Tuesday, Aug 18, 2009
What happened to deflation?
NY Times: UK inflation unexpectedly holds at 1.8%
A key measure of inflation in the UK has unexpectedly remained at 1.8%.
Economists had expected the Consumer Prices Index (CPI) to decline to 1.5% in July.
The Retail Prices Index (RPI) inflation measure, which includes mortgage interest payments, also unexpectedly rose to -1.4%, from -1.6%.
Inflation has repeatedly surprised on the upside in recent months despite the worst recession for decades.
Posted by little professor @ 11:53 AM (3092 views) Add Comment
44 Comments
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1. little professor said...
"Core inflation, which excludes volatile food and energy prices actually rose, to 1.8 per cent from 1.6 per cent, its highest level since November and significantly above forecasts. Economists said this reflected the weakness of the pound and resilient high street sales during the summer.
Analysts at Credit Suisse said that the inflation data suggested that the Bank of England might have "overdone" its scheme of pumping money directly into the economy via quantitative easing. "The UK economy may have many problems — deflation isn't one of them."
The Bank announced it was extending quantitative easing by £50 billion to £175 billion two weeks ago."
When the BoE announced the massive expansion of printing money recently, everyone assumed they must have had advanced knowledge of data suggesting deflation was worse than expected. Turns out they had no such thing, so what was their justification for the expansion?
2. paul said...
The cracks are beginning to show in the Bank of England's 'nuclear option' strategy of quantitative easing.
3. titaniccaptain said...
With lending to business and households continuing to tighten I don't see how QE could have produced inflation....
So this brings me to believe that this increase in inflation is an initial and desperate move by producers to increase profit margins in order to maintain profit levels and workforce. However with deflating wages, public sector cuts, final salary pensions going down the pan and rising unemployment means disposable income will fall and the costs will have to come down with cuts in workforce and profit margins......
4. mountain goat said...
QE can make things look better, when the GDP is actually contracting.
From Mr Eric Keetch
Sir, In a sleepy European holiday resort town in a depressed economy and therefore no visitors, there is great excitement when a wealthy Russian guest appears in the local hotel reception, announces that he intends to stay for an extended period and places a €100 note on the counter as surety while he demands to be shown the available rooms.
While he is being shown the room, the hotelier takes the €100 note round to his butcher, who is pressing for payment. The butcher in turn pays his wholesaler who, in turn, pays his farmer supplier.
The farmer takes the note round to his favourite “good time girl” to whom he owes €100 for services rendered. She, in turn, rushes round to the hotel to settle her bill for rooms provided on credit.
In the meantime, the Russian returns to the lobby, announces that no rooms are satisfactory, takes back his €100 note and leaves, never to be seen again.
No new money has been introduced into the local economy, but everyone’s debts have been settled. Is this “quantitative easing”?
Eric Keetch,
London W4, UK
5. titaniccaptain said...
Agreed MG.....
6. Chris said...
'When the BoE announced the massive expansion of printing money recently, everyone assumed they must have had advanced knowledge of data suggesting deflation was worse than expected. Turns out they had no such thing, so what was their justification for the expansion?'
I find it hard to believe anyone on this site really fell for the deflation scam. QE will probably go to near 500 billion or actually never stop until the currency collapses. BoE prints money to give to the banks in exchange for overpriced toxic assets so that the banks can then buy government debt. Isn't that what's going on? Level of QE so far almost matches the budget deficit. Coincidence?
7. titaniccaptain said...
Saying all that........once the recession is over and the banks want to start lending again they will have three options when the risky economy is stabilized..
1. Buy bonds.
2. Risky Lending.
3. Remain prudent.
The second option is likely....there will be a feeling of first one off the starter blocks.....so then we will probably see the effects of QE with inflation but not until the risk is reduced to acceptable levels dictated by a stable economy.....I think that is a while away.
8. mountain goat said...
"The UK economy may have many problems — deflation isn't one of them." - Credit Suisse
We have deflation because of irresponsible lending in the past. This article takes economists employed by various banks to say that inflation is now a problem, distracting us from the real problem. In the USA one bank after another goes insolvent, but all is well in UK banks it seems? Where is the next Robert Peston to expose them? I expect this inflation propaganda to keep coming. But bad loans keep failing and therefore deflation continues at a pace.
9. titaniccaptain said...
@Chris 6.
You raise an excellent point....
