Showing posts with label Inflation. Show all posts
Showing posts with label Inflation. Show all posts

Wednesday, January 26, 2011

Should Your Investmests Be In Stronger Currencies?

Inflation is being manifest in commodity prices. Food prices topped the high they reached in 2008. Producer prices were up 4.1 percent over a year ago driven by commodity prices. An oversupply of dollars is behind the global commodity boom as we export our inflation to the booming BRICs.

Portfolio manager, Bill Gross manages more bonds than anyone in the world.  Pimco's founder talks to Barron's Michael Santoli  on the improving economic outlook for 2011. Problems loom with declining dollar, government debt and high unemployment:

Meanwhile, the Reserve bank of India has raised its benchmark rates, yet prices may be outpacing the increases in rates. Dow Jones Newswires' Mark Cranfield reports:

Thursday, January 07, 2010

Requiem for the Dollar

Constantine the Great created the solidus, a gold coin that held its value well enough to be a monetary standard for seven hundred years.  The Bretton Woods monetary system survived a quarter century.  The U.S. dollar is worth maybe 5% of its 1900 value.

Jim Grant, the sage of the bond market, writes in the Wall Street Journal a lengthy, witty, thoughtful, and ultimately depressing "Requiem for the Dollar. "  He tells us, "To give modernity its due, the dollar has cut a swath in the world. There's no greater success story in the long history of money than the common greenback. Of no intrinsic value, collateralized by nothing, it passes from hand to trusting hand the world over. More than half of the $923 billion's worth of currency in circulation is in the possession of foreigners."

Yet like all great schemes it has its limits.  "But now the world is losing faith, as well it might. It's not that the dollar is overvalued—economists at Deutsche Bank estimate it's 20% too cheap against the euro. The problem lies with its management. The greenback is a glorious old brand that's looking more and more like General Motors.Ouch!  Take away my membership in the American Economics Association before you compare me to Rick Wagnoner!

The strength of the dollar is of both economic and geopolitical significance. 

Stable monetary values make economic calculation easier and facilitates prosperity.  Unstable money gives incentives to speculate and invest capital and human energy into unproductive activities.  Diverting human and financial capital form productive activity makes society poorer.  It is one of the two legs of Robert Mundell's "policy mix," which not only won him a Nobel Prize, but also is the foundation of Supply-Side Economics as Brian Domitrovic demonstrates in his new book, The Econoclasts: The Rebels Who Sparked the Supply-Side Revolution and Restored American Prosperity.

Our current international financial system has no anchor in the real economy.  We have floating exchange rates that float whithersoever the whims of speculators send them.  Wallace and Sargent demonstrated three decades ago that floating exchange rates have no equilibrium.  The result is uncertainty in trade, profits for banks, and the diversion of many clever folk into speculation.

President Obama's new realism (see "Is there an Obama Doctrine?" in the Economist) seems to say that we as a superpower will assert our selfs, if we can afford it.  With such an anemic dollar it is hard to say we will afford much!

Saturday, February 14, 2009

Inflation is Bad, What about Asset Price Inflation?

You may be surprised to know who wrote "By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some." The author is one of the finest economists of the twentieth century, an economist much mistreated by both his enemies and his followers, John Maynard Keynes. The quotation is from one of my favorite books, The Economic Consequences of the Peace. (Thurston Veblen reviewed the book with an ideological prism that seems quaint in retrospect.)

Note Keynes was an inflationist only in the starkly deflationary post-World War I Britain which returned to the Gold Standard at the pre-war parity. This policy forced Britain into a difficult deflation of prices and a real economic adjustment of heart wrenching dimensions. The alternative was to have Britain devalue the pound, undermine London's position as the world's capital market, and effectively default on its war debt (i.e., "Here we will pay you back the war debt, but with pounds that buy less in gold.") Britain chose economic and human disaster over financial disaster, although the choice was less obvious than my words suggest.

