06.07.2017

O Inflation, Where Art Thou?

400The Fed has invoked 2% as the magic number for inflation but claims that its goals have not been reached even though the economy is doing well and, therefore, interest rate hikes are justified. Inflation statistics depend on where one looks for inflation and the weighting given to different components. It is obvious that statistics can be manipulated and, unsurprisingly, consumer price inflation in the US is low, under 2%. Workers consequently do not have the argument of high inflation to justify requests for pay rises.

         Even so, salaries in the US rose 3.00% in 2016 and are projected to rise 3% in 2017. The rise in the price of equities since 2008 has averaged about 8% annually, and the cost of housing has undergone similar rises and is back to the levels of 2007. The average cost of a new car in the US is now about $33,560.00, up 2.6% from a year before (as of April 2017). That means that workers cannot afford a house.

         Workers earning minimum wages in the US are poor, and 45 million Americans live off food stamps. On the other hand companies like Google, Apple, Facebook and Amazon have become extremely valuable. The conclusion is that those who have kept pace with technological advances and the upper classes are doing well while the poor workers become poorer and poorer.

         The low rate of inflation calculated by the BLS, even if it goes to the 2% chosen by the Fed as a goal, will hardly help to reduce the real weight of servicing the national debt, especially as the current year is going to add almost another trillion to the burden. If the Fed raises interest rates and the Treasury ends up issuing government paper with a higher yield, assuming a rise in the debt level passes Congress, the task of servicing the debt becomes all that more difficult.

         The same is true for Europe and Japan. Higher interest rates will bankrupt many countries. As usual one can forget about Greece. The important point is that raising interest rates will slow the already sluggish recovery and probably result in a recession if not worse, given the huge global debt for countries and companies both in DM and EM. One solution to the debt problem is higher inflation, but central bankers have seen little inflation despite huge injections of liquidity into the system.

If inflated equity prices are the result of QE, then it must be concluded that QE is not going to solve the debt problem. On the other hand many American pension schemes are heavily invested in equities. The Fed has a real interest in maintaining high prices in the stock market, and proxies will probably buy dips in order to ensure stability.


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