Thursday, 2 October 2008

Inflation denial

Since the financial crisis hit its latest crescendo, I have been struck by the sudden surge in inflation denial. There is a mistaken belief that just because a couple of banks have collapsed, price growth will suddenly moderate.

If only bank crises worked in that benign way. We are one year into this crisis, and inflation has gone up, not down. Currently, the UK CPI inflation rate is 4.7 percent.

This should be no surprise to anyone who takes a glance at monetary growth data. UK money supply growth actually picked up a little over the summer. For central banks, a higher inflation rate is part of the answer to the banking crisis. Rapid inflation reduces the real value of debt and therefore makes debt servicing more manageable for borrowers.

The deflationists haven't factored in the impact of the the world banking bailout that is now being organized by the world's central banks. The key idea behind the US banking bailout is to pull out all those dysfunctional assets out of US balance sheets so that the banks can start creating credit again.

Interest rates provide a further reason for believing that inflation will be with us for quite some time to come. In real terms, policy rates are either negative or close to negative.

Finally, central banks on both sides of the Atlantic have spent the last year pumping in unfathomable amounts of monetary base into the world economy. Give this huge monetary loosening some time and we will see inflation take off like a rocket.


Anonymous said...

Dear Alice,

Please include the following article on your great blog:

Bradford and Bingley: British government nationalises second failing bank

By Jean Shaoul
2 October 2008

The government bailout of Northern Rock and B&B adds at least £127 billion onto the public sector’s liabilities, a sum equal to 8.6 percent of GDP in 2007-08, and increases total net debt to GDP to about 48 percent—assuming the government does not fiddle the books yet again.


Anonymous said...

Sorry Alice, but you strike out on this particular issue.

Alternatively, read this chart from Creditwritedowns post on UK housing falling 12.4%.

Recessionary mentality is now embedded in the UK consumer. Regardless of a willingness of banks to lend (and Naked Capitalism has a great article on how the bailout actually HARMS lending), consumers and companies simply won't want to borrow even at 0% to buy an asset that's dropping in value.


Alice Cook said...


Some asset prices may well fall. House prices will keep falling as will some equity prices. However, I believe that over the medium term, we will see the CPI inflation rate remaining surprisingly robust.


Anonymous said...

Ah hah!

CPI inflation rate. We attach considerably different importance to this number.


Alice Cook said...


Renters laugh at homeowners obsessions about house prices.

Homeowning is a mugs game.

Handle a Landlords as you would a man; "treat them mean to keep 'em keen"


Anonymous said...

So Alice, why don't you post M0 or some monetary base figures for the world largest economies, say the G4? You would be surprised.


MAB said...


However, I believe that over the medium term, we will see the CPI inflation rate remaining surprisingly robust.

I agree. And I see inflation beyond the medium term too. I feel inflation in my pocket book every day.

I just don't see domestic and foreign producers selling me goods cheaper in the future. No way.

Asset values are ficticious and largely based on optimistic assumptions about future production. CPI goods are real - each and every day.

Anonymous said...

If by inflation, you're just talking about CPI, then there will be no deflation as it only measures what the Gov want to measure.

But the purchase of a house is an important part of people's budgets. Many people spend half their wages on it.

If a house comes down 10% in a year, then other prices would have to rocket up to balance that.

After all - housing loses £15,000 in one year, and carrots go up by 15p per pound - how many carrots must you be buying for it to balance?

If by inflation, you're talking about "increase in the supply of currency and credit", then you need to take a look at Doug Noland's "the moneyness of credit" concept.

The upshot of that is there are no readily availably figures of what constitutes "money equivalents" and so we are just going to have to wait for the wave to come from the sea and smash us into the mountains before we see how bad it is.

It is going to be bad. Two banks nationalised, another taken over, and it's barely 2 years after the figures said something was wrong, and inflation is nowhere (relatively speaking), interest rates are nowhere, and unemployment is nowhere (relatively speaking).

Either we are far too fragile this time around, or the undertow is strong enough to break legs. Or even both.

Either way - it's not good news.