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Strategies & Market Trends : The coming US dollar crisis -- Ignore unavailable to you. Want to Upgrade?

To: ggersh who wrote (57150)	3/10/2015 8:43:57 AM
From: John	Read Replies (1) \| Respond to of 71463

Good questions. With the world awash with money, coupled with falling energy prices, lower-than-expected inflation seems to be the order of the day for the foreseeable future. The article below provides some insight and a link to a new paper on the relative risk of inflation, and it describes a relatively new market for betting on inflation or deflation that falls within certain ranges. Visit the link for the entire article and graphics. I'm just relaying in a portion of it. A Prediction Market for Inflation, or Deflation nytimes.com excerpt: Something unusual is happening to prices right now: They are falling. The recent sharp decline in gas prices is part of the story, but there is now growing fear that the Federal Reserve will undershoot its own 2 percent inflation target, hindering the economic recovery. There’s also a small but worrying risk that the economy could enter a deflationary rut. At issue are inflation expectations. Economists believe expectations are critical because they shape the decisions individual shopkeepers make when deciding whether and by how much to raise their prices. Beliefs about inflation create a self-fulfilling prophecy in which today’s expected inflation becomes tomorrow’s actual inflation. The trick to managing inflation then, is to manage inflation expectations. In practice, though, it is very hard to observe what people expect inflation to be. That’s why it’s worth paying close attention to the disturbing portents from a relatively young and obscure derivatives market that provides new perspectives on inflation expectations — tracking not only the likely level of inflation, but also the risks that inflation might be too high, too low or just right. In this market, derivatives called inflation caps and inflation floors are, effectively, bets on the trajectory of prices over the next few years. Think of it as a prediction market for inflation. Just as prediction markets are better than experts, computer models or surveys at forecasting elections, sporting events and the weather, it seems likely that these markets are better at capturing inflation expectations. The math involved is tricky, but recent research by Yuriy Kitsul, a Fed economist, and Jonathan Wright, a professor of economics at Johns Hopkins University, provides a useful guide. For example, the two economists show that by buying and selling various derivatives you can form a portfolio expected to pay $100 if the average rate of inflation over the next five years is between 1.5 and 2.5 percent. At the moment, this bet sells for $49. If traders are betting to maximize their expected profits (more on this in a moment), then this price will rise or fall until it reflects the probability of that level of inflation. The $49 price suggests the market believes there’s slightly less than a 50-50 chance that the Fed will deliver an outcome that is roughly consistent with its stated inflation target of 2 percent.