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Inflation is coming no doubt but later than you'd think
07/17/2009 9:55 am EST
Right now, I don’t think there’s a doubt in the world that eventually inflation is headed upwards—perhaps into the stratosphere. But when? Later rather than sooner, I now believe.
The economy is just too weak. The global surplus of manufacturing capacity too large. The danger of one more asset bubble popping just too great.
Yes, the governments of the world have poured trillions into the global money supply and built up huge debts. At some point that will lead to runaway inflation as the value of many of the world’s currencies plunge and at least some governments admit that they just can’t meet their obligations. But not in 2009 or 2010 or even, 2011, I’m now convinced. And that has led me to a re-evaluation of how much of my portfolio I want to devote to bets on rising inflation over the next 12 to 18 months.
Economists, depending on their school of thought, believe that inflation is caused by some combination of too much demand chasing too little supply and too much growth in the money supply.
It’s certainly hard to see any evidence in the near term for inflation of the first sort. The world is awash in excess labor and excess factory capacity.
In the minutes from the end of June meeting of its Open Market Committee the Federal Reserve said that it expected unemployment to range from 9.8% to 10.1% in the last quarter of 2009. Not much surprise there. The unemployment rate stood at 9.7% in June.
But the Fed went on to say that it thinks unemployment will remain stuck at 9.6% in 2010 and fall just marginally to 8.6% in 2011.
That’s one slow, un-inflationary recovery.
The U.S. and the world aren’t just awash in excess labor either. The world went on an investing orgy during the last boom cycle and the result is more manufacturing supply than the world’s consumers can soak up. According to the World Bank, factories in the United States operated at just 69% of capacity this spring. That’s the lowest level since this data was first collected in 1967. In Germany capacity utilization was just 72% and in Japan 65%. In some of the developing economies that have become the world’s low cost factories, utilization is as low as 50%.
And China? It’s always wise to take any economic data from China with a grain of salt, but the numbers from the beginning of the year say that China hasn’t been an exception to the global glut. In the semiconductor industry, for example, first quarter capacity utilization fell to just 43%. In the first quarter government economists were projecting that capacity utilization in the steel industry for all of 2009 would come in at just 72%.
No inflation in those numbers.
What about the other source of inflation, growth in the money supply? The globe is awash in money—or at least that’s the way it seems at first glance. Money supply as measured by M2, the most inclusive measure that most governments track these days grew at an annual rate of 25.7% in China in June. In the United States the rate was a more modest seemingly 9.0% for the 12 months to June 2009.
Since any growth in the money supply greater than the rate of economic growth is thought to be inflationary, in normal times these two economies would be well on their way to double digit inflation tomorrow.
But these aren’t normal times. In the United States much of that increase in the money supply is either going right back to the Federal Reserve’s vaults as bank, determined to shrink their balance sheets, send cash back to the source rather than lending it. Cash on deposit with the Fed doesn’t push up the prices of much of anything.
Consumers and businesses are using a good part of that cash to de-leverage. They’re paying down debt or saving in an effort to get at least part way out of the hole that they dug for themselves during the easy money binge that ended in 2007. Money being saved or used to pay down debt doesn’t contribute as much to inflation as money spent.
How about China? One of the advantages of running a command economy is that when the government tells banks to lend, they lend. And lend. And lend.
Told to stimulate the economy by making new loans, state-owned banks have lent $1.08 trillion in the first half of 2009. That’s nearly twice what banks lent out in all of 2008. And, so far, officials in Beijing haven’t told banks to step on the brakes.
That much new money has indeed created massive inflation—but in the price of financial assets, again, and not by and large in the Chinese and global economies as a whole. Real estate speculation is back with construction starts up 12% in the year to June 2009 and real estate prices in urban areas climbing back toward re-bust levels. The stock market is on a tear and hot money is flooding into China--$70 billion in the second quarter—in anticipation of further gains. In contrast in the first quarter $65 billion in foreign investment money left the country.
But the amount of money flowing into these asset markets is one reason that inflation has barely budged in China. A Yuan spent in stock market speculation is one Yuan less spent in buying TVs.
When it bursts what amounts to a new asset bubble in China will vaporize a good part of the excess money supply created by this surge in bank loans. And because China’s state-owned banks don’t have to be any more honest about their losses than the government wants them to be, that bust won’t take down the Chinese financial system. It will simply serve to convert some state-owned reserves into new capital to keep state-owned banks solvent. But the bust will work to keep global inflation under control longer than now seems likely.
Anyone trying to predict the estimated time of arrival for the inflation express should drink a dose of humility by considering the Ford administration’s WHIP Inflation Now campaign of the 1970s. Despite an attempt to galvanize the nation into reducing inflation by a World-War-II style campaign of national sacrifice, inflation kept climbing through the end of Ford’s term, through Jimmy Carter’s presidency, and into the early years of Ronald Reagan’s first term.
For me, my new inflation time table suggests that I can back off on buying and holding inflation-hedges until 2010 at least. No reason to sell them if they pay good interest or dividends as some natural resource stocks and master limited partnerships due. But no reason to rush out to buy them unless the dividend yield is high enough to make them an enticing present investment. Gold is less attractive in this scenario as an inflation hedge—no dividend—but still of interest as a chaos hedge. A busting of the Chinese bubble will result in another period of financial turmoil of exactly the sort that’s good for gold prices. So no reason to sell all gold out of your portfolio but time to be selective about what you own. (More on that next weekt. I was going to post some kind of action today but I want to ride the current trend a little longer.)
And, of course, time to see what a Whip Inflation Now (WIN) button will fetch on eBay.
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