A close friend, far richer and better-informed than I (not difficult) sent me some completely speculative global economic notes, which he admits depend upon force majeure and all that. See how many you agree with. I personally think the oil price drop is overstated, since  China, India, parts of SE Asia some parts of Latin America but particularly Brazil are still growing. If India and China descend into full blown recession, then the world is in terminal trouble and we had better get used to austerity, if we’re not already there.

• Complete and fairly permanent reduction of bank credit globally, with certainly 3 and possibly 10 years or more of credit limitation. Absolutely no chance of inflation in the UK, USA or Western European Euro nations for the next 3 – 5 years at least. 

• Big potential arbitrage play between € and $.

• Swiss franc and US dollar the only worthwhile currencies for the next 24 months. Sterling to be back at 1.35€ – 1.50€ within 3 years, due to the relative economic weakness across the Eurozone. US dollar to be 1.05 – 1.15 against sterling by 2010 / 2011 (it currently stands at 0.68).

• Oil to bottom at between $16.00 and $19.00 per barrel over the next 12 months (currently $51.00).

All bets are off if the US adopts protectionism, apart from currency levels, which will be about the same and the oil price which will be even lower. If protectionism were to take hold in the USA the downside will be greater in the UK, Europe and China. (This last one I agree with, wholeheartedly).

Happy Easter, John J Kelly

Inflation is a handy device for stealthily lowering wages, while deflation makes money cheaper but discourages both risk-taking and saving. By Adam Keats.

Few would debate that it is preferable to have a small amount of inflation (see Michael Prescott’s comment, Thus passim). The real debate is whether policy makers should veer on the side of caution of push for growth if faced with the choice (dove/hawk argument). Most of the literature on this focuses on inherent bias that the monetary policy actor exercises short term opportunism to stimulate the economy at the expense of a higher inflation rate in the long term. Hence a lot of the debate focuses on the desirability of creating systems to increase the penalties to policy makers for overshooting targets, such as the open letter system in the UK. The 1989 New Zealand Reserve Bank Act explicitly links monetary policy to inflation, and I believe they have a system that actually fires the head of the central bank in the event of inflation overshooting agreed targets. The US approach is slightly different in nominating long term Chairmanship of the Fed to encourage compliance with agreed inflation-limiting targets.

 .  . . . . . but that’s hardly a reason to be cheerful. And deflation might dampen wasteful consumerism. By Peter West

There’s only one thing worse than inflation, and that’s deflation. Inflation got a bad name for itself in the seventies, but just recently when it has looked like being replaced by its satanic brother, deflation, we have had cause to think what a good idea it was after all. Remember, the Monetary Policy Committee’s remit was not to keep inflation below a certain limit, but the Governor of the Bank of England was required to write and explain himself to the Chancellor of the Exchequer if it fell below maybe 2%.

So why is deflation such a bad idea?
Two big reasons: it discourages spending if people know that anything they can buy today is likely to be cheaper if they put off the decision for a month or two; and it discourages investment if you know the returns will continually diminish. How many people would have invested in Buy-to-lets if we didn’t expect a capital gain? Who would buy shares if they thought company revenues and profits would progressively get less?

And why is inflation such a good idea?
Because it makes us go out and spend. If we know the TV that costs £500 today will be £520 in a few months’ time we will buy; and it encourages us to invest because we know the assets we invest in will go up no matter how we manage them. Most of our (older) generation have done very well (thank you) riding the house price inflation train. Whether we cashed it in or not, the fact that the value of our homes was going up made us feel we were doing well, so we went out and spent freely, in the knowledge that that nest egg was there for us.

Inflation is what the Prime Minister dreams of now to stimulate the economy more than anything he can do. Goodness knows we have a right to expect it. Something that has gone largely unreported is that Sterling’s 25-30% decline against the $ and Euro, when most things we buy are imported, should be expected to lead to either serious inflation or savage reductions in company profits.

Inflation is what the banks are crying out for because it will restore value to the assets on which their loans are secured. No wonder Crispin Odey wants inflation back. He has plenty of assets and wants to see them increase in value again.

