Inflation, interest rates, and the Fed

[Diego Mamani]

[quote=Rich Toscano]I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

That’s my point precisely. And I fear that the Fed won’t be prescient enough to pinpoint the exact time when the monetary brakes need to be applied. In any case, due to political pressures, the tightening will come too late. If inflation was so easy to fine tune using policy tools, why did it get so awfully out of control in the 1970s?

Newsweek has had at least two articles recently where they state that inflation won’t be a problem. The fact that the biggest liquidity injection in US history could fan inflation is ignored, even laughed at. Newsweek’s argument? That inflation is low and getting lower today, so it won’t be a problem in the future.

Newsweek’s position is just like that of the drunk guy who jumped from a 50th floor window. Half way down he’d probably be thinking “geez, all those people who said I’d die if I jump were a bunch of idiots! I jumped, and so far I’m fine!”

[Diego Mamani]

[quote=XBoxBoy]If I read Hussman’s view correctly, he’s only saying that if the govt wants, it can always create inflation. (Which is pretty much Bernanke’s view as well) So, that begs the question, is it your view that the govt will print enough money to cause inflation?[/quote]

I think the government already has printed enough money to cause inflation to get out of hand. Inflation hasn’t shot up yet, and it won’t until 2011 or later due to persistent excess capacity, but that won’t stay that way for too long.

The question to me is not if, but when and how high.

[Diego Mamani]

[quote=XBoxBoy]If I read Hussman’s view correctly, he’s only saying that if the govt wants, it can always create inflation. (Which is pretty much Bernanke’s view as well) So, that begs the question, is it your view that the govt will print enough money to cause inflation?[/quote]

I think the government already has printed enough money to cause inflation to get out of hand. Inflation hasn’t shot up yet, and it won’t until 2011 or later due to persistent excess capacity, but that won’t stay that way for too long.

The question to me is not if, but when and how high.

[Diego Mamani]

[quote=XBoxBoy]If I read Hussman’s view correctly, he’s only saying that if the govt wants, it can always create inflation. (Which is pretty much Bernanke’s view as well) So, that begs the question, is it your view that the govt will print enough money to cause inflation?[/quote]

I think the government already has printed enough money to cause inflation to get out of hand. Inflation hasn’t shot up yet, and it won’t until 2011 or later due to persistent excess capacity, but that won’t stay that way for too long.

The question to me is not if, but when and how high.

[Diego Mamani]

[quote=XBoxBoy]If I read Hussman’s view correctly, he’s only saying that if the govt wants, it can always create inflation. (Which is pretty much Bernanke’s view as well) So, that begs the question, is it your view that the govt will print enough money to cause inflation?[/quote]

I think the government already has printed enough money to cause inflation to get out of hand. Inflation hasn’t shot up yet, and it won’t until 2011 or later due to persistent excess capacity, but that won’t stay that way for too long.

The question to me is not if, but when and how high.

[Diego Mamani]

[quote=XBoxBoy]If I read Hussman’s view correctly, he’s only saying that if the govt wants, it can always create inflation. (Which is pretty much Bernanke’s view as well) So, that begs the question, is it your view that the govt will print enough money to cause inflation?[/quote]

I think the government already has printed enough money to cause inflation to get out of hand. Inflation hasn’t shot up yet, and it won’t until 2011 or later due to persistent excess capacity, but that won’t stay that way for too long.

The question to me is not if, but when and how high.

[davelj]

[quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…

[davelj]

[quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…

[davelj]

[quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…

[davelj]

[quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…

[davelj]

[quote=Rich Toscano][quote=davelj] But taking into account unempolyment + capacity utilization + asset deflation + a low savings rate (which will increase and cut into consumption) + a massive amount of debt that needs to get paid down… probably leads to low inflation for a while. What “a while” is is hard to know…[/quote]

Good list, although I would quibble with the massive amount of debt item… in theory that SHOULD lead to higher saving and lower inflation, but in practice, my strongly held opinion is that it will lead to higher inflation as the political pressure to inflate away the debt is overwhelming.

Anyway, I completely agree that there are factors in place that are holding inflation in check for now (but as you say, how long “now” lasts is a whole different question).[/quote]

Ultimately the question comes down to this… how much “quantitative easing” (“money printing” in the everyday lexicon) can the Fed engage in and not produce meaningful inflation given the circumstances? The answer is not at all straightforward.

