Inflation expectations my butt

So, Bernanke has given markets what they need to hear. First, it’s damn the lifeboats on commodities inflation:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.

Next, it’s whatever you want, whenever you need it:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter. The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.

Now, don’t get me wrong, I have some sympathy with the US position. Since the GFC, which began the reckoning of the global imbalances (which were in part caused by loose  US monetary policy), the US has faced an intractable problem in its trade deficit with China because the latter won’t budge on its currency, when it damn well should. In this context I can accept the justification for loose monetary policy to a degree.

But, let’s get over this silly idea that it isn’t inflationary. And secondly that “inflation expectations” are in any way an adequate tool for us to draw this conclusion.

Inflation expectations surveys are of consumers. They are therefore a measure of some combination of labour and consumer items inflation expectations.

But today’s inflation is not in labour or household items. It is in financial assets. Excess liquidity these days doesn’t suddenly appear in product prices and wage claims. It appears in securities markets and, until the irresistible warning of the GFC, housing markets.

In other words, inflation expectations are now operative in capital not labour markets.

I know some will argue that the FOMC watches Treasury markets for inflation expectations in capital. But how reliable is that when the market is dominated by the purchases of foreign governments whose goals are national interest not market related, as well as the FOMC itself? Members of the FOMC have themselves acknowledged the uselessnes of the measure.

The inflation of capital is important because it is one half of the new boom and bust growth cycle that has taken over the global economy (the flip side being the real and perceived shortages in various hard assets, that is, commodities).

If you want to get a gauge of future inflation, you need to be surveying the expectations of capital market traders, not labour market consumers. And if you did your survey after today’s FOMC meeting, expectations would be very high indeed.

Bernanke’s new bubble just inflated a little more.

Comments

    • I don’t consider silver “the” risk asset Avid: AUD/USD, spot gold, SP500 and the hard commodities (oil, copper) fit that bill.

      silver is/was in a major parabolic uptrend with signs of a blowoff – either from a short squeeze or perceived (but not real) physical shortages.

      • I’m not so sure GOLD is as risky as you seem to believe Prince, at least not yet. The underlyng conditions seem to favour continued strengthening in the POG. It hasn’t been a quick spike upwards, it has been a very gradual uptrend with many corrections.

        Additionally the Fed is still providing liquidity (though not through QE) and if markets tank the Bernank only knows how to do one thing and that’s start QE again.

        We may be at a nominal high for gold, but when you adjust the 1980’s high for inflation in today’s dollars it’s more than $2,500 per oz. Additionally when you look at the chart adjusted for inflation you can see the massive spike in the 80’s, whereas the recent action is a steady uptrend that shows no “spikes.” It still has some steam left before it “tops out” imho.

  1. Very true, however, inflation in purely financial assets like equities has no deleterious effect in the real world. OTOH, inflation in commodities (and commodity currencies like the AUD) is driving profound changes in the real economy.

    Unfortunately the price of commodities and currencies has become a speculative game driven by millions of screen jockeys around the world, fueled by excess liquidity courtesy of the Fed. This massively amplifies the cycle and delivers us results like $200 iron ore, $150 oil and $1.10 AUD. Of course, the victims of this speculative pricing are real businesses, producing real products in the real economy. Eventually the Austalian (and global) economy will crack and we’ll overshoot on the downside, like we did in early 2009.

    This will lead to another round of attempts to regulate the financial markets, which will be completely ignored once markets take off again.

    You’d think humanity would come up with a better way of managing its finances, but the disease that is trading seems to be accelerating.

    • Have no fear, Obama will hunt down the perpetrators.

      Until then the wild ride continues.

  2. Inflation hurts savings and reduce debt in real terms, Now consider who the biggest saver in the world is, and who is the biggest debtor in the world, and you’ll see the reason for the policy.

  3. Not just the screen jockeys around the World, Lorax, but the $Billions of free money available for commodity speculation.