And why is inflation such a bad idea?
Because it eroded the wealth of those with savings and those on fixed incomes and because it took property out of the reach of people on normal incomes. It created a chasm between those who had and those who hadn’t. House prices became a self-perpetuating bubble – until it burst.

And why is deflation such a good idea?
Because it will bring property back down to more sensible levels – maybe half what the market peaked at (bad news for those that got in late with big mortgages, but good news for those waiting to get a home); and it will discourage people from spending pointlessly in a world where there is an unsustainable level of consumption. This does mean less jobs, but it also means the world’s resources will last just a little longer. ]]> http://thusmagazine.com/2009/01/inflation-may-be-marginally-less-depressing-than-deflation/feed/ 0 http://thusmagazine.com/2009/01/more-about-inflation-crispin-odey/ http://thusmagazine.com/2009/01/more-about-inflation-crispin-odey/#comments Wed, 28 Jan 2009 10:22:09 +0000 John Kelly http://thusmagazine.com/?p=2138 Writing in today’s Financial Times, often-controversial hedge fund manager Crispin Odey echoes some of the arguments put forward on THUS by Chris Gilchrist (below). 

With full attribution and respect for the FT’s copyright, here is a brief extract from his piece:

The world’s total outstanding debts have to be reduced. Our populations and companies need the means and the time to pay them off. These means are profits and pay rises. The other thing we need is inflation.   

Inflation will allow debt to reduce day by day. Price rises will make companies going concerns, earning their way back to profit. Pay rises will enable households and consumers to pay down what they owe while saving more and spending some. And inflation allows interest rates to rise but still remain negative in real terms. It is healthier that people receive an annual pay rise than take out an extra annual loan – as they have been doing since 2000. This package will allow markets to breathe again.

Inflation is coming in any case as a by-product of today’s world-wide policy intervention. If it comes by force through currency and debt dislocation, then it may come as hyper-inflation at terrible social cost. But it is not useful to see hyper-inflation and deflation as opposite ends of the spectrum. They sit too close to each other on the circle.

Both kill economies and businesses. Our aim must be to achieve an inflationary world until the debt comes down, choosing the right target for the times. The responsible choice is to opt for managed change, to deal with the pain inflation will inflict, at its acutest in the first years, and to fix an exit strategy. We should choose to take this path, set a softer inflation target rate and use forms of quantitative easing, with fiscal action to encourage wage rises.

To fight inflation is to fight the last war. In a modern monetary economy the mortal enemy is deflation, and the absence of growth, profits, and wage increases.

You can read the full article: here: Insight: Debt’s burden on the economy.

This is a very valid debate, and I’m pleased we were among the first to air it, but for the record, I don’t agree with either Crispin or Chris. I sense that inflation will be rehabilitated at G20. A degree of inflation will reduce the debt burden, and thus, if wages rise ahead of inflation, the economy will grow and the debt burden, in real terms, will diminish (though inflation will also apply to the credit card providers and bank lenders, who automatically apply interest rates of an order of magnitude greater than inflation, which has historically had a habit of spiralling out of control in bad times, with disastrous consequences. Neither article has addressed what happens if consumer prices rise ahead of earnings. In the 1970s, for example, the VAT regime was far less pervasive: income taxes may have been higher, but taxes on discretionary spending, or even necessary spending, were less. Consumers were not burdened by mobile phones, television subsriptions and internet bills, items which have acquired the status of de facto essentials. Likewise usurious utility bills, the regulation of which the government appears to exercise little or no control.  In the 1970s the profits from state-operated utilities went back into the state coffers. Now they go via France, Germany or wherever and are paid as dividends to institutional investors. Another consideration is that in the 1970s Britain was predominantly self-sufficient in fossil fuels. 

The inflation argument is absolutely relevant and I want to hear more from people who know a lot more about this than I do – which isn’t hard. So please enlighten us.

John J Kelly

 

Economists, governments and central banks have grown increasingly worried about the level of consumer indebtedness, which is especially high in the US and the UK. In the UK, mortgage lending on residential properties is now over £1,200 billion. Unsecured debt adds another £230 billion, with credit card debt running at more than £57 billion per month. Mortgage affordability has deteriorated steadily since 2000, with 2007′s first-time home buyers using a third of net household income to make mortgage repayments. Repossessions are rising fast, as are defaults on consumer debt.

