Tuesday, March 31, 2009

The Court of Public opinion: creating the spectre of deflation to validate irresponsibility

It's time to admit inflation is going to be a major problem

Spotted this just now. I remember talking about the fact that inflation is the real issue going forward - and that deflation is way overstated. Very useful article

Posted by growler @ 10:02 AM (1692 views)
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36 thoughts on “The Court of Public opinion: creating the spectre of deflation to validate irresponsibility

  • This article makes too many easy assumptions like oil at $60 when it could just as easily go to $30. It also deliberately ignores the deflationary effects of increasing unemployment, lower wages and reduced demand for manufactured goods. It’s interesting that he complains about deflation propaganda and then makes such a light-weight propagandised case for inflation

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  • For some time I’ve been writing that the only thing that is deflating is house prices and that economic policy (both of the government and the BoE) is entirely geared to reinflating the “housing market”.

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  • matt_the_hat says:

    What I fail to understand is why inflation targeting is per annum, should this not be over an economic or parliamentary cycle, i.e. 10/5 years

    This would mean that inflation should be targeted at 1.02^10 = 22% over a decade.

    Also the annual setting at 2%±1% means we could have inflation per decade at between 10-34%.

    Every time we overshoot should there not be a period over undershoot to correct?

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  • @2: I guess time will tell, but we’ve had staglation before – recall unemployment, devalued sterling and capital flight. If we continue to see Sterling weak, given our tendency to import, unemployed or not, prices in shops will be higher. It comes back to what is the economics of inflation: cost or demand. Cost pressure will be the start, followed by sloshing money (demand) as we get over peak unemployment (a well-known undisputed lagging indicator) in about a year. Then you’ll have to deal with wage demands, again. This will reinforce cost inflation.

    It’s essentially the same issue that is involved with house prices. It does not matter how low interest rates are or how little “housing stock” there is if the same quantity of people in the market get substantially less money lent to them than they would have done in more reckless times. Pouring money in causes inflation.

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  • I generally agree with this piece. The Saudis have said that they think the ‘right’ price for oil is $75; and they have the power to make that happen by regulating their output.

    However, as the dollar devalues, along with sterling; the oil states will probably conclude that the ‘right’ price should get higher..

    ..and higher..

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  • Flashman,

    Let’s be clear about this. You are suggesting that after this country has “doubled its monetary base.” the Chancellor and BoE will display the competence and will to raise interest rates and conract the money supply as soon as an economic recovery starts?

    Inflation will help erode the huge government debts we are racking up and will probably be very popular with the electorate because nominal house prices will recover.

    I agree that there’s plenty of room for discussion about how prices, wages and interest rates will move in the next few years but in the longer term no government could afford to spend what we have borrowed and maintain the value of our currency without an electoral backlash.

    Inflation is the easy way out for government and perhaps it is the least worst option now.

    This is a repeat posting band it’s about the US instead of the UK but it illustrates the problem quite nicely:

    http://www.youtube.com/watch?v=sQ95njy0r0I
    (03:11 Peter Schiff on the National Debt, China, and Inflation)

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  • uncle tom: They really don’t have the power. Back in Bill Clinton’s day, oil was in the 20’s and there was sod all they could do about it. They tried repeatedly but in the end only the trade towers and gulf war 2, increased prices. Also, the Saudis are terrified of alternative energy and they know that if they prove to be an unreliable friend, the world will put far more resources into nuclear, coal, solar and wind. Another factor is that the oil producing countries hate each other and have a long history of cheating each other on oil quotas

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  • stillthinking says:

    But the inflation won’t show up in wages…so a better description would be that we are adjusting to being a less wealthy country.

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  • mark wadsworth says:

    Agreed, it is likely that there will be inflation on imported items. But for a given budget, the more people spend on imported stuff, the less they have to spend on housing, ergo, you could easily argue (as I do) that overall there will be ‘price stability’ being a mix of high inflation on some things and further falls in house prices. House prices are just a balancing figure after you deduct everything else.

    e.g. taken to extremes, a taxi driver will put his fares in response to high petrol prices, but is it possible that somebody selling a house can demand a higher price merely because he needs more money to spend on imported goods? I think not, because the buyer of that house also needs to spend more on imported goods.