The toxic debt that has been purchased and dare I say it... written off "could" be offset by the interest payments on savings deposits...and whilst the banks are getting little returns from investment or yields they have shown they have no interest in passing their newly found capital position onto the public.....I wonder why...
10. mountain goat said...
Following on from my sick banks @8 point above:
Today Northern Rock said: "In this context, the Company has now decided, until further notice, to defer payment of all subordinated debt coupons which the Company is entitled to defer. This will apply to the following debt instruments:"... We’d have expected the market to be ready for such an event, especially when that other clapped-out lender owned by the British public, Bradford & Bingley, skipped payments on its own subordinated debt at the end of May. But apparently not. On Tuesday, quotes for the 12 5/8% Perpetual Subordinated Notes collapsed by two-thirds, to a mid-market price of 20p on the pound."
Banking crisis is not over at all...
11. hpwatcher said...
Turns out they had no such thing, so what was their justification for the expansion?
To get more money into the economy, to fuel a debt based boom, in time for a general election....simple.
12. 51ck-6-51x said...
So start up the shredder then!
It would appear to be a game of blind man's bluff. There is no way to tell what effect any QE had ( since there is nothing to which to compare ).
13. 51ck-6-51x said...
oops - "with which" even.
14. titaniccaptain said...
What an interesting point 666
How could money be removed from the economy by the BOE?
15. mountain goat said...
Captain @14 - How could money be removed from the economy by the BOE?
I think the plan would be to sell the Gilts back into the markets, and "shred" the money received.
16. will said...
If you look at historic RPI monthly data you will notice that in September of most years the figure drops suddenly. This is because most public sector pay deals and state pensions are calculated in September each year. Funnily enough in October it rises again. Can anyone explain this?
17. titaniccaptain said...
"I think the plan would be to sell the Gilts back into the markets, and "shred" the money received."..........that can't be right.....that would mean that hyperinflation would be highly manageable!!!
18. mark wadsworth said...
@ MG, Keetch's letter was nonsense and has since been debunked as such.
Further, NR defaulting on its bonds is not the beginning of a 'new' banking crisis, it is the solution to the banking crisis!
19. 51ck-6-51x said...
TC said, "How could money be removed from the economy by the BOE?"
- they could do a number of things including the two most obvious methods:
i) by charging UK banks for holding deposits ( e.g. through a negative deposit rate ) - note that banks must hold at least a prescribed amount on reserve @ the BoE and that holding more there also means some advantages too ( although don't assume any bank would hold more than min given such a scenario ) and destroying interest received.
ii) by sale of assets and destroying [ some of the ] monies received.
20. hpwatcher said...
TC said, "How could money be removed from the economy by the BOE?"
- they could do a number of things including the two most obvious methods:
i) by charging UK banks for holding deposits ( e.g. through a negative deposit rate ) - note that banks must hold at least a prescribed amount on reserve @ the BoE and that holding more there also means some advantages too ( although don't assume any bank would hold more than min given such a scenario ) and destroying interest received.
ii) by sale of assets and destroying [ some of the ] monies received.
and raising interest rates.
21. 51ck-6-51x said...
hpwatcher said, "and raising interest rates."
- Please explain how you think that would destroy the quantity of money in the system. Do you mean by the indirect method of defaults?!
22. titaniccaptain said...
I have an idea....why don't we all have a national party with free drink, cannabis and cocaine in very large quantities over a period of a month.....the proceeds of which end up stuffed in a huge Gordon Brown effigy which we burn....just an idea.....could help to get rid of those recession blues :)
23. hpwatcher said...
by charging everyone more money on the money they borrow........though the indirect method of defaults is probably far more interesting.
24. 51ck-6-51x said...
hpwatcher
- erm... nope, I don't really get that.
At what point is money destroyed?
If you mean the BoE destroys the additional interest received from loans it sounds like a more inefficient* way of doing what I already suggested ( i.e. -ve deposit rate )
* by inefficient I don't mean there is some kind of friction but rather that they would be charging for loans, which would put up the cost of loans to the end users ( businesses & other debtors ) which would cause defaults of otherwise solvent entities. Of course a decrease in the deposit rate increases costs for banks and this will be passed on, but only on new terms, so it should not be so indiscriminate.
25. titaniccaptain said...
Sorry guys but I am shocked at how easy it seems controlling hyper inflation could be......
26. mark wadsworth said...