Why is inflation bad? It creates arbitrary redistributions of wealth and it distorts incentives. The lesson our current financial custodians fail to understand is that over expansions of credit sometimes result in the inflation of asset prices rather than the inflation of commodity prices: it inflates the prices of stocks rather than flows. But that also is unfair. They may perceive that positive conclusion. What they may fail to understand is its normative implication that asset price inflation is bad: that it too creates arbitrary redistributions of wealth and distorts incentives. Anyone who doubts that should look to the asset price bubbles of the late 1980s (house prices in New England and California); the dot com bubble of 1995-2000; and the housing bubble of 2004-6. Each created arbitrary redistributions of wealth. Each distorted incentives and created a misallocation of resources. Misallocations of resources can not be undone without pain.

In 2002 through 2004, Alan Greenspan worried about deflation: Commodity prices might fall! As the comedian in the Catskills might say, "We should have been so lucky already!"

Corrections made 1/31/2011

Wednesday, November 26, 2008

Are Stocks Cheap? Will They Get Cheaper?

Martin Wolf in the Financial Times tells us, "Why fairly valued stock markets are an opportunity." With the above graph, he looks at the long run fluctuations in Tobin's Q and cyclically adjusted P/E ratios. He gets the former from Andrew Smithers. The latter comes from Robert Shiller.

To my eye, it appears that long run market trends are associated with inflation regime shifts: the World War I inflation, the resumption of the gold standard, Bretton Woods, the Great Inflation of the 1970s beginning in the mid 1960s, the Vocker retrenchment, and the Greenspan punchbowl (i.e., "We do not prick bubbles and we live in fear of the demon deflation." The traditional role of the Fed was to take away the punchbowl just when the party got interesting.)

The valuations in the 1940s and 1950s may be understated, particularly for Tobin's Q. The government accelerated the recognition of much capital investment as part of the war effort in World War II. some economists believe this led to an underestimation of the capital stock and perhaps also an understatement of reported earnings and equity.

How sanguine should we be? Wolf concludes, "investors with long time horizons (the relatively young, or institutions) are, for the first time in almost two decades, confronting attractive, although not sensationally attractive, market valuations. ... nevertheless, formidable pressures for further falls in valuations, as leveraged players continue to be forced to offload assets at bargain prices."

Wednesday, September 17, 2008

The CPI is down!

The Wall Street Journal's Kelsey Hubbard and Kelly Evans discuss the first "good news" on inflation.

Saturday, August 23, 2008

Maybe Bernanke Should Learn Portuguese

Brazil's central bank has raised its policy rate to 13%. Our Fed has the federal funds rate at 2% or two hundred and sixty basis points below inflation. So who is following a Third World monetary policy? The home of Embraer or Boeing?

Henrique Meirelles is the head of the Banco Central do Brasil and he understands his job description.

Antonio Regalado and Joanna Slater relate in today's Wall Street Journal, "During one of Brazil's many past bouts of high inflation, Henrique Meirelles recalls, he and his maid had a deal. On payday, she didn't have to work. That way, she could rush to the store and spend her entire month's salary before it became worthless.

"Mr. Meirelles is now head of Brazil's central bank, and the country's inflationary past is a big reason why he now ranks as one of the world's toughest inflation fighters. Even as the global economy slows, the Banco Central do Brasil has acted more aggressively than many of the world's central banks against inflation, raising short-term interest rates to 13%. The bank is expected to raise rates again in September."

The whole article is quite interesting. My favorite quote comes when Senhor Meirelles explains there is little "room for leniency. When there is disequilibrium between supply and demand, he says, it will be corrected in one of two ways: higher prices or higher rates.

"'The big advantage of using the interest rate is that you have someone in the driver's seat. When inflation is taking care of it,' he says, 'no one is driving.'"

A Global Approach Is Needed to Beat Inflation

Adam Posen is an astute observer of international economics and the Peterson Institute for International Economics. His colleague, Arvind Subramanian, is a Senior Fellow. Here they give some sage advice to the worlds central bankers in a commentary on The fed has set off a world wide inflation and I will take teamwork to defeat it.

