There Is No Such Thing as Good Inflation

Bill Fleckenstein MSN Money February 12, 2011

2/11/2011 12:11 PM ET

By Bill Fleckenstein, MSN Money

Ben Bernanke seems to have won his imaginary battle with deflation, but he (like many others) seems oblivious to the real threat of inflation.

Related topics: prices, Ben Bernanke, Federal Reserve, economy, Bill Fleckenstein

Inflation seems to be viewed as one of the more quantifiable aspects of our economy, with mountains of data available to support or refute various points of view. The psychology of inflation, however, is a subject that gets short shrift.

Over the last decade and a half, as money printing has at times run wild, most of the "excess" has been absorbed by assets, first by stocks, then by real estate. Though prices of various goods and services would rise from time to time, businesses fought like hell to avoid raising prices and often ate price increases because the psychology of the day was that people were just not prepared to accept price hikes in the aggregate on a regular basis.

Can inflation help the economy?

Yes, the price of many items rose over time, but it happened slowly enough that folks could convince themselves, from a hedonic perspective, that maybe they were actually getting more for their money. Even the sleight of hand whereby the same amount of money bought you a smaller portion was ignored.

As unprecedented amounts of liquidity from the Federal Reserve have worked their way through the financial system and into the real world, I believe inflation psychology has changed. People have seen larger price increases in commodities and are resigned to accept them, which will set the stage for additional rounds of price hikes.

Bill Fleckenstein

Once that psychological shift becomes entrenched, it will be extremely hard to reverse, despite Fed Chairman Ben Bernanke's stated certainty that he can keep prices under control. Of course, he has also stated publicly several times that he thinks the inflation rate is quite low. (The Consumer Price Index calculation might support that notion, but it is also a complete farce.)

I would like to officially declare the topic of deflation dead. As I have long maintained, we may actually experience deflation if the bond market rebels and takes the printing press away from the Fed. However, in the absence of that, it should be clear by now that deflation is not going to visit the shores of America. (Remember, a decline in the price of stocks, real estate, art, cars or some variation of that is not deflation; it is a bear market in an asset class.)

What set me off on this rant was one of the most wrongheaded articles I have ever read in a serious financial publication. That is a pretty big claim, given all the lunacy and reckless recommendations we've seen from dead-fish analysts, talking heads, corporate executives and regulators in the last decade. But the Feb. 2 Lex column in the Financial Times, with the print edition headline, "Learning to love inflation" (registration required), may actually take the cake.

In it, the author essentially tries to argue that inflation is good for us, which I think is the financial equivalent of writing a column about learning to love drunken driving or some similar life-destroying activity.

The author begins by correctly noting, "Inflation has become a fact of life in much of the world." He then goes on to explain why that is beneficial: "Most important, unexpected inflation detoxifies overleveraged financial systems by eroding the value of fixed debts -- without going through disruptive defaults (what we call inflating the debt away)."

He then cites another "benefit": "Also, below-inflation wage increases are generally more palatable than actual cuts in the pay packet." In other words, if you trick people while taking money away from them, they won't mind so much. Of course, he does appear to understand that point when he adds, ". . . as long as the workers don't wake up too fast to find out what is happening to them."

What could possibly go wrong?

The author supports his case by citing the ludicrous belief of Olivier Blanchard, the chief economist at the International Monetary Fund, "that an increase in the target inflation rate would give central bankers more freedom to set negative real policy rates." This splendid idea would allow central bankers to stay more irresponsible for a longer period of time, as long as they target a high enough level of inflation.

Next follows this assertion: "There is a case for allowing higher inflation in the developed world, and an admission of this would help the debate." As if setting a high inflation rate target and hitting it would actually help anyone.

'Right' kind of inflation, like the right kind of cancer

The writer does seem to understand that inflation actually hurts some people: "The problem lies in the developing world, where rising commodity prices have created the wrong kind of inflation" (emphasis added). Of course, this is the big lie, that as long as inflation pushes up asset prices fast enough, and it doesn't impact the cost of living too much, you can pretend that everything is just wonderful.

