Inflation was meant to surge in the post-GFC stimulus orgy. So what happened?
CPI inflation rates are now falling, if anything. In Europe, inflation is barely positive at 0.3 per cent, while in the US, the latest CPI reading showed inflation actually fell 0.2 per cent in August -- the annual rate dipped from 2 per cent to 1.7 per cent. In China and Britain too, inflation rates have declined this year.
Naturally, following all of those low inflation readings -- big falls in some cases -- deflation fears have resurfaced.
At the outset I don’t think we should pretend that this is anything other than a dangerous and highly delusional fantasy, steeped in mythology, with no basis in fact or theory.
Over the years, many commentators have taken a revisionist view of history and have attempted to deride the fact that the world didn’t become engulfed by hyperinflation following years of QE, as if that somehow proved the success of the policy. Duplicitous doesn’t quite sum up these comments, as no one at the time was actually forecasting or even suggesting hyperinflation. Just that the world wouldn’t and couldn’t slip into a deflationary spiral -- that is, true deflation -- and that inflation rates would accelerate.
That this is exactly what happened is often lost on those economists and commentators, especially slavish devotees of quantitative easing.
The global economy didn’t fall into a deflationary spiral and inflation instead shot up sharply. By 2011 -- only two years after the GFC -- inflation rates were already well above target in Europe and the UK (over 5 per cent in the case of the UK). In the US, inflation rates were above the Fed’s comfort zone, peaking at around 2 per cent in late 2011/early 2012, while Chinese inflation was up over 6 per cent.
So what happened? The global economy is stronger and better since then; unemployment rates have fallen and growth rates have accelerated. How is it that inflation has moderated? Surely since 2011 - as the global expansion consolidated -- output gaps closed and excess capacity shrunk? Well yes, they have indeed. Certainly no one would argue that there is more capacity now than in 2011.
The first point to note is that we probably can’t say for certain that inflationary pressures have necessarily moderated. Remember, it wasn’t all that long ago that inflation was well above target, and since then global economy has become stronger!
Against that backdrop, the only thing we can say with certainty is that consumer price outcomes have been volatile. Inflation was elevated, now it’s not. This change came about rapidly, with seemingly no explanation.
Indeed the most likely catalyst for this volatility looks to be commodity prices, overlaid perhaps by exchange rate moves. So from the 2011 peak, the CRB index shows prices down around 25 per cent. Of course, some of that can be put down to genuine changes in supply and demand dynamics, but I wouldn’t say the bulk of it could.
The crude market is a case in point. Quite simply, there is no supply glut -- this is pure fiction. Just as peak oil fears back in 2007-08 had no basis in fact, neither does this idea that there is now some massive energy surplus driven by US shale.
It’s at this point, that a Professor of Economics at Yale University, Robert Shiller, comes in. A few articles have been run recently on his view that markets (the stockmarket in particular) are driven by ‘popular narratives which don’t need basis in solid fact’.
As regular readers know, I have argued the same thing myself for many years. Nearly all the great fears since the GFC have been driven by such popular narratives; this is how monetary policy is run as well.
The energy glut is just one more ‘popular narrative’. It’s ridiculous, but it helps drive crude lower, which in turn has the effect of reinforcing the idea that we live in a deflationary world -- or at least that it’s a serious threat.
The reality is very different. We still live in an inflationary world; that hasn’t changed. What has changed is the way that inflation manifests.
So property prices are soaring again, as are stocks and bonds etc. Asset price inflation is still the key as it was pre-GFC as well. The only difference between then and now is that the usual link, or transmission from this asset price inflation into consumer prices, has been broken, in part by his popular narrative that there is an oil glut.
How long this narrative can be sustained is anyone’s guess. Commodity prices have been range-trading for many years and there is nothing to suggest that is going to change.
In the near term, inflation will continue to be volatile, and that will allow policymakers to continue ultra-loose policy for many years to come. But investors shouldn’t confuse this volatility with deflation, or even low inflation, for that matter. These popular narratives are tenuous at best. Should the narrative change, inflation will surge. It wouldn’t take much, which means that inflation, rather than deflation, is still the key economic risk.