Dear chaps, you cannot 'destroy' money, largely because it isn't really there!
Always remember The Golden Rule that all "money" is backed by somebody else's debt (notes and coins being merely small-denomination non-interest paying bearer securities issued by the government) therefore the sum total of all money in the world is a big fat zero.
For example, I have a tax bill of £10,000 coming up (which is an asset from the government's point of view) and £10,000 in coins and notes. On the due date, I turn up at HM Revenue & Customs and hand over the coins and notes. My debt to them is cancelled and their debt to me (the 'promise to pay') is cancelled.
Is there any change in the net wealth of 'the economy' (taking taxpayer and government together)? Nope.
Or for example, a chap owns a house with a £100,000 mortgage from XYZ bank who then marries a woman with £100,000 in XYZ bank. They agree to transfer the house into joint names and the woman pays off the mortgage (assuming this to be equitable between the parties).
Has the combined wealth of the couple changed? Nope, not one bit. Have the net assets of XYZ bank changed? Nope, neither.
27. titaniccaptain said...
As you say Wadsworth QE is buying up bonds...not creating new money....it isn't there.......but if inflation somehow took root because of a DIRECT injection of cash into the economy then it could be removed.......
28. uncle tom said...
Keetch's letter is obvious nonsense - since when did tarts give credit? :)
~~~
Bad debt in the banking sector serves to contract the money supply, but the extra created by QE far exceeds the write-offs.
Is the BoE swapping CDO's and other dodgy paper for hard currency? I doubt it, (unless heavily discounted) as they would know that such a move would ultimately emerge as a scandal.
Is QE working? Not really, but stopping the process in the absence of strong economic growth is going to be very difficult, and will require a major increase in interest rates.
How long can they continue with QE before the markets lose confidence in Sterling? That's the big question. If the QE program is seen be running ahead of the US stimulus packages (on a per capita basis) then the markets will start getting twitchy, especially if the Americans seem to be winding down on stimulus while we forge ahead. Confidence in Sterling could also be lost if the financial bogeymen in the eurozone are seen to be coming under control.
By mid October the BoE is likely to have spent its extra £50bn, and will be looking at round three. October has a long history of generating financial storms - I shall await the outcome with interest..
29. hpwatcher said...
Good point, but they will probably use a combination of ways to suck up the money if they need to; BOE could even sell bonds from its account to extract the cash, though that may be storing up problems for the future.
30. Tother said...
"Has the combined wealth of the couple changed? Nope, not one bit. Have the net assets of XYZ bank changed? Nope, neither."
Yes, they now have a house thats worth £90,000 & are therefore worse off by £10,000.
31. stillthinking said...
Depends on whether we ever see an exit strategy. QE looks the same as buying a house on an indefinite interest only mortgage fixed at 0%, then selling the house sneakily and spending the money. Pretty good deal. From a bank with 0% capital reserve requirements.
There isn't much point paying it off for the government unless when they need to rollover they can't secure the same terms, but of course they can secure whatever terms they like because the BoE is above the financial system, not in it. The bank will be able to sell but making a loss, which will have everybody squawking because only the financial service industry will have benefited. The loss will depend on inflationary expectations at the time of sale. I don't see those gilts ever appearing again personally which is why I think inflation will be dealt with using interest rates. But QE is definitely inflationary. The money is going straight into the economy via the state sector/social security mechanism. Whether or not the recipients pay down debt with the money or spend it doesn't matter. In the first case, they pay down debt, but leave a real saver with an equivalent now unbacked debt (unbacked non-netting out to zero money) or they spend it (again unbacked non-netting out to zero money).
32. stillthinking said...
In fact the netting out to zero is key so I am going to expand without being asked because I think we will inflate much sooner than planned.
When I hold a fiver I know(?) that it is backed up by somebodies debt. But when the government introduce 40 year bonds, somebody is holding a fiver that is indeed backed up by future taxation, but taxation 40 years in the future. In other words, our money supply and crucially what backs it is spreading down the time line further and further and beyond people who are alive today's actual lifespan. Imagine further I am a wealthy 60 year old man and after speaking to my doctor he advises me that probably I am going to snuff it in 15 years, and imagine that there are a lot of people in that situation, call it an aging society if you will, because of some historic birthing boom years before. Now suddenly I look at my money differently. I know that the labour backing it exists but I will be dead by then. So I might then wonder that a lot of the money around is only backed by labour way way in the future, and that not everybody can spend their cash because the labour simply isn't there in the fifteen years I have left. It might then occur to me that I need to spend my money before anybody else realises this and use the backing labour available -today-. If enough people think that then 30 years worth of labour debt obligation attempts to spend itself in 15 years and there isn't enough labour!! Or a crisis of confidence basically.
