The 'Flationistas Are Flat-Out Wrong
By Ron Insana
Many pundits have suggested that the surge in the stock market, the comeback in commodities and the recent rise in interest rates is a sure sign that inflation will quickly become our next long national economic nightmare.
I'd like to kill this inflation debate before it ever gets started. The wrong-headed view of the 'flationistas could lead policymakers to prematurely end the programs that are preventing a two-year meltdown in our financial system and our economy from becoming a 1930s-style disaster.
Further, the 'flationistas who are issuing these Cassandra-like warnings could not be more misguided about the direction of the economy in general (and inflation specifically) over the next few years.
First, we are still in a period of deflation! Although stock and commodity prices have bounced off of their bear-market lows -- and quite impressively, I have to admit -- they are still well below their all-time highs of recent years.
Indeed, the stock market would have to nearly double, and prices of commodities such as oil or copper would have to triple, to bring us back to levels deemed inflationary by the Federal Reserve and other policymakers.
Broad gauges of commodity prices are far from flashing any warning signs of imminent inflationary pressures.
This is nothing like the 1970s, when the dollar crashed after the Nixon administration took the U.S. off the gold standard in 1971. That was followed by oil shocks in 1973-74 and again in 1979, raging food-price inflation, and key economic policy mistakes that caused inflation to explode to a peak of 13% in 1980.
The best that we can hope for right now is that we have entered a period of reflation. In a reflation, the expansionary monetary and fiscal policies that we see today should stop deflation dead in its tracks; if successful, these policies will lead the economy out of the worst recession since the 1930s and back to a sustained, normalized growth pattern.
It is true that the factors that drive inflation -- a rapid rise in the money supply, huge budget deficits and a decline in the value of the dollar -- are visible to the naked eye today. However, the practical conditions under which inflation accelerates during an inflationary spiral are completely invisible to even the most trained observer of markets and economics.
Let me be more explicit about why the recent upturn in stock and commodity prices, the explosion in the money supply and the Fed's balance sheet, the exponential acceleration in the federal budget deficit and the decline in the dollar are not market signals of impending inflation.
The trillions of dollars being spent to keep the economy from spiraling into a deflationary recession or depression are merely replacement capital for what has been lost in a collapsed financial system. Without the Fed's interest rate cuts, the expansion of its balance sheet, the various acronym-laden programs (TARP, TALF, PPIP, etc.) or other government stimulus programs designed to infuse our financial system with new funds, the economy would be suffering a far worse fate than the "Great Recession" that former Fed Chairman Paul Volcker says we're experiencing today.
Further, great inflations do not begin when the economy is operating at the depressed levels we are encountering now. Consider the following:
The average price of a home in the U.S., according to the Case-Shiller index, is more than 20% below its peak and still falling, albeit at a slower pace than in recent months. (Homes in Phoenix, the hardest-hit city in the country, are down more than 50% on average.)
Home foreclosures and bank-led home sales are at record highs. (This does not occur during an inflationary cycle.)
Oil prices are down about 60% from their peak of $147 a barrel, despite the rebound from a low of $34 to the current price of $58. (For those of you keeping score, gasoline, which affects consumers most, is about as cheap on an inflation-adjusted basis as it was before the first oil shock in the early 1970s.)
Commodity indices, key leading indicators of inflation, have stabilized (as shown above) but have yet to flash any warning signs of a meaningful acceleration in inflation.
TIPS spreads, which measure the premium in yields of the Treasury's inflation-protected securities over plain vanilla Treasury bonds, remain depressed, indicating that bond market investors, despite the supply-induced back-up in bond yields, are not signaling an inflation panic.
More important, the U.S. economy is operating far below not only its potential, but also well below the levels that trigger what economists call "demand-pull inflation." "Demand-pull inflation" is a condition in which the economy has been overstimulated, resulting in full employment, rapidly rising wages, peak production of homes, autos and consumer goods, coupled with the willingness of consumers to bid up the prices of those goods and services out of fear that prices will move still higher. The result is not a virtuous circle of expanding production and employment, but a vicious cycle of rapid price increases and the hoarding of goods, hardly the environment in which we find ourselves today.
Indeed, consider these highly non-inflationary economic statistics:
The U.S. unemployment rate is now at 8.9% and still rising. While possibly nearing a peak, the unemployment rate is at the highest level in 23 years and the highest since the last Great Recession from 1980 to 1982.
Housing starts are at a rate of 450,000 units annually, less than half the household formation rate in the U.S. and the slowest rate of homebuilding in a generation. An estimated 18.6 million unoccupied homes sit on the market in the U.S. today. That's called a glut -- it's hardly the stuff of runaway inflation!
Auto sales are running at an annual rate of 9.8 million units, the slowest sales rate on a population-adjusted basis since 1946. Autos are being heavily discounted, with extraordinarily generous incentives being offered. Chrysler is in bankruptcy. GM (GM - commentary - Cramer's Take) may soon declare Chapter 11 bankruptcy. Again, this is the stuff of deflation, not inflation!
Industrial production is down 12.8% year over year, while capacity utilization, or factory use, is at 69.3%, well below the 85% reading that signals an overheating economy and a breakout of inflation.
These data provide irrefutable proof that the "inflation genie" is still tightly sealed in her bottle and should put the 'flationistas back in their own box for some time to come.
History shows that it takes many years to move from a deflationary environment to a reflationary environment to an inflationary one. In each of the last three recessions -- 1980 to 1982, 1990 to 1991 and 2000 to 2001 -- it was at least three years and as many as five before the various stimulus programs that were used to reinvigorate the economy were pulled back amid signs of accelerating inflation. It will be at least that long before inflation rears its ugly head and threatens to undermine an economic recovery that, as of this writing, has not yet definitively taken root, despite the sightings of green shoots, crocuses or mustard seeds! |