    Further, why would our QE be any different to Japanese QE? We had high inflation in the 1970s because all the money they printed stayed in the country because of exchange controls. Half the money they printed to buy gilts just went straight abroad to foreign gilt sellers (most gilts owned by UK owners appear to be owned by pension funds who can’t sell them anyway). The same happened with Japan, all the money jsut went abroad and the JPY just slid down a few per cent every year for six or seven years, without them having inflation.

    There again, perhaps I’m completely wrong and this is all just wishful thinking. Hmm.

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  • quiet guy: My post makes the simple point that the article ignores deflationary influences. There are some potentially inflationary influences at work and some potentially deflationary influences. It is important to consider both. It is not sensible to sweep either side of the argument under the carpet.

    It always surprises me that most people on this site are so unequivocal about tumbling property prices/markets while being equally unequivocal about the certainty of inflation. Tumbling assets are generally considered deflationary.

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  • still thinking: ‘so a better description would be that we are adjusting to being a less wealthy country’

    I agree with this whole heartedly. I actually think the credit crunch will one day be considered a healthy turning point. High wages and a high Pound caused our economy to become unbalanced. Lower wages and a devalued pound will help us to become more productive and therefore more stable.

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  • @Mark Wadsworth;

    “There again, perhaps I’m completely wrong and this is all just wishful thinking. Hmm.”

    You’re not, and it isn’t.

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  • george monsoon says:

    I never did understand what unequivocal means.. I will inspect wikipedia for the answer..

    head down.. back to work.. hope my job is still here next year…..

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  • I don’t see the false dichotemy of some on here that we’ll see steaming inflation OR steaming deflation or the fact that crashing house prices are linked to ALL measures of inflation……. I think on balance, we’ll see a slight reduction in RPI but CPI (because CPI does NOT including mortgage costs) will stay stubbornly high.

    As for houses, and back to the RPI issue, we’re seeing a kind of liposuction of money out of the housing market. People are being lent less, the can pay less, the seller has less to buy with, so it continues down to a sustainable level. To extend the liposuction analogy; to a healthy diet.

    Flashman: Economists have been puzzled by one of the largest disparities in RPI and CPI at the moment. Most people on here seem to think house prices will probably bottom out in 2 years. Some more, some less.

    I see the issue as this: Whenever the house price crash hits the bottom (sometime 2010 before falls are less steep), expect RPI to follow CPI a lot closer. And just as RPI and CPI become unanimous, expect the discussion about inflation to be once again unanimous.

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  • Flashman,

    Global oil consumption has continued to grow year on year (and is probably only flat-lining at the moment, despite the downturn) while reserves of easy oil are rapidly running out.

    Although no-one is quite sure how much oil the Saudis really have left, they do have the infrastructure to produce (or not produce) a significant percentage of the worlds needs.

    They lost control for a while when Russia and the North Sea started exporting in quantity, but the North Sea is rapidly running out of easy reserves, and the Russians are not far behind..

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  • uncle tom: oil consumption HAS significantly fallen and there are many oil specialists who think there is way more oil that is being admitted to. If you were a large oil producer would you admit to larger oil reserves? Scarcity is good for prices. Don’t forget that oil extraction technology and oil discovery technology will not stand still and alternative energy supply will exponentially increase.

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  • george monsoon says:

    Ah .. oil reserves…

    Now what happened to the US option to open the North Alaskan oil fields? did that ever go anywhere?
    I understand that there is more oil under North Alaska than there is in the whole of Saudi..!

    Now that would effect oil prices..

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  • As I posted here yesterday Labour, the BoE and their propagandists in the media have sold the masses the lie about deflation in order to justify QE whose purpose is to create so much inflation that the debt burden will be reduced. Liam Halligan gets this. If people really think that the BoE are going to raise interest rates when inflation really takes off again they are mistaken. How would that inflate away the debt? King has already said that he is going to ignore the inflation target before the end of 2010 so you have been told in advance they will NOT be raised if inflation rockets. We’ve just had a decade of an economic illusion based on debt do you really think they’ll try and get out of it honestly?

