There is a gross straw argument being perpetrated by economists and market pundits, and that is the prospects of ‘rising’ or run-away inflation, or at least the ominous threat of such. It is important to note two things:
2. Inflation is a red herring
3. Commentators don’t even know what inflation is
“Most economists believe some level of inflation is important to a healthy economy”.
The problem with this perspective is that they think general price variance is a ‘demand phenomenon’ rather than a monetary phenomenon. The reason they think its not a ‘monetary phenomenon’ is because the Fed has launched a monetary stimulus program, and according to them, it disproved the Austrians who argued it would cause inflation. That might well be the argument of some or all Austrian economists, however I would counter that ‘cost-of-living’ inflation is not the only form of inflation. In an era of ultra-easy monetary conditions (i.e. low interest rates), money has fuelled a speculative bubble. It is easy to observe this in two respects:
1. The high prices for property in Western markets
2. The indebtedness associated with derivatives contracts has ballooned
The reason why we aren’t seeing a lot of ‘cost-of-living’ inflation like in the 1970s and 1980s is simply because in those times there was no prospect of wage restraint. Unions were unfettered in their capacity to demand higher wages, so any rise in prices was destined to trigger a wages spiral. Today, there is no prospect of a wages spiral, not because unions have been busted, as that was merely the ‘effect’. The reason is that unskilled workers in Western countries are in a very weak position to demand higher wages. Few industries are in a position to demand higher wages, and the reason is that:
1. Few industries (like mining, ports and government services) can get away with it without precipitating a shift in services offshore to emerging markets where labour is far cheaper.
2. There is no peer support from other unions for such rises. They are a collective organisation. You are not going to see 80% of union members supporting wage increases for 20% of members.
The flipside was that union membership has fallen instead because unions can no longer deliver on what members wanted – higher pay.
So what do we make of this logic?
“The U.S. central bank is targeting a 2% annual rise in consumer costs. The drop in market forecasts for inflation implies investors think the Fed will abandon that mandate and raise rates”.
The reality is that the ‘cost-of-living’ inflation is destined to tread a path broadly inline with the rate of money supply increase. The reason is not because money supply is increasing, but because governments look to rising inflation to finance government. Governments don’t want to be obliged to raise taxes. This was why it was so hard for the Japanese government to raise taxes. It would have been felt by the people. This is not a concern in other Western economies, where economic activity in rising, population is growing. Japan was unable to rely on these forms of stimulus because of its conservative people. The government was confronted with an unpopular choice – allow relaxed immigration, raise taxes or print money. It decided to print money and raise taxes. It scarcely delivered on the reform it promised.
You might wonder whether we need to be worried about rising interest rates. The answer is no. The Fed might well allow interest rates to rise, but they will never be allowed to rise more than enough to squash rampant speculation. The housing market is not overly priced. Current price levels are sustainable because there is simply no reason for raising rates, and current prices are actually reasons not to ‘scare asset markets’.
Deflation is not actually bad; its just bad for government. Deflation is a natural inclination for markets because its a signal of rising purchasing power that is associated with wealth creation. It is not however conducive to governments raising revenue, so governments like some ‘healthy inflation’, or easily-won taxation. Governments don’t like to have to qualify their actions because we have so little trust in them.