What New Labour are doing at a time the real economy (labour availability) is shrinking is expanding the money further and further into the future, eventually this will cause inflation. Further, by manipulating gilt yields they are swapping a gradual and therefore moderatable level of inflation for a sharp snap in inflation that could come at any time.
But we are still certainly in deflation at the moment.
33. 51ck-6-51x said...
hpwatcher said, "...may be storing up problems for the future"
- Well IMO the central bank system itself inherently does so.
I believe we should both implement a free banking system and dissolve big government, although I believe that without the sovereign currency big government would disappear overtime anyway leaving a far smaller and more streamlined state. But the only way that will happen is as a result of a collapse in society and/or government as far as I can see due to the scale of the project and the poser of those with a vested interest in the current system ( politicians, high up business men, big land owners, e.t.c. )
34. mountain goat said...
There is a good video of Hugh Hendry the hedge fund guy from March 2009 when QE started. At 2.30 into the video he is asked about the dollar going up or down. His answer is basically an answer about inflation and deflation that I believe to be true. His argument goes like this:
It sounds absurd but there is a scarcity of money dollars/pounds. A few years ago there was $53 trillion in debt, backed by $80 trillion in assets. But now asset prices have fallen, houses, shares, commodities, and so on. So now we have $53 trillion in debt backed by less than $53 Trillion in assets. So $53 trillion needs to be paid back and if we sell everything we have it comes to a lot less than that. QE comes along and throws a few $Trillion at the problem.
IMO, since then with this QE money investment banks have tried driving up asset prices again, clearly they have succeeded in the past few months. Economists show up saying we need to fear inflation. But the debts need to be paid and the economy is weak. China's state run stimulus economy is about to fall flat. There is a shortage of money, dollars, to pay back the debts. This is why the dollar will go up and why we will continue to have deflation as house prices fall. You can't look at QE and say it will be inflationary without taking into account that there is $53 Trillion debt that is in negative equity (not to mention interest payments). One or two Trillion is small change in comparison to the debt mountain in negative equity.
35. 51ck-6-51x said...
MG - good comment.
MW said, "Dear chaps, you cannot 'destroy' money, largely because it isn't really there! "
- Well you are right in one sense and wrong in another. The BoE can create ( destroy ) money, in that it can create more debt on it's own behalf ( in the old sense it would print more notes, each of which states "I promise to pay the bearer on demand..." ) In the same way it may destroy money. This is, of course inflationary ( deflationary ) since it destroys ( creates ) the tangible value of a unit of said currency.
You are right that in no sense is wealth created or destroyed across the system - although "wealth" is a dubious term in economics anyway ( there may be some definitions by which there is a change ) it is generally considered to be a relative measure of concentration of material possessions ( although the measure of value starts to contribute to a non-linear measure of wealth, but we start to get too philosophical ).
Basically the fact remains that the BoE has an effective, but constrained, monopoly on the supply of Pounds Sterling, the only competing forces are those of other forms of capital ( other currencies & assets ). The BoE may create as much debt ( or remove as much debt ) as they wish ( ignoring their subservience to the state ) the effect of which will be local inflation ( deflation ) leading to changes in the value of the currency they manage.
You correctly point out that QE is the purchase of assets, but you fail to observe that the money with which they credited the counterparties' central bank accounts was newly created ( they did not first find someone on the other side of the equation ).
36. 51ck-6-51x said...
MW - you are, however correct in that money created ( destroyed ) by a central bank is an increase ( decrease ) in the level of debt of the state on behalf of who the central bank does it's business - maybe that is all you were getting at, but I believe it is an oversimplification of the system :)
37. vacuouspolitician said...
@1. Very worrying.
38. mander said...
All comes down to restarting the housing bubble because if prices do not go up there is no point in buying. It is very difficult to admit that we have reached the end of house price increases. Since polititians have no intention to allow the housing market to heal itself we will probably be hit not by inflation but by massive unemployment. Companies providing the goods have higher costs which should translate in selling more expensive goods and would be inflation but this is not possible in recession so companies cut costs like jobs instead of putting price up on their goods.