On the one hand we see this: http://calculatedriskimages.blogspot.com/2010/06/household-net-worth-q1-2010.html

Domestic household net worth declined peak-to-trough by $17 trillion. Now it’s “only” down about $11 trillion (after rallies in stocks and housing prices). But, as the graph notes – oops! – we’re still above the long-term trend! When the S&P was around 800 and housing prices were at the trough last year – lo and behold – net worth as a % of GDP was about in line with the long-term trend. Bizarre that both housing prices and the S&P 500 were at roughly fair value back then based on their individual long-term trends. Funny how that works. But I digress…

So, we know that the Fed can’t just print up $11 trillion to fill the current “hole” (a hole only relative to the bubble peak, of course); that would be massively inflationary eventually. On the other hand, the Fed can probably print up a couple of trillion before inflation is ignited (particularly if net worth trends back down, which it probably will do here shortly). That is, “some part” of that hole can be plugged with funny money without dire long-term inflation consequences. (And I’m admittedly simplifying the whole process and thinking here – household net worth is just ONE issue to contemplate in the inflation/deflation debate.) So, the $64 trillion question is: What is that number – between $1 trillion and many trillions – that can be printed up and over what period? I don’t know the answer. But I’m betting it’s much closer to the lower number than the higher numbers. One way or another, we’re going to find out…

[Nor-LA-SD-guy]

http://www.economist.com/blogs/freeexchange/2010/03/volcker_recession

Another factor supporting spiraling inflation increases was the wage-price feedback loop. As prices rose, labour organisations demanded ever high wage increases, which fed back to consumer prices, which spurred additional wage increases. This was a key factor contributing to broader consumer price inflation in America in the 1970s. But would this loop have been sustained, in the absence of recession?

Perhaps not. The share of union members in the American workforce had been in slow decline from the immediate postwar period through the early 1970s, but during the 1970s the erosion of labour power picked up speed. Between the early 1970s and the early 1980s, the share of the workforce in unions fell from around 30% to 20%. In the private sector, unionised industries were subject to increasing competition from rapidly developing, export-oriented Asian economies, notably Japan. It seems likely that eroding worker bargaining power would have made it ever more difficult for labour to demand significant wage increases on a regular basis. Declining unions would have helped to stop inflation.

[Nor-LA-SD-guy]

http://www.economist.com/blogs/freeexchange/2010/03/volcker_recession

Another factor supporting spiraling inflation increases was the wage-price feedback loop. As prices rose, labour organisations demanded ever high wage increases, which fed back to consumer prices, which spurred additional wage increases. This was a key factor contributing to broader consumer price inflation in America in the 1970s. But would this loop have been sustained, in the absence of recession?

Perhaps not. The share of union members in the American workforce had been in slow decline from the immediate postwar period through the early 1970s, but during the 1970s the erosion of labour power picked up speed. Between the early 1970s and the early 1980s, the share of the workforce in unions fell from around 30% to 20%. In the private sector, unionised industries were subject to increasing competition from rapidly developing, export-oriented Asian economies, notably Japan. It seems likely that eroding worker bargaining power would have made it ever more difficult for labour to demand significant wage increases on a regular basis. Declining unions would have helped to stop inflation.

[Nor-LA-SD-guy]

http://www.economist.com/blogs/freeexchange/2010/03/volcker_recession

Another factor supporting spiraling inflation increases was the wage-price feedback loop. As prices rose, labour organisations demanded ever high wage increases, which fed back to consumer prices, which spurred additional wage increases. This was a key factor contributing to broader consumer price inflation in America in the 1970s. But would this loop have been sustained, in the absence of recession?

Perhaps not. The share of union members in the American workforce had been in slow decline from the immediate postwar period through the early 1970s, but during the 1970s the erosion of labour power picked up speed. Between the early 1970s and the early 1980s, the share of the workforce in unions fell from around 30% to 20%. In the private sector, unionised industries were subject to increasing competition from rapidly developing, export-oriented Asian economies, notably Japan. It seems likely that eroding worker bargaining power would have made it ever more difficult for labour to demand significant wage increases on a regular basis. Declining unions would have helped to stop inflation.

[Nor-LA-SD-guy]

http://www.economist.com/blogs/freeexchange/2010/03/volcker_recession

Another factor supporting spiraling inflation increases was the wage-price feedback loop. As prices rose, labour organisations demanded ever high wage increases, which fed back to consumer prices, which spurred additional wage increases. This was a key factor contributing to broader consumer price inflation in America in the 1970s. But would this loop have been sustained, in the absence of recession?

Perhaps not. The share of union members in the American workforce had been in slow decline from the immediate postwar period through the early 1970s, but during the 1970s the erosion of labour power picked up speed. Between the early 1970s and the early 1980s, the share of the workforce in unions fell from around 30% to 20%. In the private sector, unionised industries were subject to increasing competition from rapidly developing, export-oriented Asian economies, notably Japan. It seems likely that eroding worker bargaining power would have made it ever more difficult for labour to demand significant wage increases on a regular basis. Declining unions would have helped to stop inflation.

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