Fleck-Why all roads lead to inflation
A combination of global expansion and money printing to avoid today's economic pain has set us up for tomorrow's spiraling prices.
By Bill Fleckenstein
Inflation is a topic that does not receive enough attention. I'll try to address that deficiency in this week's column.
Regular readers know my motto (which is on the masthead of my Web site): "In a social democracy with a fiat currency, all roads lead to inflation." Over the past couple of decades, through all the occasional chatter about deflation, I have resolutely maintained that deflation would not be the outcome we would see because the Fed would do what the Fed has done.
One major force helped hold inflation at bay during the 1990s: globalization. As Jim Grant points out in a brilliant essay titled "The Close of the Era of Peace and Quiet" in the current Grant's Interest Rate Observer (subscription required): "Between the early 1980s and the late 1990s, an estimated 2 billion new pairs of hands had joined the global labor force. Employers never had it so good, especially so in countries like the United States, where relocation to low-cost meccas of the East was no idle threat, but an actionable business plan."
Cheap labor, when combined with the technological advances of the late 1990s -- which were powerful, though no more potent than those we'd seen in the 1920s and 1960s, for instance -- helped offset the Federal Reserve's money printing.
However, in the wake of the stock bubble, that money printing set off the U.S. housing boom and began to cause different consequences.
In addition, because so many countries see their currencies as linked to ours, the Fed's money printing has led to global money printing, which continues to this day. And, in the wake of the mortgage debacle, we have once again chosen to flood the system with easy credit. That has forced parts of the world in the late stages of an economic boom, with already-high inflation rates (such as the Middle East and some Asian countries), to follow our ill-advised and shortsighted policies.
The global boom's bite
Exacerbating those inflation trends is the synchronized economic boom that the world has enjoyed for the past couple of decades, which is a major focus of Marc Faber, the editor of the Gloom, Boom & Doom Report (subscription required).
Combining Grant's and Faber's views, we see that the first decade of the global economic boom and the attendant expansion in the labor force held inflation in check. Now those laborers all over the world want more money, and economic expansion in countries everywhere is creating a tremendous drain on the world's resources, leading to higher commodity prices (exacerbated by more money printing).
That, ladies and gentlemen, is a recipe for accelerating inflation. And that is not going away anytime soon.
As Faber pointed out to me during our recent meeting: "Central bankers have become hostage to inflated asset markets. Tight money will be difficult to implement."
In fact, Faber says, tight-money policies will be impossible to put in place, given the socialization of central bankers.
Get used to higher prices
I believe inflation will be with us for quite some time. Only when money printing leads to a collapse in the dollar or in the U.S. Treasury market will there be any possibility of the asset-market declines we face actually turning into the deflation that so many people still seem to expect.
While on the subject of inflation, Faber pointed out something about the Consumer Price Index that I had not been aware of (even though I'd known the CPI was a cheat and had devoted a chunk of a chapter in my book to that topic): In addition to the errors in the CPI that I routinely talk about -- those being hedonics and substitution -- he says food and health care are underweighted in the CPI. In fact, the U.S. counts food as only 8% of the index. Whereas, it counts for about 10% in the United Kingdom, about 15% in the rest of Europe and more than 18% in Japan.
Interestingly, if you look at the proportion of U.S. household spending on food, by income quintile, all but the top 20% of earners spend at least 20% of their paychecks on food. Thus the CPI weightings understate what is already an understated rate.
Inflation not only robs people of their wealth, it steals from their discretionary spending. It's hard for U.S. consumers to keep buying discretionary items when food and energy take up so much of their paychecks. Of course, that makes a mockery of the Fed and anyone else silly enough to talk about inflation without food and energy -- and have the nerve to call that reduced rate the "core rate." Many farces have been perpetrated in the past couple of decades, but none is more absurd than that.
Inflation and a global bust
Back to the current Grant's Interest Rate Observer, where Grant writes: "The president of the World Bank, Robert Zoellick, speculates that inflation has pushed 33 countries to the edge of civil insurrection. If globalization has made one world economy out of a myriad of national economies, it follows that inflation is a world problem, not a localized one."
Indeed it is.
Rising inflation is one feature of the late stage of an economic cycle, as it seems the landscape is dotted with cranes (and I'm talking about the metal ones, not the kind that can fly). The world itself could be looked at as one economy in the late stages of a business cycle -- in which capital spending is exploding, especially in fast-growing regions such as Asia, the Middle East and parts of South America. Inflation is rising, and certain sectors are starting to have problems.
The U.S. can be considered one of those sectors, with the burst real-estate bubble already starting to impact demand in the world while inflation is eats away at the world's ability to consume.
That leads to one of Faber's conclusions: "It is quite likely that the current synchronized global economic boom and the universal, all-encompassing asset bubble will lead to a colossal bust." In other words, the synchronized boom will have a synchronized bust.
What folks would like to know is when that will happen. It's impossible to say, but Faber would not be surprised if it were to occur in the next couple of years (though I expect it could happen sooner). We do know that when an economy enters the late stages of an economic cycle, what happens next is a slowdown, though we cannot know whether that slowdown will be dramatic or gentle. What we know is that the likelihood is quite high, given that the latest worldwide economic boom is now quite old.
When more debt doesn't do it
Faber points out a major concern: The debt-burdened U.S. economy may have reached "zero hour" -- that being when a dollar of new debt has no incremental positive impact on U.S. gross domestic product.
For the past 30 or 40 years, it's taken increasingly larger amounts of debt to increase GDP. From 2000 to 2007, total credit market growth was $21 trillion, and nominal GDP growth was only $4 trillion. We have reached the stage where a dollar in debt produces only 20 cents or so in economic growth (versus about 90 cents produced in the 1960s).
Although it's impossible to know whether we will actually reach zero hour, it does seem possible when thinking about adding more debt to a post-housing-bubble economy. An economy that reaches Faber's zero hour is one in which increasing debt creates no growth. It only increases prices.
The unanswerable question is how long the world debt markets will allow inflation to ratchet up before they start to decline, as they price in, say, a 6% inflation rate and 2% to 3% of "real" yields!
Faber offered that either the debt markets will have to crack or commodity prices will have to break -- though if commodities were to break, he suspects the break would be temporary. (Of course, "temporary" could be measured in many months.)
At some point after the world's current boom ends and a slowdown begins, growth will resume and the supply-and-demand problems in commodity markets will persist.
Bottom line: Over the long term, inflation is liable to stay with us, and interest rates are headed higher, although the ebbs and flows of economic strength and weakness will have an impact. |
