Inflation Killed by Recession
... and Other Lies to Destroy Your
Feb 13, 2008
"The US recession is
sure to send inflation to zero - just like it didn't in four
of the last five recessions"
Worried about inflation? ...
Oh stop your carping and set an extra place at dinner for the
fast-looming recession instead.
See, your cost of living can't
possibly keep rising now that Europe and the United States are
plunging into a credit-led slowdown. Inflation is dead, killed
by the slump. The value of money is going to stop sliding, even
as interest rates fall.
Says who? Says just about everyone.
"A US recession is now
an even bet as job losses and the housing contraction jeopardize
the longest-ever expansion in consumer spending," says Bloomberg
News, reporting its latest survey of professional number-crunchers.
"The world's largest economy
will grow at a 0.5% annual rate from January through March, capping
the weakest six months since the last economic slump in 2001,
according to the median estimate of 62 economists polled from
Jan. 30 to Feb. 7."
And your cost of living can
NEVER go up during a recession, right?
Oh sure, inflation in US consumer
prices accelerated by one-half during the recession of 1973-75.
It then hit an all-time peak during the short recession of 1980.
Inflation went on to beat its
previous 30-year average during every month of the 1981-82 recession.
(Don't misread that "fall" from 10% to 5% year-on-year;
the Dollar's buying power still shrank by almost one-tenth inside
16 months). And the cost of living then spiked higher again when
recession next struck in 1991.
But this time, well... this
time it's just going to be different, okay? Think 2001 rather
than the four previous US recessions. And not just in the United
"The Eurozone economy
is now clearly slowing down," says Michael Hennigan, founder
and editor of Finfacts, the leading financial news site in Ireland.
"Oil prices are also off their peak, [so] combined, these
factors should act to dampen inflationary pressures in the economy.
In particular, it should help prevent excessive wage increases
that could endanger price stability."
Here in the United Kingdom
- the world's fourth or fifth largest economy, depending on how
you count China's boom - growth just slid to 0.5% in the three
months ending January, says the National Institute of Economic
and Social Research. And that slowdown, the worst rate of growth
since 2005, gives the Bank of England "room for further
cautious reductions in interest rates," reckons Martin Weale,
the NIESR's director in London.
"I don't see the risk
of inflation being a constraint."
Back across the Atlantic, "the
economy is rapidly slowing on all fronts, Wal-Mart [is] slashing
prices again, and rising unemployment and delinquencies are going
to further restrict bank lending," says Mike Shedlock in
his Global Economics Analysis blog.
"There is simply no way
to get inflation out of this mix," Mish concludes. "The
Fed Fund rate is headed to 2% or lower, and the 10-year Treasury
yield will likely make a new all time low yield. Those shorting
Treasury bonds with impunity will have their heads handed to
Hands up, inflation as properly
defined - meaning an increase in the money supply - continues
to rise. Growth in the M2 measure "is running at almost
a 6% year-on-year," admits David Rosenberg at Merrill Lynch.
But "of course it is," he then spits.
"Most of [this new money]
is situated in non-transaction savings accounts, and these are
up almost 8% from a year ago. So transaction balances are falling
and precautionary balances are rising - what does that tell you
about consumer spending and saving behavior?
"This is all, from our
lens, very deflationary. Not the other way around."
Big picture, even the Euro-crats
of the European Central Bank agree; slower growth will
result in lower inflation - even if the ECB did sit on the Eurozone's
4.0% interest rates once more on Thursday. Pressured to repeat
the magic words "vigilant on inflation" at the press
conference that followed, Jean-Claude Trichet managed instead
to send the Euro plunging to a near-three week low by hinting
at cheaper money to come.
"Some of the menace behind
[his] anti-inflation comments in previous months seems to have
been softened," as David Brown at Bear Stearns noted to
AFX Thomson, "and there appears to be greater stress on
the downside risks to growth."
Put another way, lower growth
- if not recession - will take the heat of prices. Because lower
growth means falling demand. And only rising demand can ever
push prices higher. Or so everyone says. Which is odd given the
"Few empirical regularities
in economics are so well documented as the co-movement of money
[supply] and inflation," as Mervyn King, now governor at
the Bank of England in London, said in a speech of late 2001.
And the world's supply of money
is surging right now, even as "deflation" hits US housing
"Over the 30-year horizon
1968-98," King went on back in 2001, "the correlation
coefficient between the growth rates of both narrow and broad
money, on the one hand, and inflation on the other was 0.99"
Narrow money means cash in
circulation, but as King said, the relationship with cost-price
inflation holds just the same for "broad money" (shown
above) - meaning all notes & coins, cash on deposit, and
short-term bills, notes and bonds.
0.99 is as near-perfect as
you'll find in any pair of data. An absolute 1.00 only ever exists
for the very same thing measured against itself - say, the cost
of living mapped onto the cost of living, or Gold Prices correlated
with Gold Prices, for example.
Yet if we now race back to
the present, and re-appoint Mervyn King for his second term running
UK monetary policy, "the disruption to global financial
markets has continued," explained the Bank of England -
with King at the helm - when it cut UK rates on Thursday.
"Credit conditions for
households and businesses are tightening," the BoE explained.
"Consumer spending growth appears to have eased...Output
growth has moderated to around its historical average rate and
business surveys suggest that further slowing is in prospect."
In sum, "these developments
pose downside risks to the outlook for inflation."
