When Will Inflation Really Hit Us?
Terry Coxon
Editor, The
Casey Report
Oct 27, 2009
Most of us are gathered at
the station, watching for the Inflation Express to come rumbling
in. But we've been waiting for a while now. Just when should
we expect the big locomotive to arrive and start pushing the
prices of most things uphill?
We'd all like to know the exact
date, of course, but no one can know for sure. Not even a careful
reading of the Mayan calendar will help. What we can do is estimate
a time range for price inflation to show up, and that alone should
have some important implications for investment decisions.
Why It's Expected
The reason for expecting price
inflation is the recent, rapid growth in the money supply and
the deficit-driven likelihood that more such growth is coming.
As of July, the M1 money supply
(currency held by the public plus checking deposits) had grown
17.5% in a year's time. That's not just unusually rapid, it's
extraordinarily rapid. Since 1959, M1 has grown more rapidly
in only one other 12-month period - and that was the one ending
last June, when the M1 money supply jumped 18.4%. Even in the
inflation-plagued 1970s, growth in M1 never exceeded 10% in any
12 months.
Dropping large chunks of newly
created money into the economy leads to price inflation, because
the recipients are likely to find themselves overprovisioned
with cash. As they try to unload the excess, they bid up the
prices of the things they buy, whether it be stocks, shoes, gasoline,
silver coins, or granola. The sellers of those things then find
themselves cash rich and start doing some buying of their own,
and so the wave of excess money and the bidding it inspires propagate
through the economy.
The process isn't instantaneous.
It takes time. Just as each player in the economy has a sense
of how much of his wealth he wants to hold in the form of money,
everyone will move at his own speed to make adjustments when
his actual cash holdings seem to be off target.
And the process can seem to
stall, especially when fear is growing. When people are worried
or otherwise feel a heightened sense of uncertainty, they will
gladly hold on to abnormally large amounts of cash - for a while.
But when fear abates, as it will when the economy begins to recover
from the recession, that temporary demand for extra cash will
also fade, and the hot-potato process of trying to pare down
cash balances will emerge to do its inflationary work.
But when?
The speed at which the public
tries to unload excess cash and the timing of the effects have
actually been measured, in the work of the late Milton Friedman
and his monetarist colleagues. The method was indirect and roundabout,
and so the results, unsurprisingly, were nothing as precise as
nailing down the value of a physical constant.
What the monetarists (or the
first of them to be equipped with computers) found was that when
the growth rate of the money supply rises:
- The initial effect is on the
prices of bonds and stocks, an effect that comes within a few
months.
.
- The peak effect on the growth
rate of economic activity comes about 18 to 30 months after the
pick-up in the growth rate of the money supply.
.
- The peak effect on the rate
of consumer price inflation comes about 12 to 18 months after
that, which is to say it comes 30 to 48 months after the peak
growth rate in the money supply.
As Friedman famously put it,
the lags in the effects of changes in monetary policy are "long
and variable." He might have said, "It's a big, wide
blur, but we're sure we've seen it."
And even that picture exaggerates
the precision that's available to us. The emergence of money
substitutes, such as NOW accounts and money market funds, has
added its own muddiness to the picture of how growth in the money
supply translates into growth in the level of consumer prices.
It is only because the recent episode of monetary expansion has
been so extreme that we can look to the results just listed for
an indication of what's to come.
If you apply the findings of
the monetarists to the present situation, here's what you get.
The peak growth rate in the money supply occurred last December,
so based on the general monetarist schedule:
- Some of the effect on stocks
and bonds should already have been felt.
.
- The peak effect on economic
activity should come between the middle of 2010 and the middle
of 2011.
.
- The peak effect on consumer
price inflation should come between the middle of 2011 and the
end of 2012.
A More Particular Schedule
This time around, should we
expect things to move more rapidly or more slowly than average?
My bet is on slow, which would push the peak inflation rate out
toward the end of 2012. One reason for slow is that the government's
rescue packages are delaying the process. Rescuing banks that
are choking on bad loans postpones the day of reckoning for both
the banks and the loan customers. It retards the pace of foreclosure
sales (whether of real estate or other collateral) and puts the
deleveraging that has been going on since last fall into slow
motion. A wilting of the recent stock market rally would confirm
this.
Investment Implications
The big plus about the Mayan
calendar is that, right or wrong, it is very definite about things.
Human civilization will come to an end, I'm told, on Dec. 21,
2012 - not on the 20th and not on the 22nd. There was no room
for monetarists in those step-sided pyramids, but there still
are few what-to-do implications from the monetarist findings.
1. When you hear would-be opinion
leaders cite the current absence of rising prices at the supermarket
as proof that all the new money isn't a source of inflation,
don't believe them. It is much too early for the inflation bomb
to be going off, even though the powder has been packed and the
fuse has been lit.
2. If the large and growing
federal deficits and the Federal Reserve's unprecedentedly easy
policies tempt you to leverage up on inflation-sensitive assets,
such as gold, give the idea a second thought. It likely will
be a year or more until price inflation becomes obvious and undeniable
(which is what it would take to bring the general public into
the gold market). In the meantime, your inflation-sensitive assets
could get paddled rudely as the deleveraging that began last
year continues.
For at least the next year,
the simple, fire-and-forget strategy is 50-50 gold and cash -
gold for what looks to be inevitable but on its own schedule,
cash to be ready for the bargains that may show up while we're
waiting for the inevitable to arrive.
The editors of The
Casey Report keep their ears to the ground, listening for
the first rumblings of the inflation stampede coming in. But
you can bet on rising inflation - and interest rates - right
now and be way ahead of the investing herd. To learn more about
investing in this all but inevitable trend, click
here.
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