I am not a fan of having an engineered solution to the problem.
39. 51ck-6-51x said...
mander said, "I am not a fan of having an engineered solution to the problem."
- Here here!
40. Chilli said...
As far as I know the whole crisis centered on the 'quantity theory of money'.
M V = P T
Basically, that the amount of money-in-circulation times frequency-of-transactions (volume as well.) equals
current-price-level times index-of-expenditure-in-real-terms.
Since the banks ran into their crisis, their play money was frozen in toxic debt. Since they cannot lend, the velocity of money drops away completely. (Other effects as well, like consumer confidence prevents spending, so no velocity). M2 money starts shrinking like mad. Since T is an index of real expenditure (effected by real supply and demand, technology etc) which is not effected in this scenario, the P has to change, which is price, and hence you have deflation, even when the money quantity is static. The reason is that money is not moving as fast. (Banks not loaning to each other or offering mortgages etc.)
Quantitative Easing is implemented by buying up Gilts etc, which means those investors don't have their Gilts anymore, so have to find other investment vehicles for their excess cash; bank accounts, bonds (which is corporate debt, which translates into corporate liquidity), stocks (which frees up other investor funds). This has a ripple effect which eventually gives liquidity back to the banks, which increases velocity again.
During normal times, interest rates slowly effect the quantity of money. Also bank capitalization ratios have an effect as well but on V. But QE is a drastic shock treatment. And you can't drop interest rates below zero. Or perhaps you can if you are japanese, but the situation still isn't good. Anyway, problem is - when the liquidity is re-established and bank capitalization ratios are back to normal, the M part of the equation will magnify the V part which is returning to normal, and the result will be a much greater P (price). Inflation. In a drastic way. The only way out of this is to have a way to pull M out of the system as fast as it went in. Selling the original Gilts won't work as people will only buy them if they are offering competitive interest rates, which would defy the point. Also, who is going to buy a inflation sensitive investment when inflation is ballooning?
One solution is to increase bank capitalisation ratios (eg for every 100 deposited, the bank has to hold 10% rather than 5%. This effects the elasticity of M), which would suppress V. This makes banks less susceptible to bank runs, but drops the ratio of M2 money to M which is the money issued from the BOE. This is probably bad, as it means less transactions which suppress the real economy. Perhaps a better way is to require all banks to capitalise up to a certain level and then, in one go, remove those funds from the economy and drop bank capitalization back to more reasonable levels. Problem is how to legally do that. Maybe the only solution is hyper inflation along with associated high interest rates.
I'm beginning to think that we have fundamentally broken the rules of the 'free market economy' that encourage economic sense and efficiency which means we have postponed our punishment until a later date.
41. uncle tom said...
mander,
We are at the end of a fifty year cycle of upwardly oscillating house prices.
This is now the bust, the big bang; and it requires some 'blue sky' thinking to come to terms with what is actually happening.
We are currently dealing with various levels of denial, enriched by countless incomplete arguments as to why this isn't really Armageddon.
All will turn to dust, and there are a lot of knock-on consequences to attend to.
Britain has in many ways played the game of 'we are wealthy because we are, and will therefore live as such' - without realising that the means of generating wealth in this nation has quietly gone up the Swanee...
Fifty years ago, you could buy a basic three bed Victorian semi in the home counties for £1,000. A new property might have cost £1,500
In today's money, that's £15,000 or £22,500.
Fifty years ago we had a skilled workforce, and an entrepreneur could set up in business without having to cover his back at every turn; lest he be accused of sexism, racism, ageism - or have to worry that a thief might injur himself breaking in to his factory...
The nonsense has run its course, and while it may take a little longer to sort than we might like, this is showtime...!
42. mander said...
uncle tom,
Thanks, I couldn't agree more with your view. We all know how difficult it is out there at the moment especially for the unemployed. From the politics point of view the West must abandon house price speculation in order to be able to compete with Asia in real terms. A house is still a house and we should not be working a lifelong to pay for it. Other things are important in life too.
43. devo said...
39. uncle tom...
This post should be disseminated far and wide. Well said!
44. 51ck-6-51x said...
Chilli
- Good summary. Yes - distorting free markets tends to store up problems ( but can be maintained, for example some subsidies and trade barriers have existed for a long time, as has London's greenbelt ) the distortions in question cannot be maintained.
Oh - one may effect an effect however an effect only ever causes an affect ;p