thirst of the Federal government. The Fed is buying somewhere around 75% of new US debt. Monetization is the last thing inflation doves want to talk about—it’s all monetary stimulus, don’t you know, and will be reversed when the time comes. But what if that time never comes?
For reasons I and others have discussed, meaningful Federal spending cuts (or actual spending cuts, for that matter) are not in order anytime soon. If short term interest rates exhibit any kind of mean reversion, we can expect them to eventually return to the 5% range. This fact alone will have tremendous consequences for the Federal Budget, namely a sharp increase in the interest burden of the debt, possibly offsetting any miracle spending cut that might make it past the Oval Office.
Ben Bernanke, for all his alleged genius and courage in fending off “catastrophic collapse” with the monetary firehose, is going to find himself in quite a pickle someday. Just when he thinks its time to remove accommodation and (finally) raise rates, the gutless Congress and President will need him like never before just to keep the lights on at the capitol (and the bond markets off their backs).
So I would contend, contra Chapman, that the real inflation is still around the corner. In focusing on past statistics, Chapman and the doves are building up a false sense of security. Sure, inflation is not near 1979 levels (yet!), but our reading of both the current monetary and fiscal situation, and their trajectories into the next several years, suggest to us inflation Cassandras that it’s probably too late to avoid a return to high inflation sometime soon. In other words, the die has been cast.
Now on to Chapman’s finer points. First, to say “gold doesn’t matter” is to utterly misunderstand to point of gold. Gold is wealth insurance. When the price of insurance goes up, you better believe that people are expecting a higher chance of catastrophe. Chapman basically says “aw shucks, but gold has been rising for ten years.” I think the more valid observation would be, “hmm, gold reached its last secular fiat-money era low in 2000, when the US deficit was… (hang on while I google it)… $0.” Thus the fact that gold has been rising in tandem with Federal Deficits—especially the sharp run-up in 2009-2010—should suggest something about the fears that motivate gold buyers.
What about the Dollar vs. Euro? Again Chapman claims, “nothing to see here, folks.” But remind me, in which currency are bonds of the Euro debt crisis nations denominated? And the Dollar is falling against that? Sounds heartening.
The best argument in Chapman’s salvo is probably his claim about the low low yields on T Bills right now. Why would anyone in his right mind settle for a 1% return if they thought inflation was going to exceed that? Thus “the market” has not priced in inflation risk. I can hear the doves egging us on “come on, you guys (i.e. hawks) of all people should trust ‘the market’!” Yes, markets eventually correct themselves, but people make mistakes all the time (sometimes in large groups—herds, shall we say). The “housing market” was wrong in early ’06, and the “bond market” could be wrong now. Quiz: when was the last time US government bondholders earned negative returns for years in spite of themselves? Answer: the 1970s. And before that? The 1940s. Negative T-Bill returns are nothing new.
At any rate, all markets can’t be wrong. The Gold markets seem to be saying something different from the bond markets, as well as those shorting government bonds. I wonder what Chapman would have to say about them?
To summarize my take on the inflation hawk stance: it’s mostly simmering fiscal problems—coupled with an “accommodative” Fed—that presage more inflation to come, recent statistics notwithstanding. In the final analysis, the ability of US monetary authorities to avoid a serious day of reckoning will come down to a revival of fiscal and monetary rectitude. Much as I’d like to hope our “leaders” (and “entitlement”-dependent interest groups the nation over) will somehow get religion about their spendthrift ways, I’m placing my chips on the square labeled “INFLATION.”