Everyone understands the linkage between spending and debt, and few dispute that a healthy economy depends on consumer spending. But the increasing cost of servicing and repaying household debt is now the biggest drag on the economy. The ‘credit crunch’ has forced politicians and monetary authorities to turn on the taps, using methodologies such as quantitative easing, to prevent a catastrophic spending freeze, which will result in deflation, as evidenced in Japan in the 1990s, or an increase in the rate of inflation. The worst case scenario would be stagflation, the toxic combination of monetary inflation and economic stagnation which occurred in the UK after the 1973 oil price shocks and which laid the foundations for the ongoing fixation with curbing inflation at all costs. In an ideal world, prices remain relatively stable while economic growth proceeds apace. Today’s crisis has largely arisen because the supply of credit has dried up. To avoid stagflation, we may be obliged to embrace inflation. And this may have the effect of reducing the real value of the debt mountain and freeing up consumer spending power.

This argument in favour of the beneficial effects of inflation is supported by the case for inflation as a mechanism for reducing the state’s own burden of debt. By 2012, total UK government debt is likely to be about £800 billion or 60% of GDP. Repayment of this debt will require a larger slice of government revenue, which will mean less schools/hospitals/services or higher taxes. Inflation will soften the blow. An inflation rate of 5% for five years would cut £200 billion from the real value of UK debt and make it much easier for politicians to pursue their social and political aims.

Policymakers obsess about inflation in the form of rising prices, but generally ignore the way a reasonable rate of inflation erodes debt. For example, the effect of one year’s inflation at 5% on the UK’s £1,400 billion of consumer debt is a real write-off of £70 billion, more than the tax cuts in all of Gordon Brown’s Budgets combined. Over five years, 5% inflation would cut the real value of debt of all the UK’s indebted households by an average of about £20,000.

Baby boomers made money from home ownership in the 1970s not so much from the rise in prices – the average rise in house prices from 2000-05 was greater than that of any five-year period in the 1970s in real terms – but from the inflationary devaluation of their debts. For example, the real value of my mortgage halved over five years from 1973-8. Like most people’s, my earnings rose roughly in line with prices, so mortgage repayments accounted for a shrinking proportion of my earnings, and I carried on spending.

We know from the experience of the 1970s that people are much happier with house prices rising at 4% a year and inflation at 8% than they are with inflation at zero and house prices falling by 4%. After a long period of relatively stable prices, it will take several years of rising inflation before consumer behaviour adjusts to the ‘money illusion’ (we tend to treat tomorrow’s pound as equal in value to today’s even though it will buy less). Five years of inflation at about 5% could make housing affordable again for first-time buyers as well as releasing substantial spending power for homeowners as mortgage repayments absorb a declining fraction of income.

Higher inflation rates will have another major benefit: it will partially reverse the huge transfer of wealth that has taken place over the past decade from the young and poor to the old and rich, partly through the rise in house prices and partly through rising income inequality. Inflation transfers wealth in the opposite direction, from the old and the rich to the young and the poor. However desirable it may be, such a transfer is politically impossible if it has to be accomplished through taxes in a no-inflation environment. The young, who must save more towards their retirement, need to raid the piggy banks of the old. Inflation enables them to do this quietly and without confrontation. Meanwhile, the one big category of potential inflation losers – the old poor – are the easiest to protect through inflation-linked state benefits.

These arguments are even more applicable to the US, which I expect to be the first to endorse inflation as the ‘least bad alternative’. The UK, then mainland Europe, will – at first reluctantly – follow the US lead. When it is embedded, economists will tear up their anti-inflation tirades and start to write treatises about why it is a Good Thing.

About the author:

Chris Gilchrist has 30 years’ experience as a financial journalist, editor, author, lecturer, TV and radio broadcaster and commentator. He launched a series of monthly financial magazines and has been involved in programme series for Channel 4, BBC1 and BBC Radio 4. He is currently a director of investment advisers Churchill Investments PLC.