Monday, May 18, 2009

Perceived Inflation Pressures Are High

Last week, I presented an article on real versus perceived inflationary pressures. The reality (for now) is that inflation is low; the perception is that inflation is just around the corner.

This week Dr. John Hussman, who is a must read for any serious student of the markets, essentially echoes a similar sentiment. (As an aside, I want to state that I am no Dr. Hussman, yet I like his writings and insights very much, and I thought this would be a good time to share that with my readers who are not familiar with him.) In his article, "The Destructive Implications of the Bailout - Understanding Equilibrium", Hussman writes:

"by transferring wealth from those who did not finance reckless loans to those who did – providing monetary compensation without economic production – the bureaucrats at the Treasury and Federal Reserve have crowded out more than a trillion dollars of gross investment that would have otherwise have been made by responsible people in the coming years, shifted assets to the control of those who have proven themselves to be irresponsible destroyers of capital, and have planted the seeds of inflation that will cut short any emerging recovery."

These are our percieved inflationary pressures.

Hussman goes on to state in bold print (for emphasis I presume):

The bottom line is that the attempt to save bank bondholders from losses – to provide monetary compensation without economic production – is not sound economic policy but is instead a grand monetary experiment that has never been tried in the developed world except in Germany circa 1921. This policy can only have one of two effects: either it will crowd out over $1 trillion of gross domestic investment that would otherwise have occurred if the appropriate losses had been wiped off the ledger (instead of making bank bondholders whole), or it will result in a stunning and durable increase in the quantity of base money, which will ultimately be accompanied not by a year or two of 5-6% inflation, but most probably by a near-doubling of the U.S. price level over the next decade. As I've noted previously, the growth rate of government spending is better correlated with subsequent inflation than even growth in money supply itself, particularly at 4-year intervals. Regardless of near-term deflation pressures from a continued mortgage crisis, our present course is consistent with double digit inflation once any incipient recovery emerges.

With regards to our inflation indicator that assesses the strength of the trends in crude oil, gold, and 10 year Treasury yields that actually ticked down at the end of last week. See figure 1.

Figure 1. Inflation Pressures/ weekly

Nonetheless, with crude oil plus 5% today, with stocks up over 2.5% today, and with 10 year Treasury yields up over 2.5% today, the message is clear: whether inflationary pressures truly exist or not is another matter. The perception is that inflation does matter, and a stock market that has been pumped up on steroids (i.e., liquidity) will likely remain vulnerable to selling pressure when the trends in crude oil, Treasury yields, and gold are strong.


dacian said...


I read Hussman from time to time and it's a shame he's making statements without precise figures.

1 year ago, the market expectations for inflation were even higher than today (the yields were higher, oil was much higher; the market had it all wrong of course)

Here is something I read on a french blog regarding this subject (I just do a summary of those figures).

1) As curbes are showing, people started to save (and I think is a sustainable and lasting trend - I do it myself more than before). A historical average of 8% savings will get out from the economy ~800$ billions

2) There is ~35000$ billions of debt in the US. If we assume we go back to an average of 100% of GDP and absorb the extra amount over say 15 years, that will take out 2300$ annually from the economy.

3) Before the crisis, there was an increase in debt by ~4000$ billions per year

Now if the FED and government would like to substitute themselves to all this, they need to inject ~7000$ billions per year, which is the equivalent of 7/8 Obama plans.
That would imply the public debt will double in less than a year. It's no brainer that a state like this will become rapidly insolvent and the borrowers (the few left) will ask for much higher yields for government bonds; that will create panic among investors and leads to a high rate of inflation (or hyperinflation if there is total collapse). The problems are that bigger to be compensated by a "small" TARP of 700$ billions and a few trillions FED is giving here and there.

Though, if the authorities insist in their approach (say engage 8/10$ trillions more), than I guess the bets are off and they will only precipitate the crisis (total collapse is not impossible).

So the power of the FED and government are limited contrary to what many think; it's the bondholders who limits them. If they decide to ignore the bond market, then I agree we will have big inflation and such things.

Guy M. Lerner said...

Whichever way "it" goes, I believe the perception of inflation is greater than the reality, and we are beginning to see this dynamic take hold (with the strong trends in crude oil, gold, treasury yields)

dacian said...

Oh, definitely (every forum or blog you read, with the exception of few, are talking - for more than a year now - the USD's collapse is iminent, crash of treasuries, etc). But the question is, will the market face the reality (no inflation at all these days) or continue to ignore it and trade higher with those anti-inflation things? The problem with this sort of situation (I have very little experience actually to make any clear statement) that it's pure bet and all those inflationary investments might turn against you quickly.

I saw Shilling yesterday on bloomberg saying he thinks we will experiment deflation in the short term (we are in deflation, so I think he was suggesting deflation will continue unabated).

I personally believe the deflation will end when the isolationists throw in the towel (no matter what the stock market does).