A global approach is needed to beat inflation

By Adam Posen and Arvind Subramanian

The Financial Times: August 21 2008

The world’s top central bankers meeting in Jackson Hole this weekend should do more than bemoan their respective financial risks. They should hammer out a joint approach to reducing global inflation, centred on a common public commitment to tighter monetary policies. Moreover, with the European Central Bank and a few emerging market central banks (such as those of Brazil and India) having taken the lead, the spotlight should be on the US Federal Reserve and People’s Bank of China. They must participate in this effort, rather than try to free-ride – which would only delay and increase the cost of their own inevit­able tightening.

The view of many central bankers is that there are few if any gains from monetary policy co-ordination. This view profoundly misreads the present situation.

Wednesday, July 16, 2008

Inflation Hit 5% in May

These are numbers Ben Bernanke and his colleagues at the Fed can not ignore. Inflation is sucking out purchasing power from the economy faster than any stimulus can add it back. The way to fight the recession is to stop inflation now.

The ECB's Monetary Policy Is Tighter But the Eurozone's Inflation Is About As Bad as Ours.

Elga Bartsch and Joachim Fels, managing directors at Morgan Stanley, wrote in yesterday's Wall Street Journal: "The main driver behind rising global inflation pressures is well understood: a very lax global monetary policy stance, particularly in the U.S. and in many emerging-market countries. This has fueled higher food and energy prices, and other prices are likely to follow – especially as most central banks around the world are unlikely to tighten policy sharply anytime soon.

"So it is not surprising that inflation is rising everywhere. What does appear puzzling is that, at 4%, euro-area inflation is at about the same level as that in the U.S. and has actually risen by a greater amount over the past year. That's despite a significant appreciation of the euro against the dollar during the same period."

The solution they suggest may be microeconomic rather than macroeconomic: structural reform.

Thursday, July 10, 2008

The IMF to the U.S. and the Other Top Economic Powers: Inflation Must Be Your Chief Concern

Dominique Strauss-Kahn, Managing Director of the International Monetary Fund (IMF) told the leaders of the Group of Eight (G8) July 9 in Hokkaido, Japan that inflation should be the top concern of policymakers confronted by higher food and fuel prices.

The Fed's Inflation Is Driving Wichita's Raw Materials Costs Up

Dan Voorhis reports in the Eagle that "The skyrocketing cost of commodities is putting the squeeze on many Wichita-area manufacturers and wholesalers.

"The leading commodity indexes have risen between 45 and 55 percent in the past 12 months.

"Commodities are raw materials -- such as oil, aluminum, wheat and lumber -- that make up everything consumers buy."

According to Ken Vandruff in the Wichita Business Journal, "Airxcel manufactures air conditioning and heating equipment for recreational vehicles, schools and the telecommunications industry." To produce RV air conditioners, as does Wichita's Airxcel, you need to buy aluminum, steel, and other raw materials. Aluminum prices are up 18% over a year ago. Dan Voorhis quotes "Gary O'Neal, division manager for Central Plains Steel in Wichita," to the effect that hot rolled steel is up 80%.

I am quoted as placing the blame on the worldwide inflation set off by the over expansion of dollar denominated credit. What the ten wisemen at the Fed seem to have forgotten in their haste to deal with the credit crunch is that a general inflation first shows up in commodity prices. Moreover in the three rounds of accelerating inflation Americans suffered through during the Great Inflation of the 1970s, food price inflation was a leading indicator of general inflation. Our own regional Federal Reserve Bank of Kansas City president, Thomas M. Hoenig, has frequently been an inflation hawk, but he rotated off voting membership on the Federal Open Market Committee in January.

-Malcolm C. Harris, Sr., Professor of Finance, Friends University

Monday, July 07, 2008

The ECB Has Focus

The European Central Bank (the ECB) has one focus in its mandate, inflation. It takes that single mandate seriously. While the U.S. Federal Reserve drove the federal funds rate to 2% two hundred and twenty basis points below the U.S. inflation rate, the ECB has raised rates. The ECB's policy rate is now at 4.25%. Here the Wall Street Journal's Joellen Perry questions Jean-Claude Tichet, the ECB President.

Read her article here.

Friday, July 04, 2008

A $64 Billion Dollar Beer?

