mlk_man
12-23-2005, 08:11 AM
INFLATION MONSTER CAPTURED
by Mike Shedlock
I am pleased to report that the inflation monster has been captured and
placed in a jar.
This stunning announcement as well as an accompanying video detailing
the
highlights was made by the European Central Bank, in cooperation with
the
national central banks of the euro area. Along with the announcement,
the
ECB has produced an information kit on inflation entitled "Price
stability: why is it important for you?" It is targeted at young
teenagers
and teachers in all the official languages of the European Union.
The ECB's eight minute video is actually somewhat entertaining so I
recommend that everyone click on this link take a look:
http://www.ecb.int/home/html/educational.en.html (http://www.ecb.int/home/html/educational.en.html)
Even though it is entertaining, it sure flops as an educational tool
unless of course the goal is self-serving propaganda by the ECB, for
the
ECB.
Unfortunately the video does not explain that the real source of
inflation
is printing of money by the central bank itself. Nor does it explain
why
2% is such a good inflation target. Finally it does not explain how
prices
across the board can be contained by broad brushed practices like
setting
of short-term interest rates.
Those things were not explained simply because they cannot be
explained:
Why should inflation be targeted at 2%, not 1% or 3%? Why should any
inflation be targeted at all? Even if it were for some reason smart to
target prices, can prices really be measured accurately? What do
central
banks do to overcome lag effects of monetary tightening and loosening?
Is
this just blind faith that "we know neutral when we see it"?
The problem, of course, is targeting prices in the first place.
Sometimes,
money flows into houses and stock and bonds, instead of goods and
services. Sometimes, productivity improvements mask inflation.
Sometimes
falling commodity prices mask inflation. Of course, I am talking about
"real inflation" as measured by increases in money supply, as opposed
to
hedonically adjusted price inflation, as seen through the eyes of
central
bankers.
The last paragraph is exactly what made a fool out of Greenspan. In the
mid-to-late-1990s, "real inflation" (a rampant increase in money
supply)
was masked by productivity improvements, falling oil prices, and
falling
prices of goods from Asia. Greenspan called it a "productivity
miracle."
It was a "miracle," indeed. Rampant increases in money supply fueled
the
2000 stock market bubble and spawned nonsensical talk about "new
paradigms." Then, in the sheer "after-the-bubble-pops" panic
adjustments
that he likes to make, Greenspan refused to allow a recession to run
its
course. Instead, he slashed interest rates to 1%, fueling the biggest
housing bubble the world has ever seen. Here we are three short years
later, now facing a "new paradigm" in housing, with debt levels far
worse
at both consumer and governmental levels.
Greenspan will soon be gone, and Bernanke is next to bat, waiting in
the
on-deck circle. Like the ECB, Bernanke wants to set price inflation
targets of 2%. I have some advice for him: It simply cannot work.
With all the hedonic adjustments, with all the nonsense about core
versus
noncore inflation, with all the imputed economics, with all the
understating of medical costs, and with enormous discrepancies between
rental costs and housing ownership costs, there is not a person on this
Earth who could possibly know 2% price increases if they hit them smack
in
the face.
Compounding the problem for these so called "inflation fighters" is
energy
costs. One reason energy costs are rising is Peak Oil. Another reason
oil
costs are high is geopolitical tensions. A third reason energy prices
are
high is supply disruptions. Finally, oil and natural gas demand are
relatively inelastic. As prices go up, people more or less have to pay.
To
maintain a CPI price target of 2%, central banks might have to raise
interest rates to unreasonably high levels if energy prices are
included
in their measurements. That clearly would be bad policy. The root
problem,
of course, is assuming it is wise to target prices, rather than money
supply, in the first place.
I almost forgot to mention that the ECB claims to have "the deflation
monster" bottled up as well. I guess we will see, but I think they are
hopelessly wrong. The ECB points out "deflation monster" problems when,
in
fact, deflation is both a blessing as well as the natural state of
affairs.
Rising productivity is "price deflationary": More goods are produced
faster by fewer people. Prices naturally decline as a result. Look at
how
few farmers today produce more grain than 100 times as many farmers did
not that long ago. Corn prices fell to 1943 levels a couple weeks ago.