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  • In posting this Telegraph piece by Liam Halligan ‘growler’ commented that it was a “very useful article”.

    Before placing too much reliance on Halligan’s opinion you might look at this from last Summer;

    http://www.telegraph.co.uk/finance/comment/liamhalligan/2793847/The-state-of-the-economy-needs-to-be-put-in-its-proper-perspective.html

    (The first half a dozen commenters seemed distinctly unimpressed.)

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  • Flashman: “If you were a large oil producer would you admit to larger oil reserves? Scarcity is good for prices.”

    This type of oil price manipulation seems implausible with so many competing nations with so few shared interests. In as much as it has been tried, it has clearly failed in the past year given such prodigious oil price volatility.

    From a UK political standpoint, perhaps the only financial option left is the variety of inflation least likely to hurt Labour voters, so that’s what Brown will try. From every other standpoint, it’s bonkers, but that seems junior to the interests of our political leadership today.

    A major turd in the oil-pipe for Brown is whether holders of UK debt will allow the atrophy of their holdings that may accompany inflation. China has signaled its edginess about US plans to inflate away their debt, so Brown’s strategy is by no means a slam dunk – or should I say, open goal – and is likely to require an interest rate hike.

    In which case he’s back to square one regarding house prices.

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  • Some good comments here. I think there are too many assumptions made by the article’s author. However, the actions already taken by the central bank do look like they have produced and may continue to produce some inflationary pressure, but there is not yet any sign of an impending hyper-inflationary environment without a turnaround in sentiment.

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  • mountain goat says:

    There are not many people alive who know what deflation is. I can try imagine what would have happened if governments hadn’t stepped in to save collapsing banks. The financial system would have failed. Now that probably would have led to deflation.

    So now governments have taken on the bad debt.

    As long as investors are dutifully going to buy and hold government debt then maybe deflation can be avoided. But will they?

    Government debt is actually taxpayers debt. As long as taxpayers dutifully keep paying higher taxes then maybe deflation can be avoided. But will they?

    Historically when the economy is over-loaded with debt in a boom, this is followed by deflationary bust. The alternative is money printing which has led to hyper-inflation Weimar/Zimbabwe style. Our authorities are committed to avoiding both extremes. What we get in the end seems very unsure to me. I suspect we won’t know for years and will go through periods where it looks like one and then the other (with stock market and housing prices fluctuating according to what the consensus is at the time).

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  • “oil consumption HAS significantly fallen”

    All the historical data, and all the projections I can find, show it rising, even accelerating slightly – where is your data source?

    “If you were a large oil producer would you admit to larger oil reserves?”

    If you understood how OPEC worked, you would know why their members overstate their reserves.

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  • Dogget: yes – Liam does look weak with this connection. But this is the “property vested interest – come – lack of research” side that most journos talked last year. Remember Ambroses’ predictions…

    I don’t think Liam was a great property crash speculator (waiting for someone to prove me wrong here!) therefore he would not have thought the impact of particularly RPI reducing activities that have led to the CPI disparity of now.

    My view: back then, RPI was much higher than CPI due to still relatively higher property numbers and intererst rates at what would be termed “crazy high” in todays World. Look at the HPC stats for June 08: only we here thought -30% to -40% was on the cards.

    It’s this disparity – clearly the property factor – that has forced RPI down and CPI a lot LESS lower.

    Once we lose the property crash factor as the bottom hits, Liam will be more “right” – and interest rates will have to go up.

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  • As far as I understand the current crisis the situation is this: collectively the banks, and private individuals/businesses racked up huge amounts of debt. As a result when interest rates rose it became apparent that not everyone would be able to pay back what they had borrowed. The banks were effectively bankrupt. The govt has stepped in behind the banks and taken on their debt, and prevented systemic collapse. This has solved one crisis (banks going bust, savers losing their money, depressionary downward spiral), but created another one – how can the govt finance all the debt it has taken on, plus what it is spending extra to boost the economy?