Robert Mugabe has long been an embarrassment to Africa. He has built a totalitarian regime on the crudest thuggery. Now he is committing economic crimes against humanity. Zimbabwe's hyperinflation is, to the extent it is measurable, running at a million percent, according to David Gaffin on Marketbeat. The picture on the right shows how many bank notes are needed to buy one bottle of beer. But that was a few days ago, prices change minute to minute.

Supplying paper to print the currency has been a lucrative business for a Bavarian company, Giesecke & Devrient. The Wall Street Journal describes it as "a secretive, family-owned Bavarian company that once made its money churning out worthless cash for the doomed Weimar Republic in the 1920s." Giesecke & Devrient "has been airlifting tons of blank notes to the Zimbabwean capital Harare. The company, which has been doing business with the African nation since before Mr. Mugabe took power in 1980, is one of the few sources in the world for the specialized paper that is so important in an age when computers and laser printers have made forgery easy."

What is Zimbabwe's fiscal policy? It is the same as its monetary policy: have paper will print! However that may end. Under pressure from the German government, Giesecke & Devrienthas stopped supplying Mugabe. Will the Chinese now supply his printing presses?

Wednesday, June 11, 2008

The Economy Needs Shock Treatment

The chairman of the Federal Reserve has finally noticed that the dollar is making Latin American currencies look strong. His speech to the International Monetary Conference, in Barcelona, Spain was widely interpreted as “jawboneing” the dollar up. What is really needed is shock treatment: a large and unexpected hike in the federal funds rate. Bernanke’s attempt to fight the recession and the credit crunch by flooding the world with liquidity is instead drowning the economy in a flood of inflation and sinking the financial institutions he hoped to save.

What caused the Fed’s Chairman to finally notice the dollar?

Firstly, inflationary expectations are red hot. The market for indexed treasury bonds indicates investors are expecting inflation of 3.4 percent over the next ten years. That is based on data from the Cleveland Fed. Investors are voting with their dollars that the Fed is way off its 1-2 percent inflation target. Households are telling pollsters a similar story. Last month, when the University of Michigan asked consumers what they expected inflation to be over the next twelve months, they answered 5.8 percent. That is the highest reading in twenty-six years. What they told the Conference Board was an even scarier 7.7 percent (a record high survey result.) Lynn Franco, Director of its Consumer Research Center said "Consumers' inflation expectations, fueled by increasing prices at the pump, are now at an all-time high and are likely to rise further in the months ahead." The last time households were this pessimistic about prices, they were the walking wounded still skeptical about Paul Volcker’s epic war against inflation.

Secondly, import inflation is sucking purchasing power out of the economy so fast that it is aborting any potential recovery. Import prices rose 17% over the last year. America imports $2 trillion worth of goods and services. Do the math: that is a loss of purchasing power of about $340 billion. That is more than twice the size of the fiscal stimulus package.

Thirdly, inflation on domestically supplied goods is taking away another $200 plus billion of purchasing power. As inflation gets more and more entrenched, the economy will become progressively more immune to fiscal and monetary stimulus.

Fourthly, the monetary mavens at the Fed have started to realize their big mistake. By focusing on the so-called “core inflation rate,” they took their collective eye off the ball. The Fed has targeted “core inflation” at the expense of “headline inflation.” What the Fed calls “headline inflation” measures the rise in the prices of what we actually buy. Little wonder that makes the headlines. We measure “core inflation” by pretending we do not eat, do not feed the kids, do not heat and cool the house and do not drive the car: we subtract food and energy prices from the price index. The theory is that “If core inflation is OK, we are OK.” The Fed thinks we are OK. A trip to the supermarket would have cured that delusion. While oil prices have had the lion’s share of the headlines, food price inflation has really hit American households hard. It is those trips to the supermarket that have the American consumer hopping mad. Food prices are rising at two and a half times the “core inflation” rate. Consumer inflationary expectations are tracking food price inflation much more than they did in the past. Worse, given the rapid rise in inflationary expectations, this is going to start bleeding into wages and the prices of other goods and services. If you look carefully at the Great Inflation of the 1970s, that nightmare we all want to avoid reliving, food prices consistently led both “headline inflation” and “core inflation.”