In his conclusion, he seems to recognize that too much inflation in the industrialized world could lead to trouble via turmoil in developing countries, but he doesn't seem too concerned about it.

My point in bringing all of this up is that, obviously, the FT is a very important paper, and to have it lend its influence in support of inflation by saying that it is a net benefit for the world really crosses the line from mere opinion into editorial negligence -- if not Orwellian "ignorance is strength" propaganda.

This column is a synopsis of Bill Fleckenstein's daily column on his own website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles. To comment on this article or on MSN Money in general, please send e-mail here.

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Mail"},"omniAccount":"MSNPORTALSCP","ratingsControlId":"ratCntrlBinary","ratingsItemId":"scp:bbcdiscussion:592f8650-6378-4f8f-8033-422a99efbcf0","appUri":"http://social.msn.com/boards","pageUrl":"http://money.msn.com/currency/no-such-thing-as-good-inflation-fleckenstein.aspx","ratingTags":["00120065-0000-0000-0000-000000000000","00000065-02a6-0000-0000-000000000000","ART"],"fblkShow":false,"fblkAppId":"","fblkRef":"","fblkTrkName":"","fblkTrkVal":"","twtShow":false,"twtTrkName":"","twtTrkVal":""}); }); /**/ 1CommentNewestOldestBestWorstControversialb_capp4 hours ago

Yes, the Fed chief, Ben Bernanke, is ATTEMPTING to create inflation ... but this will eventually backfire ... when the created inflation prevents the culture from functioning as 'planned.'

In the current economic environment ... there is simply no way to pass through inflation to the 'end consumer' ... which will eventually balk at high prices ... and will ... stop driving to the movies ... stop going on vacations ... stop buying new clothes every month ... stop buying electronic phones ... AND/OR ... stop paying the home/car mortgage.

Why so?

Because this time around ... instead of a 'tech stock bubble' ... or a 'housing bubble' ... the global economy is about to have a 'commodity bubble' ... which ... as most important commodities are 'consumed on a regular basis' ... are not 'normally treated' as assets like they should be. Such a bubble does not 'help the end consumer' ... like the previous two bubbles may have. Eventually, the inflation will become 'unacceptable to most' ... and when 'most people' can't afford to drive to work ... the culture will change ... and a lifestyle/way of life which had been deemed 'valuable' ... will instead be labeled 'worthless.'

When that happens the stock market ... AND THE CURRENCY ... will have little real value. So how soon will it happen? Sometime in the next three years is my guess ... but my guess is India folds first ... as the average person in India devotes half of his daily income to food costs. When such developing nations 'slide' ... that will take the pressure off of crude oil demand for a few months ... but eventually ... as more and more light sweet crude is demanded ... and supply can't keep up ... eventually .. Paul Krugman's keynesian global economy ... WILL FALTER.

Ignoring possible armed conflict ... more than likely ... the USA, Japanese, and Euro nations will crack ... as they are all 'net transportation energy importers' ... before Norway, Great Britain, Australia, Mexico, and Russia ... which are mostly 'energy rich' and net 'commodity exporters' ... and thus their economies will not slide to the degree of the USA or Japan or Eurozone. Google 'eia gasoline refinery yield' ... and look at the finished motor gasoline yield chart. When it dips below 42% ... and stays there for a year ... that's when you'll know Peak Oil has hit ... and the 'car culture' is over.

Some might say I have a negative attitude ... my response is ... I find it unlikely a culture which has spent a hundred plus years building strip malls, drive thru fast food, interstates, and airports ... can adjust and compensate to the diminished light sweet crude oil natural resource ... within a ten year time span.

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In his conclusion, he seems to recognize that too much inflation in the industrialized world could lead to trouble via turmoil in developing countries, but he doesn't seem too concerned about it.

Yes, the Fed chief, Ben Bernanke, is ATTEMPTING to create inflation ... but this will eventually backfire ... when the created inflation prevents the culture from functioning as 'planned.'

Why so?

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There Is No Such Thing as Good Inflation

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