    This problem has yet to be faced. And whatever solution is chosen (or happens whether politicians choose it or not) will not be good. At best we face a Japanese style decade or more of low growth, high taxes and reduced spending to slowly whittle away at the debt moountain. Or we face an old fashioned UK currency crisis, with rising (possibly 10%+) inflation, falling pound, and the IMF called in. Worst case scenario – pound drops drastically, gilt buyers strike, hyperinflation kicks in. Take your pick. None are very palatable. But to think we can survive a credit boom and bust of such magnitude with a year or two of recession, a milllion or so extra unemployed, and a rapid growth pickup within 2-3 years of the crisis starting, is not credible. There is more pain to come, in one form or another.

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  • another alan says:

    Halligan was on Newsnight yesterday, and pretty angry about the economy and government etc

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  • uncle tom: I get my data from the EIA (Energy Information Administration). They forecast a 1.2 million b/d drop in 2009. If you do a Google search on falling oil consumption, you’ll find a few hundred items. Worldwide factory closures and slow downs are the culprit.

    Also put these words into a Google search: “The pressure on companies to understate reserves by the analyst community has created a gross misunderstanding of how much oil …”

    Google search “oil reserves understated” will also come up with several articles.

    Peak oil is a theory that ignores the unknowable and new discovery and extraction technologies. It might be true but no one can be sure

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  • Hi all, to add my two penneth to the oil price / inflation discussions the oil price has been in strong contango ever since the plummet last year. Pls take it from someone in the industry that the reality of today is that the reduced global demand and low price scenario has shaken out a number of players and written off alternative oil supplies (look at the impact of <$90/bbl to Canada's plans and their FX). Furthermore it's impacted the investment in alternative energy as a result of the plummet in CO2 value, whilst this is temporary I'd say that defining investment in alternative energy as "exponential" is slightly optimistic... Call me old fashioned but surely the threat of inflation has to be bad for potential buyers (such as myself). Given the current trends I do no link inflation with a rise in house prices but rather an increase in potential ownership costs hence tempering my enthusiasm to own...

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  • rocket robbie says:

    Would someone mind explaining to me what would happen if the goverment didn’t bail the banks out. I know they would be broke but what would happen for instance to those who had mortgages with the banks.

    My dad thinks its a good thing (he would do he is a BTLer) but i have always thought its corrupt and unfair on the British taxpayer but i cant put up a good enough argument.

    Help!

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  • @30: The creditors’ administrators would seek to recover all liabilities from mortgagors/debtors (person paying mortgage) leading to probably an immediate request for closure of the account so that funds could pay of creditors. That would mean a lot of people having to find alternative mortgages – some of which would not be getting one –> unrest. Hence little choice but to support such an organisation.

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  • jvm: Investment in alternative energy will exponentially increase. When new technology is introduced there is always a period of denial and lagging development, followed by an explosion. The catalyst could be technological breakthrough, global warming, keynsian spending, political security, demand etc etc The computer industry is a good example. The 1940’s saw some deveopment but then not much appeared to happen. Suddenly a critical mass is achieved and then it is breathtaking.

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  • rocket robbie says:

    Thanks Growler

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  • Tenyearstogetmymoneyback says:

    10. mark wadsworth said…Agreed, it is likely that there will be inflation on imported items. But for a given budget, the more people spend on imported stuff, the less they have to spend on housing, ergo, you could easily argue (as I do) that overall there will be ‘price stability’ being a mix of high inflation on some things and further falls in house prices. House prices are just a balancing figure after you deduct everything else.

    I agree completely. At the end of the 1980s boom a colleague came up with the theory that as the price of consumer goods fell
    people just spent more on their houses. Back in 1986 the people I bought my first house from has a £600 video recorder; the equivalent of spending about £3500 on one today. Another colleague recalled how his first washing machine cost 10% of what his house had cost.

    Anyway the point is if the cost of other goods goes up we could end up back at similar ratios.

    :- Duncan

    Bought 1989 £65500 sold 1999 £70500 treated myself to a £300 video in about 1994

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  • @krusty

    Ahw, we were doing so well and now this. I don’t agree with flashman sometimes either but why the name calling?

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  • 34. krustyatemyhamster

    Oil free? lol, no brainer! @ $35 it was a BARGAIN!!!!!!!

    Go the $30 lol who cares in the long run. D’oh!

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