Lessons of the 1970s

A sober economic historian would judge the years 1973 to 1982 as the worst decade in the last sixty years. The misery got started when another Fed Chairman, Arthur Burns, pumped up the supply of money and credit to achieve domestic objectives (reelecting the president.) The money supply grew 13.4% and liquidity assets in double digits in 1971. With the dollar as world’s reserve currency, exported his inflation to the rest of the world. The main economies started expanding in unison setting off a global commodity price boom. Oil prices, then as now, only took off after the bandwagon already had a powerful momentum going. In short order, the dollar was devalued and the international monetary system thrown into chaos. New York started losing ground as the world’s financial center to London and others. The economy went into a severe recession as inflation sucked purchasing power out of it and inflation disrupted economic decision-making. After a decade of accelerating inflation and three recessions, economic sanity was restored with much pain and suffering. Vast amounts of wealth were redistributed and unemployment averaged seven percent.

I am experiencing a terrible feeling of déjà vu. In the U.S., an overexpansion of credit caused a house price bubble, particularly for high-end houses. This was fed by and help to feed the creation of ever more complex financial instruments whose connection to the underlying fundamentals was evermore distant. As with all speculative excesses, this one too had to come to an end. As these distortions started to correct themselves, the housing market turned down. The esoteric instruments born in the boom had been sold globally. Investors around the world started to realize that they had bought a pig in a poke and the pig was now starting to stink. The resulting stampede to sell these securities led to a credit crunch. The Bernanke Fed’s initial attempt to deal with the crisis was to flood the world with liquidity and slashing the federal funds rate. The result was uncomfortably like being in a house where someone in the living room is cold. This thin-blooded soul jacks up the thermostat so that everyone else is sweating. A wiser solution would have been to put on a sweater or get a space heater.

Monday, June 02, 2008

A Tip from the TIPS Market: Investors are Expecting More Inflation

Inflationary expectations are growing. That comes across loud and clear from a number of surveys:

When the Conference Board surveyed households in May they found they expected an inflation rate of 7.7 percent for the year ahead (a record high survey result.) Lynn Franco, Director of its Consumer Research Center said "Consumers' inflation expectations, fueled by increasing prices at the pump, are now at an all-time high and are likely to rise further in the months ahead."

The University of Michigan reports that households expect inflation over the next five years to be near 3.4 percent, its highest reading since 1995.

The professional forecasters surveyed by the Federal Reserve Bank of Philadelphia (the old NBER/ASA survey) projects inflation over the next five quarters at 2.5 percent.

Another gauge is the difference between regular treasury bond yields and those on Treasury Inflation-Protected Securities (TIPS.) Currently the spread is 2.45 percent which would appear to indicate that investors expect a 2.45 percent inflation rate over the next ten years. But that may understate investors' true expectations. The Federal Reserve Bank of Cleveland adjusts the raw spreads for liquidity premia. Charles T. Carstrom and Timothy S. Fuerst explain how that is done in a briefing. With this adjustment the implied expected inflation rate is 3.32 percent.

Saturday, May 31, 2008

Will Our Global Inflation Cause Bonds to Again be "Certificates of Confiscation?"

Min Zeng and Liz Rappaport noted in yesterday's Wall Street Journal that "Treasurys are in their worst selloff in months as investors return to riskier assets and have second thoughts about government debt in the face of inflation concerns." More fundamentally, investors now realize the credit crunch has been dealt with by a vast overextension of short term credit by the U.S. Federal Reserve. This has set off inflation in the U.S. and a global commodity boom that dangerously resembles the beginning of the Great Inflation of the 1970s.

Historically investors have had to protect themselves against rising inflation by demanding higher yields. There is a nasty lesson every bond market neophyte learns quickly and painfully: higher yields mean lower prices. In the 1970s, bonds were called "Certificates of Confiscation," because their losses were so great. The bonds' principal kept losing value in real terms as inflation eroded their purchasing power. Then prices fell each time inflation accelerated. Investors marked them down to keep yields up with inflation.