Phew! And to think that five-
and 10-year bond yields had finally shot higher just before the
credit crunch bit in summer 2007 because inflation - whether
in prices or the money supply - had finally became the No.1 worry
for fixed-income investors.
concerns, the benchmark 10-year US Treasury note last week had
its biggest decline in price in more than two years, as investors
abandoned projections the Fed would need to lower rates by year-end
to stimulate growth," reported Bloomberg on June 11th.
about US inflation levels have sent short-term bond yields in
Australia to their highest level since mid-2002," said Australasian
Business Intelligence on June 20th.
"...The global economy
in 2007 is still expected to register close to 5% growth for
the fourth year in a row," added Fidelity Investments on
July 20th. "In response to this rapid growth, central banks
around the world have continued to tighten their monetary policies,
with the Eurozone, United Kingdom, Japan, China, and India all
raising short-term rates."
You might wonder - as we do
here at BullionVault
- whether that sudden surge in bond yields sparked the banking
crisis of August. But either way, here in Feb. '08, "persistent
fears over a possible US-led global slowdown [have] fuelled further
profit taking in crude oil," as one London analyst told
Agence France Presse at the start of this week.
And here starts the chain of
logic linking the housing slump to falling inflation, and by-passing
the impact of monetary inflation altogether.
"Between January 2003
and January 2008 alone," as the Financial Times quotes
Goldman Sachs, "the world price of metals rose by 180% and
of energy by 170%, in good part because of China's demand."
That demand, in its turn, came thanks to America's credit-led
bubble in consumer spending, but now the US consumer's tapped
out - and his house-keys are back with the lender.
So China can't grow, because
the US can't shop. Therefore oil prices and base metals will
sink, and inflation worldwide will now vanish.
Who knows? Things might just
pan out that way. But ignoring the flood of money - first created
as credit and now stacked up in Treasury bonds across the emerging
economies - would mean ignoring that perfect-as-damn-it connection
between growth in the money supply and inflation in prices.
- The People's Bank of China
is rumored to want money-supply growth of 15% per year, down
from the current 18% plus;
- India's broad M3 money-supply
is rising 22.4% per year;
- Singapore's money-supply increased
by 14% in 2007;
- Britain's broad M4 measure
of money has expanded by 12.3% since Jan. '07;
- Western Europe is "enjoying"
monetary inflation of 11.5% per year, three times the central
- Last year saw 16% money-supply
growth in Australia, 13% in Canada, and 22% in Saud Arabia;
- The US money-supply - if the
Fed still reported M3 - is now guess-timated to be showing 15%
Remember, that near-perfect
connection between money-supply growth and consumer-price inflation
is one of the few clearly established facts in economics. Over
a 30-year horizon, they match each other almost exactly. Which
is to say they won't necessarily move together this week or next.
Similarly, the last time runaway
inflation hit, the cost of living for Western consumers raced
ahead AFTER raw commodity prices had begun to slow down.
During the inflationary '70s,
the price of commodities - as measured by the Reuters/CRB Continuous
Index - peaked out in Nov. 1980. For the next 21 years, it was
then downhill all the way.
Adjusted for inflation, however,
the price of raw materials had in fact been falling since Feb.
1974. That was when the rate of US consumer-price inflation overtook
growth in the CRB index, surging on the previous commodity-price
hikes and feeding into service prices and wage demands. Inflation
in the cost of living finally peaked out in April 1980, hitting
an all-time record high of 14.7% year-on-year.
How did consumer-price inflation
keep soaring for more than five after commodity-price inflation
began slowing? No doubt things really are different today, starting
with the fact that the current bull market in commodity prices
- beginning in 2002 - represents the only real secular bull run
for raw materials since the Reuters/CRB index began in 1956.
The 1973 doubling of commodity
prices came thanks to the first Opec oil shock. Might the Federal
Reserve be taking things a little too coolly - not least with
the value of dollars - by saying it "expects inflation
to moderate in coming quarters" as it cuts the returns paid
to Dollar holders?
"The Opec [oil cartel]
would trim output if oil prices slip to $80 per barrel,"
according to a Bloomberg report. It cites one un-named Opec delegate
for the price target; two other members told the newswire that
$70 would be "unacceptable".
Says Johannes Benigni of JBC
Energy in Vienna, "it wasn't Opec's fault it moved above
$80, but now it's there, they justify keeping it."
Then there's the pile of dollars
stashed away by the central bank in Beijing...up from $156 billion
at the start of 2000 to more than $1.5 trillion at last count.
If the sorry demise of the US consumer really does dent the buying
power of China, might the Chinese government not step in - and
bid for crude oil, copper, soybeans and grain - to keep the fastest-growing
economy growing just as fast as it can?
Conjecture and guesswork is
no substitute for an answer, of course. And for as long as Gold
Prices keep screaming that something, somewhere is amiss between
inflation and bond yields, then that dumb lump of metal might
just keep finding a bid.
Gold has now risen in 18 weeks
of the last twenty-four. On Friday alone it hit new record highs
against both Pounds Sterling and Euros.
Still, nothing to worry about.
The US recession is sure to send inflation to zero - just like
it didn't in four of the last five recessions.
8 Feb, 2008
Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events - and must be verified elsewhere - should you choose to act on it.
Contact the author regarding this article.
Adrian Ash runs the research desk at BullionVault, the world's #1 private investor gold service. Formerly head of editorial at Fleet Street Publications - London's top publisher of financial advice for private investors - he was City correspondent for The Daily Reckoning for four years, and is now a regular contributor to 321gold, FinancialSense, GoldSeek, Prudent Bear, SafeHaven and Whiskey & Gunpowder among many other leading investment websites. Adrian's views on the Gold Market have been sought by leading news organizations including the Financial Times, Bloomberg and Der Stern in Germany.
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