The Inflation/Deflation debate seems to be constantly coming up — from clients, institutional accounts, and the media. Let’s look at a few points on this:
Deflation is a fact. It is happening now, it is real, and we see it in the actual data.
Inflation does not exist presently. It is, at best, an opinion. It might happen in the future, or it might not — but it does not exist, at least on a measurable form, presently.
What about deficits? Debt? Overspending? QE/ZIRP/Low rates?
Well, Japan cut rates, wildly overspent, borrowed like loons — and they had a decade plus of deflation, not inflation. We may not be Japan, but they are the 2nd largest economy in the world, and represent an actual economy that behaved, well, the way the US is.
Until the slack in the labor market is reduced — near record low weekly hours, 16% U6 unemployment, etc. — inflation simply is not a threat.
The 10 year Treasury Bond is at record low yields, so bond buyers are looking for more economic softness, not inflation.
The first heads up about inflation you will see will be when the Bid to Cover ratio of the Treasury Bonds — how many buyers are there relative to bonds for sale at US auction — right now, its oversubscribed 3X. Once buyers start insisting on greater yield, the Treasury department will have to start raising the bond rates they offer — we will know that Bonds are a short, due to impending inflation.
That will be your early inflation warning.
But now? Its nowhere in sight . . . .
You forget asset inflation due to liquidity in the financial markets. Are commodities really worth today’s prices or would they drop considerably if commodity markets ratcheted down a lot of the financial innovation of recent years, causing a lot of the cash commodities are floating in to go somewhere else? Likewise, how much of today’s stock price is based on corporate performance and how much is just leftover sugar high from the Fed’s last injection of $1.5t directly into financial markets?
When inflation comes back it will be back with a vengeance
BR, I have Kohler, GE and Verizon ads rolling all over your site with a vengeance, GE looks like an infomercial
“Until the slack in the labor market is reduced..”
If those jobs were exported rather than being lost to the recession, the expectations change. The slack may now be permanent, or at least persistent. However, there could be shortages in specialized areas. Workers may not be as interchangeable as they may have been decades ago.
I used to think all this monetary madness would yield inflation. But it hasn’t and it doesn’t appear that it will–anytime soon anyways. Velocity seems to be declining faster than money supply can increase.
The problem is directly tied to expansive monetary policies throughout the aughts and even before. When the Fed tried to prevent price declines (mostly after 9/11) that structurally should have been happening because of efficiencies in production and lower cost international labor, it effectively instigated the production of vastly more products and services than the economy actually demanded–from houses to cars to widgets from China. Until this oversupply is worked through, more money will not mean inflation. It will perhaps forestall some price declines that should be happening, but all the money in the world wouldn’t make the price of ice increase for an Eskimoe.
Bill Gross was interviewed by Bloomberg yesterday and pinpointed the real source of deflation–demography–and observed that efforts to spur consumption are just a waste of money in the face of declining demand due to demographic forces. He wondered whether capitalism can survive without population growth. So do I. A summary of the interview can be found here:
http://www.bloomberg.com/news/2010-07-28/gross-equates-spending-to-lift-consumption-with-flushing-money-down-toilet.html
This leaves open the question of what is the signal that triggers buyers to stop purchases of treasuries and insist on a greater yield? Is high inflation something we can ‘foresee’? Seems like quite a chicken-egg scenario. I guess you can only keep an eye on the data to assess when the deleveraging cycle might be beginning to turn.
I must admit there is something in Hugh Hendrys observation that in prior years investors were unquestioningly snapping up trillions in issuance of synthetic bonds, but now that treasury is doing the same there is ‘concern’ (it’s the bogeyman).
Thanks. Decisive and supported.
Great piece from Gross, Curm. Makes A LOT of sense. All that’s left is asset price stimulation.
“Deflation is a fact. It is happening now, it is real, and we see it in the actual data.”