Is
that a problem? For whom? It's only a problem because the United
States'
and Europe's central banks blow countless billions of dollars every
year
on price crop supports. It is a total waste of money.
Bear in mind that China is actually losing textile jobs. The enquiring
mind might be asking to whom? The answer might be shocking: to no one.
Fewer workers are needed to turn out the same amount of goods. That is
one
of the reasons this protectionist talk you hear right now out of
Congress
is total nonsense. Those jobs simply are not coming back, ever.
Cranking
up money supply in an attempt to create jobs lost by productivity
improvements and outsourcing can only result in asset bubbles and/or
increased overcapacity. Besides, who does not like lower prices on
goods
and services?
If deflation is such a good thing, why do central banks fear it? One
answer is because deflation is debt's worst enemy. If asset prices and
wages fall, people cannot possibly ever pay back what they owe. Banks
and
credit card companies don't seem to like that state of affairs. Is that
a
problem with deflation? No, that is a problem created by reckless
lending,
easy credit, and the endless cheerleading on CNBC every time consumer
spending rises and people sink heavier into debt.
The second answer is because inflation benefits those who receive money
first. The government and banks are at the very top of the list. The
former benefits via automatic tax increases not indexed to inflation
(especially property taxes), the latter simply because banks are first
in
line to receive money from the Fed at rates no one else sees. By the
time
lending standards drop so that the masses have access to credit, the
boom
is well under way. By the time credit is granted to anyone that can fog
a
mirror, the boom is nearly over. Those buying assets late in the game
will
eventually be crushed by those selling assets who got in early. Simply
put, inflation eventually becomes a moral hazard.
We are now at or close to the pivot point. The pivot point (or tipping
point, if you prefer) is when consumers cannot or will not take on any
more debt and/or corporations simply are unwilling or unable to extend
more credit. I have been writing about various tipping points for some
time now, and we seem to be hitting those tipping points simultaneously
in
many areas: jobs, housing, consumer spending, and credit expansion.
The malinvestments of the have-it-now, me-too ownership society are
about
to be unwound. We are where we are because central banks have printed
ever-expanding amounts of money to prevent normal business cycles, to
satisfy politicians wanting to waste more taxpayer money with silly
projects, and to foolishly fight deflation. The only thing the central
banks have accomplished is putting off the inevitable deflationary
credit
crunch, while making it worse along the way.
There are many who think true deflation (decrease in money supply)
cannot
happen under a fiat system. I disagree, but perhaps the point is moot.
Money supply itself actually never contracted in Japan. Instead, it
grew
very slowly for quite some time. However, bank credit outstanding
contracted for 60 months in a row. Clearly, there was a credit
contraction. How did money supply still manage to grow? Fiscal deficits
were ramped up immensely, roads to nowhere were built, and the Bank of
Japan monetized all of it.
In addition, money velocity plummeted. The net effect of the credit
contraction on prices was clearly what one would nowadays call
"deflationary." Prices across a broad range of assets and goods and
services fell. Indeed, practically everything fell but government
bonds.
People were amazed at the alleged "bond bubble" as well as the zero
interest rate policy (ZIRP) of the BOJ. However, a 1% interest rate on
a
10-year bond makes sense when prices fall 2.5% annually. The real yield
is, obviously, far higher than 1%. Perhaps a practical way to think of
deflation under a fiat system is the destruction of credit/debt that
exceeds growth in money supply.
Regardless of social and economic differences, I fully expect the
United
States to follow in the footsteps of Japan. Although a central bank
might
be able to sustain a certain amount of inflation by resorting to
extreme
measures, it cannot stop a credit contraction in the private sector.
Nor
will a central bank bail out consumers at the expense of themselves and
other creditors. The Fed, like the BOJ, will stop short of destroying
itself and its power.
Life would be so much simpler if central banks everywhere would stop
trying to micromanage both prices and economic cycles. Quite simply,
they
are trying to achieve nirvana when nirvana cannot possibly be measured,
nor can nirvana be achieved in the first place with the policies they
have
in place.
Yes, we will still have economic cycles if central banks do those
things,
but the cyclical peaks and valleys would not be as exaggerated as they
are
now. It seems as if we have learned nothing from the Great Depression
or
the more recent experience of Japan. I fear we may get a second chance.