    Yep, inflation is now the game. I should run out and borrow lots of money, so my debts can be inflated away, just like America’s.

    I suppose we should be grateful that the escalation of the $A at least dampens some of the inflation in Aus, but at what price?

    I think you are an optimist, tho, Lorax – not about the next crash – its’ coming all right – but since the leading actors in that crash will be Banks that are so totally multi-national, that no one country will have any chance of regulating them, and probably won’t even try. Imagine Greece trying to regulate CitiBank!

    • If the governments all over the world can ban short-selling of bank shares with the stroke of a pen during the GFC, don’t they now have the power to ban commodity speculation via derievatives?

    • Not just the screen jockeys around the World, Lorax, but the $Billions of free money available for commodity speculation.

      Commodity speculation by screen jockeys using borrowed money is the worst kind of trading. Unlike trading in equities, commodities speculation drives up costs for real businesses, and puts upward pressure on commodity currencies like the AUD.

      Trading is a disease. It makes zero contribution to the real economy, and merely amplifies the boom-bust cycle.

      I never cease to be amazed at how many people claim to make a living ‘trading’ these days, usually on small cap miners. It reeks of late-90s America when taxi drivers would give you tips on tech stocks.

  4. Beranke’s objective is to just keep throwing money at problems and eventually you will get lucky. It is kind of the antithesis of time / labor / money foundation of capitalism.

    I do not see where he has offered any concrete productive outcome or product to society, except theft from someone else.

    He cannot and will not achieve either of his mandates, maybe he has a third mandate; extend the time to infinity; as he has a never ending supply of capital.

    • You say tomato I say …

      Bernanke admitted the central bank created $1.3 trillion out of thin air to buy mortgage backed securities.

      Two pronged sword …

    • I look at it as a never ending supply of paper currency to buy back government debt from the Chinese 🙂

  5. “In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter. ”

    Though this adds extra liquidity it’s technically not QE because the balance sheet isn’t expanding.

    “But today’s inflation is not in labour or household items. It is in financial assets. Excess liquidity these days doesn’t suddenly appear in product prices and wage claims. It appears in securities markets and, until the irresistible warning of the GFC, housing markets.”

    —-> and this is where the mal investment that Austrian economists love to talk about comes into play. QE and monetary inflation causes artificial price signals in the economy, and hence capital is allocated inefficiently leading to asset bubbles and so forth. Mal investment has lead to a hollowing out of the USA manufacturing sector amongst other things.

  6. “The Committee expects these effects to be transitory” – transitory to what? Permanent inflation? Given Bernanke has just endorse an open ended QE operation, of course the end of QE2 will not be noticeable, the markets will always be greased with an all but assured transition to permanent inflation.

  7. Some excellent points here, many of which have been obvious from the start of QE2. However I don’t know whether it’s true the Fed actually uses consumer surveys to measure inflation expectations surveys.

    It would be rather dense, as most consumers will tend to overlook or ignore deflation in housing-related assets and exaggerate headline inflation. This is because declining house prices don’t lower the overall cost of living for most. Lower interest rates do, but they’re already at zero.

    Inflation expectations used to be roughly gauged by TIPS spreads. But since the Fed’s QE is distorting the bond market in so many ways, and ever further up the yield curve, nobody really knows what yields would look like without it.

    So by its own actions the Fed is obscuring the best available measure of inflation expectations, while at the same time relying on those expectations to time the exit strategy from its monetization mania. The longer QE continues, the harder it becomes to model what will happen to yields once it stops.

    Obscuring a variable is not the same as controlling it.

  8. No inflation? Iowa City inflation yearly
    at least 12%…. for years! Most expensive place in Iowa to live. It has ruined everything here with no relief in sight. That is why I am probably going to have to leave asap. The problem is now everyone wants to be like Iowa City! It’s 100% hopless with runinous consequences for all GUARANTEED NOW!
    THANKS OBAMA!