Why Christians should care about inflation

The official rate of inflation recently soared above 8% according to state statistics. Readers may have a gut feeling that prices have risen higher, and you may be right. According to Shadow Statistics, the inflation rate is closer to 15% using the same methods the US government employed in 1990. 

Why should Christians be concerned about inflation? Because it’s theft from the poor and middle classes on the grandest scale possible. Eight percent inflation means that someone has stolen 8% of your money by making it buy less food, clothing, gas, etc. 

Biden blamed Putin for inflation: "Your family budget, your ability to fill up your tank, none of it should on hinge on whether a dictator declares war and commits genocide a half a world away…"

Are We Headed For Inflation, Deflation, Or Stagnation?

Source: AP Photo/Pablo Martinez Monsivais

With the historic collapse of oil prices and glutted tankers sloshing around off the coast of Los Angeles, some forecasters are predicting deflation as far as they can see. They tend to believe that shocks to supplies cause inflation or deflation in commodities that spreads through the economy like a virus.

Others look to the Fed gorging itself on anything that resembles financial paper and predict hyperinflation like that of Germany a century ago or Zimbabwe recently. Historically, growth in the Fed’s balance sheet signaled a rapidly expanding supply of money that would ignite inflation. So which will it be: inflation, deflation, or stagnation?

Interest rates have fallen and can’t get up!

Some of us suffer from Fed head: we have allowed anger at the Fed to infect our brains to the point that we blame it for everything from flat tires to broken bed springs. George Selgin, an Austrian friendly economist at the Cato Institute, says take two aspirin and read his blog in the morning:

The view that the Fed might have raised interest rates long ago, had it only wanted to, became notorious during the presidential campaign, when Donald Trump publicly accused Janet Yellen’s Fed of keeping rates low for political reasons. But Trump was merely embroidering a belief common among many (mostly conservative) Fed critics...

The unvarnished truth, I hope to persuade you, is that interest rates have been low since the last months of 2008, not because the Fed has deliberately kept them so, but in large part owing to its misguided attempt, back in 2008, to keep them from falling in the first place.

Zombies threaten growth in 2017

Most economists expect the economy to grow at its most rapid rate next year. One of my favorite economists wrote this:

“If the new Trump administration cuts taxes and deregulates the economy, expect higher economic growth and another good year on Wall Street. However, I also expect higher interest rates and more inflation. 'King Dollar' should continue its rise, which will make it difficult for gold and other commodities. Avoid bonds and gold -- stay invested in the stock market.”

Let’s get the obvious problems with that forecast out of the way: higher interest rates and inflation are bad for the stock market and inflation is good for gold prices. And inflation means a lower dollar, not higher.

Economics Trumps polling

One of the big news stories today is how the national polls got the results of the presidential election so wrong.

Part of their problem was the demonization of Trump by the media. When media bias turns a policy or person into the instantiation of evil as they did with Trump, those who favor that policy or candidate will not want to side with that “evil” when answering poll questions. So they tell pollsters what they think people want to hear.

One older lady told me she planned to vote for Trump but asked me not to tell anyone. I read about a rabid Clinton supporter who wrote that his mother had promised him she wouldn’t vote in this election because she didn’t like either candidate. But when he wasn’t looking she slipped out and voted for Trump. The media shot themselves in the foot on this one.

Back in July I wrote a post on economic models that were Trumpeting a win for the Republican candidate or modestly admitting the outcome was too close to call. The accuracy of those models showed that people consider the economy their most important issue.

Abenomics' big fail and the sinking of the rising sun

Economists predicted a 2.25% gain in Japan’s GDP after the 7.3% fall in the second quarter. As usual, they missed it again. Japanese GDP fell 1.6% last quarter according to initial estimates. Mainstream economics’ theory of business cycles states that such downturns in the economy are random events, shocks to equilibrium. As the London School of Economics told the Queen, they had successfully predicted that no one can predict the onset of the worst recession since the great one. Still, they crank out GDP forecasts as if they could predict a recession. They irony is huge, but apparently unnoticed by most of the profession.

However, the most important part of the story was that Prime Minister Abe has been conducting a major monetary policy experiment. He promised to boost nominal GDP and achieve a minimum inflation of 2% by printing as much money as was necessary. No limits. Paleo-Keynesians like Paul Krugman were giddy. 