Regards,
Mike Shedlock ~ "Mish"
for The Daily Reckoning
by Mike Shedlock
I am pleased to report that the inflation monster has been captured and
placed in a jar.
This stunning announcement as well as an accompanying video detailing
the
highlights was made by the European Central Bank, in cooperation with
the
national central banks of the euro area. Along with the announcement,
the
ECB has produced an information kit on inflation entitled "Price
stability: why is it important for you?" It is targeted at young
teenagers
and teachers in all the official languages of the European Union.
The ECB's eight minute video is actually somewhat entertaining so I
recommend that everyone click on this link take a look:
http://www.ecb.int/home/html/educational.en.html (http://www.ecb.int/home/html/educational.en.html)
Even though it is entertaining, it sure flops as an educational tool
unless of course the goal is self-serving propaganda by the ECB, for
the
ECB.
Unfortunately the video does not explain that the real source of
inflation
is printing of money by the central bank itself. Nor does it explain
why
2% is such a good inflation target. Finally it does not explain how
prices
across the board can be contained by broad brushed practices like
setting
of short-term interest rates.
Those things were not explained simply because they cannot be
explained:
Why should inflation be targeted at 2%, not 1% or 3%? Why should any
inflation be targeted at all? Even if it were for some reason smart to
target prices, can prices really be measured accurately? What do
central
banks do to overcome lag effects of monetary tightening and loosening?
Is
this just blind faith that "we know neutral when we see it"?
The problem, of course, is targeting prices in the first place.
Sometimes,
money flows into houses and stock and bonds, instead of goods and
services. Sometimes, productivity improvements mask inflation.
Sometimes
falling commodity prices mask inflation. Of course, I am talking about
"real inflation" as measured by increases in money supply, as opposed
to
hedonically adjusted price inflation, as seen through the eyes of
central
bankers.
The last paragraph is exactly what made a fool out of Greenspan. In the
mid-to-late-1990s, "real inflation" (a rampant increase in money
supply)
was masked by productivity improvements, falling oil prices, and
falling
prices of goods from Asia. Greenspan called it a "productivity
miracle."
It was a "miracle," indeed. Rampant increases in money supply fueled
the
2000 stock market bubble and spawned nonsensical talk about "new
paradigms." Then, in the sheer "after-the-bubble-pops" panic
adjustments
that he likes to make, Greenspan refused to allow a recession to run
its
course. Instead, he slashed interest rates to 1%, fueling the biggest
housing bubble the world has ever seen. Here we are three short years
later, now facing a "new paradigm" in housing, with debt levels far
worse
at both consumer and governmental levels.
Greenspan will soon be gone, and Bernanke is next to bat, waiting in
the
on-deck circle. Like the ECB, Bernanke wants to set price inflation
targets of 2%. I have some advice for him: It simply cannot work.
With all the hedonic adjustments, with all the nonsense about core
versus
noncore inflation, with all the imputed economics, with all the
understating of medical costs, and with enormous discrepancies between
rental costs and housing ownership costs, there is not a person on this
Earth who could possibly know 2% price increases if they hit them smack
in
the face.
Compounding the problem for these so called "inflation fighters" is
energy
costs. One reason energy costs are rising is Peak Oil. Another reason
oil
costs are high is geopolitical tensions. A third reason energy prices
are
high is supply disruptions. Finally, oil and natural gas demand are
relatively inelastic. As prices go up, people more or less have to pay.
To
maintain a CPI price target of 2%, central banks might have to raise
interest rates to unreasonably high levels if energy prices are
included
in their measurements. That clearly would be bad policy. The root
problem,
of course, is assuming it is wise to target prices, rather than money
supply, in the first place.
I almost forgot to mention that the ECB claims to have "the deflation
monster" bottled up as well. I guess we will see, but I think they are
hopelessly wrong. The ECB points out "deflation monster" problems when,
in
fact, deflation is both a blessing as well as the natural state of
affairs.
Rising productivity is "price deflationary": More goods are produced
faster by fewer people. Prices naturally decline as a result. Look at
how
few farmers today produce more grain than 100 times as many farmers did
not that long ago. Corn prices fell to 1943 levels a couple weeks ago.
Is
that a problem? For whom? It's only a problem because the United
States'
and Europe's central banks blow countless billions of dollars every
year
on price crop supports. It is a total waste of money.
