Is there a real threat of inflation?
- Created:
- 20 January 2010
- Updated:
- 21 January 2010
- Written by:
- Martin Li
YES, says Charles Gibson
Of course there are inflationary pressures. Just because they aren’t yet fully apparent does not mean that they don’t exist. The only question is when they will express themselves. There are two very good reasons why they will. First, the US monetary base has almost doubled since 2007 under the influence of quantitative easing (QE). To put that in context, after 2008 the next highest rise in the monetary base was 16 per cent in 1999 and, before that, 11 per cent in 1978.
As US Federal Reserve chairman Ben Bernanke himself put it: “Like gold, US dollars have value only to the extent that they are strictly limited in supply. But the US government has a technology, called a printing press, that allows it to produce as many dollars as it wishes at essentially no cost.” His predecessor, Alan Greenspan, similarly argued that it takes approximately three-and-a-half years for a policy of QE to feed through into inflation statistics.
For those who say that it is possible to reverse such a rise, we would observe that only twice in the 49 years between 1960 and 2008 has the US monetary base contracted and never by more than 4 per cent. As such, the genie is already out of the bottle.
The second reason why there will be inflation is that it is greatly in the government’s interest. Over the past three years, the government debt burden (US and UK) has risen from 40 per cent to 100 per cent of GDP. This is an almost impossible level to reduce via taxation - and certainly one that is politically unacceptable. If, however, the government can keep the nominal level of the debt stable for 10 years, while the economy grows at 7 per cent a year, then the debt to GDP ratio will halve quite naturally to a more palatable 50 per cent.
Given that the real economy is unlikely to grow at more than about 2.5 per cent a year, the balance will have to be made up by inflation - perhaps 4.5 per cent a year for 10 years. As such, we still expect inflation to surprise on the upside (notwithstanding this week’s UK statistics), on which basis real assets such as commodities will be attractive investments.
Charles Gibson is head of mining research at Edison Investment Research
NO, says Jane Foley
It cannot be denied that energy prices are rising. However, the temporary nature of present price rises suggests they should not significantly alter medium-term inflation expectations. Stable inflationary expectations combined with excess capacity in industry and high levels of unemployment should continue to bear on wage deals and inhibit the ability of retailers to pass on higher costs.
Fear of future inflation was given a major boost when some central banks (including the Bank of England and the US Federal Reserve) last year embarked upon the policy of quantitative easing. The apparent printing of money associated with this course of action supported the opinion that higher inflation must be a longer-term consequence of the plan.
A year down the road and there is next to no evidence to suggest that QE has prompted a significant rise in inflation. As in the eurozone (where QE was largely avoided), growth in M4 (broad money) in the UK remains very disappointing, suggesting that QE’s reach to the real economy has been meagre. Granted, cheap funds probably fed last year’’s speculative rally in commodities such as oil, but underlying inflation in the west remains relatively low.
Energy prices remain a main driver of the rises in the consumer price index. In the UK, base effects surrounding last year’s temporary reduction in VAT are also impacting. Insofar as both of these effects are likely to be temporary, inflation is likely to fall back to more moderate levels in a few months’ time. Oil prices have already fallen 5 per cent from their January high as the market reins back its growth expectations for 2010 in the wake of disappointing US economic data and monetary tightening in China.
Last year’s rally in oil happened despite the fact that oil inventories remained persistently above their seasonal average. This smacks of speculation and the supply pressures suggest that prices will remain more vulnerable to negative fundamental news than to positive news going forward. Stripped of volatile items such as energy, underlying inflation remains benign in the US and the eurozone and low in the UK.
Jane Foley is research director at FOREX.com
http://www.investorschronicle.co.uk/YourOpinion/article/20100120/b538ee2c-05bb-11df-9122-00144f2af8e8/Is-there-a-real-threat-of-inflation.jsp
January 21, 2010
Is there a real threat of inflation?