Barry, with all due respect, we have yoy core cpi at + 90 basis points, headline at plus 110 basis points. Now, I’ll support you in all sorts of arguments that cpi is a poor measure of inflation, but it is what is generally used, and the numbers are positive. I understand the sentiment you’re expressing, but deflation, strictly speaking, is not a fact–prices have increased, admittedly at a tiny pace, over the last year.
Now if you want to accept Jim Grant’s recent formulation, one with which I take no particular issue, then yeah, I might agree that deflation is a fact. “Deflation is a crisis of money and credit, a sympton of which is falling prices.”
cheers
The stipulated event will be no harbinger of inflation but instead will merely be verification that private domestic investment is no longer dead. Look at TIPS spread for inflation indications.
BR –
Disagree with you on the early warning being expressed through the bid to cover ratio on US bonds.
If the Fed guys US bonds, it can keep the bid to cover ratio high and simply can print money for its purchases (QE).
Should this happen, you will see first a downward move in the US dollar, to the extent market participants even understand that money supply is increasing —
Then, as investors understand money supply is increasing / the dollar is depreciating, you may see yields backing up to the extent investors expect higher inflation, since the US imports more than it exports and will be paying for imports in depreciated dollars…..
Then you may see the worst of both worlds: further decreases to the dollar, further increases in US yields, etc.
To the extent the public knows that the Fed is using QE, that may only make the dollar depreciation worse….
It is a good piece re: Gross’s view, but it paints the demographic picture in the developed world with too broad a brush.
The U.S. is in a very different demographic situation than both Japan & Europe. Our population is still growing, and there are plenty of skilled, intelligent potential immigrants clammoring to move to the U.S. if only silly H1B visa restrictions were eliminated.
One of the best things we can do to encourage growth in the U.S. is to allow visas for more of these skilled potential immigrants…
BR –
Regarding your assertion that inflation may not occur in the future —– I believe the Japan analogy is seriously flawed: Japanese debt was sold to the Japanese and as a result they do not have a high level of foreigners who have to keep buying their debt.
All foreigners have to do is cut down on buying US debt and there may begin to be dollar weakness resulting in ncreased inflation in the US.
NOTE BR – you were great on calling the housing crisis — part of that was understanding that just because an unsupportable position existed for a long period of time does not mean it will not ‘correct’ or adjust one day.
I would argue that Inflation in the US has these characteristics — better to have some protection for this event while it is cheap and nobody believes it will happen, but don’t bet the farm because you could be very, very early.
Drip after drip of deflation data
Forgive me if I am becoming a "leading indicator" bore but these turning points in the cycle are fascinating. The US Conference Board's index of consumer confidence fell again in July to 50.4 after plunging in June.
"Concerns about business conditions and the labour market are casting a dark cloud over consumers that is not likely to lift until the job market improves. Given consumers' heightened level of anxiety, along with their pessimistic income outlook and lackluster job growth, retailers are very likely to face a challenging back-to-school season," said the Board.
This follows the fall in the ECRI leading indicator for last week to -10.5, a level that has always been followed by recession in the post-war era. The Economic Cycle Research Institute is careful not to jump the gun, waiting for further confirming data before issuing a formal recession call that would hurt its credibility if proved wrong by events.
All of this squares with the fall in truck shipments and rail car loadings over recent weeks.
"What we're looking at is an invisible wall, which we've run into here. Which, essentially, as far as I can see, is a typical pause that occurs in an economic recovery," said Alan Greenspan earlier this month.
"I will grant you that this is not a normal economic recovery. We've just come out of what I believe is the most extraordinary and virulent global financial crisis that the world has ever seen."
A historian (not an economist or a trader) Nial Fergusson thinks that the odds are that *you_know_what* will hit the fan almost overnight, maybe literally overnight. If he’s correct, there won’t be enough time to analyze the “bid to cover” ratios, your net worth will sustain a major damage before you can ask “WTF?”
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