Bear in mind that China is actually losing textile jobs. The enquiring
mind might be asking to whom? The answer might be shocking: to no one.
Fewer workers are needed to turn out the same amount of goods. That is
one
of the reasons this protectionist talk you hear right now out of
Congress
is total nonsense. Those jobs simply are not coming back, ever.
Cranking
up money supply in an attempt to create jobs lost by productivity
improvements and outsourcing can only result in asset bubbles and/or
increased overcapacity. Besides, who does not like lower prices on
goods
and services?
If deflation is such a good thing, why do central banks fear it? One
answer is because deflation is debt's worst enemy. If asset prices and
wages fall, people cannot possibly ever pay back what they owe. Banks
and
credit card companies don't seem to like that state of affairs. Is that
a
problem with deflation? No, that is a problem created by reckless
lending,
easy credit, and the endless cheerleading on CNBC every time consumer
spending rises and people sink heavier into debt.
The second answer is because inflation benefits those who receive money
first. The government and banks are at the very top of the list. The
former benefits via automatic tax increases not indexed to inflation
(especially property taxes), the latter simply because banks are first
in
line to receive money from the Fed at rates no one else sees. By the
time
lending standards drop so that the masses have access to credit, the
boom
is well under way. By the time credit is granted to anyone that can fog
a
mirror, the boom is nearly over. Those buying assets late in the game
will
eventually be crushed by those selling assets who got in early. Simply
put, inflation eventually becomes a moral hazard.
We are now at or close to the pivot point. The pivot point (or tipping
point, if you prefer) is when consumers cannot or will not take on any
more debt and/or corporations simply are unwilling or unable to extend
more credit. I have been writing about various tipping points for some
time now, and we seem to be hitting those tipping points simultaneously
in
many areas: jobs, housing, consumer spending, and credit expansion.
The malinvestments of the have-it-now, me-too ownership society are
about
to be unwound. We are where we are because central banks have printed
ever-expanding amounts of money to prevent normal business cycles, to
satisfy politicians wanting to waste more taxpayer money with silly
projects, and to foolishly fight deflation. The only thing the central
banks have accomplished is putting off the inevitable deflationary
credit
crunch, while making it worse along the way.
There are many who think true deflation (decrease in money supply)
cannot
happen under a fiat system. I disagree, but perhaps the point is moot.
Money supply itself actually never contracted in Japan. Instead, it
grew
very slowly for quite some time. However, bank credit outstanding
contracted for 60 months in a row. Clearly, there was a credit
contraction. How did money supply still manage to grow? Fiscal deficits
were ramped up immensely, roads to nowhere were built, and the Bank of
Japan monetized all of it.
In addition, money velocity plummeted. The net effect of the credit
contraction on prices was clearly what one would nowadays call
"deflationary." Prices across a broad range of assets and goods and
services fell. Indeed, practically everything fell but government
bonds.
People were amazed at the alleged "bond bubble" as well as the zero
interest rate policy (ZIRP) of the BOJ. However, a 1% interest rate on
a
10-year bond makes sense when prices fall 2.5% annually. The real yield
is, obviously, far higher than 1%. Perhaps a practical way to think of
deflation under a fiat system is the destruction of credit/debt that
exceeds growth in money supply.
Regardless of social and economic differences, I fully expect the
United
States to follow in the footsteps of Japan. Although a central bank
might
be able to sustain a certain amount of inflation by resorting to
extreme
measures, it cannot stop a credit contraction in the private sector.
Nor
will a central bank bail out consumers at the expense of themselves and
other creditors. The Fed, like the BOJ, will stop short of destroying
itself and its power.
Life would be so much simpler if central banks everywhere would stop
trying to micromanage both prices and economic cycles. Quite simply,
they
are trying to achieve nirvana when nirvana cannot possibly be measured,
nor can nirvana be achieved in the first place with the policies they
have
in place.
Yes, we will still have economic cycles if central banks do those
things,
but the cyclical peaks and valleys would not be as exaggerated as they
are
now. It seems as if we have learned nothing from the Great Depression
or
the more recent experience of Japan. I fear we may get a second chance.
Regards,
Mike Shedlock ~ "Mish"
for The Daily Reckoning