Inflation inflation everywhere

We have been writing about the quickest way to resolve the Euro crisis, and in the UK and increasingly less so, in the USA.  There is a long history of taking your losses within a broken economy hard and fast.  There is then generally a real hit to GDP, many people out of work, government steps in with funding to finance new job growth as the private sector contracts, and within a short space of time there is a turnaround in the economy and it starts moving up.  Not rocket science.

During this period the central bank cleans out those banks that have made the lending mistakes, supporting those that will survive by pumping funds into the financial system for liquidity purposes, and pushes down official interest rates with the intention that lower rates will flow through the financial system into the economy to bolster consumption. 

So far so normal.  The key point is that there is a sharp contraction, and then a quick turnaround.  The McKensey Global Institute report ran the numbers and proved what us old hands already knew.  

This time round though, there have been a few problems.  First of all the GFC was bigger than previous crisis, so the pain to be taken deeper.  And the central bank in the USA, EU and UK ran out of short term rates to bolster the economy.  In the UK, it was so bad the government stepped in to take over the broken system.  And in Europe, they are taking the proven wrong road of actually taking no losses at all and saving all the financial institutions whether or not they are rotten or not. Plus counter growth policies of austerity. 

And that is how we got the new “normal” central bank economic bolster of Quant Easing.  

Well we all know this right? 

But this will be the outcome.  Inflation.  Written so eloquently by Nick Carn in Prospect Magazine.  He says it is either “bad debts or inflation”.  Meaning, Europe especially, either write off the bad debts and take the pain or expect rampant inflation as you pump money into the system.

And he is not alone, including your scribe.  But the central banks using quant easing (or derivatives of) are all playing along the yield curve, pushing down market expectations of inflation, and inflation is also not being seen in the official data.  As I have written previously.

I believe that the inflation genie is still there.  With the central banks dancing up and down the yield curve, one thing is very obvious:  the extensive money being pumped into the system is not leaving the balance sheets of the banks and entering the whole economy.  Yet.  But it will.  For the moment there is a serious credit crunch in most developed countries.  

Instead, for example, in Europe, UK and USA, the quant easing money is being used by the banks to buy up government debts / gilts.  Some suggest this is for better liquidity buffers within the system.  But that will not fix the broken economies.  Nor the banks for that matter.  The weak should fail.  

So in our view it is inflation delayed not averted.  And there are a host of problems waiting to emerge.  

Of course, as Lord Molson said (1903-1991): "I will look at any additional evidence to confirm the opinion to which I have already come." So I would agree.

So let’s look at another perspective.  Very interesting analysis here on the blog Macrobusiness.

In the blog he applies futurist Ray Kurzweil’s exponential IT curve to the financial sector.  When it has entered other sectors (than IT) it has seen the costs of products reduced to near zero.  Think the music industry and recordings, the price of which are now nearly negligible.

The problem he observes is that the problem with this effect in finance, is that it leads to self referring feedback loops that don’t occur in other industries.  Because the product in financial sector is of course:  money. This is because we measure the value of money, with money.  “And because something cannot be measured by itself, then we have lost the most important role of money — its function as a store of value. To measure the value of something effectively, by definition you have to have something else with which to measure it. “

Well I agree with the latter, and fall into the camp bemoaning the loss of gold as a store of value against which the production of money could be measured.  But it is all too late now, the genie is out of the bottle and being printed like there is no tomorrow.  We are literally drowning in money.

So I am going to take his argument further.  What does this mean for inflation?  If the price of money (unfortunately measured against itself) is going to fall and fall and fall as the price of other sectors that have experienced the IT exponential curve, then there is no inflation unless it can then be measured against what money can buy you.  So you would then expect that it would take more and mroe money to buy the same things, ergo inflation.  But this inflation is not showing up in the official statistics (yet?).

Of course another way to describe that is just devaluing the savings of the population; or deflating values of assets and income.  And we know that is already happening in most developed economies. 

It explains a lot about finance and its massive growth without seeming inflationary effect (so far).  But again I think that this is also illusory. As the value of everything in monetary terms falls in price, so then does the value of essentials rise in my view.  Especially with the rising middle class (in this generation to be 4.8 billion) and the shift in dietary wants to protein dense food.  

So I am going to return to the essentials.  Here I wrote about the potential bubble in farmland prices.  But what of the price of food, water, energy, and health?

I will end on this graph from good old trusty Investmenttools.com for the feeder cattle futures in the USA.  That looks like food price inflation to me.  Click on the graph to see a larger version.

And another tip.  If you put a US$1,000 in the bank you will earn interest rate of maybe 1%.  If you buy a cow for that amount, you will get an 80% annual return from each calf.  Now that is real investment returns, huh!

And social instability rising from this devaluation of all our money?  This erudite summary of what occurs, what has occurred, and the timing, is another of those “why write what has already been written so well”.  But it is not good news.  Although he does argue that there is a consumption strike by the general population who have been so unfairly treated in the distribution of the wealth of the economies in trouble.  That could suggest why inflation is benign, indeed in the assets and revenue of the general population there is deflation.  But he warns so clearly that this dissatisfaction will soon grow into collapses of those economies, whereby the elite also suffer. 

But they will still need food, energy, health services and shelter.  The essentials.