Abe also promised to reduce the deficit through tax increases and reform the structure of the economy. Partly as a result, the Japanese stock market climbed 55% and the value of the Yen fell 25% in 2013.

The Mysterious Case of Missing Inflation

When the Fed dramatically expanded its balance sheet after the latest recession began, many economists expected to meet high inflation barreling down the road. Fear of inflation helped send the price of gold to $1,800 per ounce. Instead, inflation has been very mild and Europe is flirting with deflation. What happened?

Of course, Austrians needed Hayek and Mises to remind us that the quantity theory of money shouldn't be taken mechanically. Someone has to borrow money and spend it in order for lower interest rates or QE to increase the money supply. The state borrowed and spent in the hyperinflation in Germany during the 1920’s. And the US government borrowed and spent during the 1960’s and 1970’s to create high inflation.

Today, the government borrows to maintain spending while spending increases are relatively small due to high existing debt and political opposition to increasing debt. Businesses aren’t borrowing because high taxes and massive regulation raise the profit bar to pole vaulting levels. So people are borrowing to invest in assets such as real estate and the stock market or exporting newly created money by investing overseas or buying imported goods.

Julien Noizet at spontaneousfinance.com informs us that banking regulations are directing lending to real estate. In “A new regulatory-driven housing bubble?” Julien explains the effect of risk weighted assets (RWA) on lending:

Basel regulations are still incentivising banks to channel the flow of new lending towards property-related sectors. A repeat of what happened, again and again, since the end of the 1980s, when Basel was first introduced. I cannot be 100% certain, but I think this is the first time in history that so many housing markets in so many different countries experience such coordinated waves of booms and busts.

So far we’ve had two main waves: the first one started when Basel regulations were first implemented in the second half of the 1980s. It busted in the first half of the 1990s before growing so much that it would make too much damage. The second wave started at the very end of the 1990s, this time growing more rapidly thanks to the low interest rate environment, until it reached a tragic end in 2006-2008. It now looks like the third wave has started, mostly in countries where house prices haven’t collapsed ‘too much’ during the crisis.

The Basel regulations require banks to hold more reserves for riskier loans. The safest loans go to governments, which carry a zero risk according to Basel. Real estate carries the next lowest risk. Business loans are among the riskiest and force banks to keep more cash idle.

One of the latest casualties of the Basel regulations has been the Bank of England’s Funding for Lending Scheme. The scheme set aside funds for loan to small and medium enterprises, but as Julien writes,

Since the inception of the scheme, business lending has pretty much constantly fallen… According to the FT: Figures from the British Bankers’ Association showed net lending to companies fell by £2.3bn in April to £275bn, the biggest monthly decline since last July.

The Basel accords pretty much guarantee that lending in the future will go mainly to governments and real estate, not so much to businesses. Most governments in the West are trying to limit spending, so for the foreseeable future we can expect repeated real estate and stock market bubbles and little CPI price inflation. That makes bonds a better prospect when real estate and the stock market are in bubble territory, but it also makes gold less attractive.

Of course, I could be wrong, so always hedge. 

Bubble Detectives

“One important conclusion is that the probability that the S&P 500 index is currently in a bubble is only 20-33 per cent,” according to Gavyn Davies in his recent article for the Financial Times, “How to detect amarket bubble.” “But that could change fairly quickly during 2014 if the recent pace of advance in equity prices continues.”

Davies approves of the New Palgrave definition of a financial bubble:

Bubbles are typically associated with dramatic asset price increases followed by a collapse. Bubbles arise if the price exceeds the asset’s fundamental value. This can occur if investors hold the asset because they believe that they can sell it at a higher price to some other investor even though the asset’s price exceeds its fundamental value.

Davies then mentions two other bubble detectors:

Based on the Shiller cyclically adjusted p/e (CAPE), the probability of a bubble is estimated at 33 per cent in December 2013, while the price/dividend model produces a bubble probability of 20 per cent.

The Fed's Zombie Apocalypse

Economists are trying to figure out why the Fed hasn't generated higher inflation. According to Gavin Davies, "In most countries, headline CPI inflation has been falling significantly since the end of 2011, and it has now dropped to less than 1 per cent in both the US and the euro area." Here's a graph of inflation in the US and UK from Davis: