Inflation is catching up with the US

 

           The Fed’s first news conference, held this week, apparently passed off well. It is difficult to understand why the press did not ask more and tougher questions. They have been waiting long enough for such an opportunity.

             The Fed, like the Bank of England, pumped up the bubble in 2005-7.  The Fed, like the Bank, decided deflation was just around the corner more recently, and has now created enough money to help cause inflationary problems right round the world. The latest figures show that even the USA herself is feeling the impact of  world commodity price rises, as the emerging market economies have been doing for some time.  Worse still for the Fed, and for the rest of the world, the first quarter GDP figures were not great. A combination of poor growth and rising prices is not good news.

            I suspect the rest of 2011will not be so bad in the USA. The tax reductions will take effect, and there will be some further boost from the various stimuli. Next year is more of a worry. This year they should worry about inflation.

            US politicians are at last debating how to get their deficits down, and some States are taking strong action to do just that. National politicians are talking about it, but still deferring the bigger cuts  until after the next Presidential election. They rely on the dolar’s status as the world’s reserve currency to see them through with more borrowing.

           The truth is that all too many western governemnts are still borrowing too much. This makes their budget strategies risky. The West has to wean itself off so much debt, and find new ways to supply goods and services on a bigger  scale that the rest of the world wants to buy. In the public sector there is still huge scope to do what needs to doing with less money spent. Public sectors in many western democracies have fallen far behind the best of the private sector when it comes to quality and efficiency.

           Reining in private sector debt is more difficult. To avoid a second phase to the Credit Crunch the authorities have to set a monetary policy which avoids a further collapse of asset prices, undermining bank loans and threatening the stability of the weaker institutions. They also have to avoid printing oney which generates inflation or asset bubbles. Finding the balancing point is never easy. So far we seem to have rapid price inflation in commodity markets, and a shortage of credit for small and medium sized enterprises. It is going to take a change of approach to banking regulation and to money policy to rebalance western economies that have relied too much on borrowing and consumption, and too little on saving and investment. Tax systems could be more helpful to reinforce these messages.

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25 Comments

  1. lifelogic
    Posted May 1, 2011 at 7:08 am | Permalink

    Your last paragraph is spot on “So far we seem to have rapid price inflation in commodity markets, and a shortage of credit for small and medium sized enterprises. It is going to take a change of approach to banking regulation and to money policy to rebalance western economies that have relied too much on borrowing and consumption, and too little on saving and investment. Tax systems could be more helpful to reinforce these messages.”

    The current tax system with say 4%+ inflation and up to 50% taxes people on profit that have not even been made in real terms and virtually ensures they loose money after tax on their bank deposits and investments.

    The key thing is that any borrowings, private or state, should be to used to make sensible investments and produce good returns not, as so often, on excess consumption, tipped down the drain by the state, invested in daft green energy subsidies, employing people to inconvenience the productive or just buying votes.

    The government uses much money just to promoted, subsidise and encourage people to invest in daft green energy schemes – what madness.

  2. Mike Stallard
    Posted May 1, 2011 at 7:26 am | Permalink

    Cutting back hard on taxation would really help.
    Cutting back on regulation would really help.

    But neither are going to happen. Politicians need to feel that they are making a change. And changes are very, very expensive. Too many people are just hanging there on our taxes, whether as “clients” or as “Managers”.

    If only they would start bringing in money instead of using it up.

  3. Peter
    Posted May 1, 2011 at 7:48 am | Permalink

    I’d say it is very easy to know why the US press don’t ask difficult questions of the Fed – the press is owned by the same corporations that benefit from the deficit policies of the US government which is only possible because of the Feds money printing.

  4. Stuart Fairney
    Posted May 1, 2011 at 8:29 am | Permalink

    Bernanke’s news conference passed off well eh?

    The spot price of gold put on $60 in two days to close at an all time record, due to gentle Ben’s complacency.

    US politicians, like those in Europe are talking about deficits as an alternative to doing anything, there is no plan B with statists. The market however will not be denied; the dollar will soon no longer be the world reserve currency due to the vast debasement and then watch US inflation rip, especially as those holding dollar reserves see the writing on the wall and dump them. I really don’t think the Americans realise what is at stake for them.

    Reining in private sector debt is indeed difficult in a fiat, fractional reserve system with politically manipulated interest rates.

  5. Duyfken
    Posted May 1, 2011 at 8:30 am | Permalink

    The way so many nations base their respective economies on obtaining credit reminds me of the collapse of the London insurance market in the 1990s from similar-seeming trading. The then so-called LMX market traded the same risks back and forth in what was termed a spiral. The more inwards liability one assumed, the more outwards cover was required – and obtained from the self-same underwriters. One effect was to inflate the values of the portfolio of risks to huge, artificial levels, and eventually the whole house of cards fell, spectacularly.

    As one country borrows from another and that borrows from a third and so on, is there not a similar spiral of debt being constructed? Perhaps we just need one of the players to pull the plug for it all to gurgle down the plug-hole. The banks provide a fine example.

    In such circumstances, what is the best way to protect oneself? Ideally, reduce one’s borrowing and only borrow from such countries which themselves do not need to borrow. A bit late for Britain to take advantage of such advice, and the government’s policy of trying just to reduce the deficit, ever so gently, seems ill-focused. It is only when the debt begins to reduce may we see some hope of escaping the vortex.

    • Simon
      Posted May 1, 2011 at 11:36 am | Permalink

      I used to work for a software house servicing the Lloyd’s insurance market in the early 1990’s and developed amongst other things a program to extract the statutory “RI Ceded report ” (reinsurance ceded within the Lloyd’s market) .

      If I remember properly none of the syndicates went cap/pistol in hand to the taxpayer .

      A major difference here is that we are not talking about an earthquake in San Francisco or Mexico , Piper Alpha or Asbestosis , infact no real tangible loss or destruction at all .

      You cannot insure a real ship , car or anything else multiple times with the intention of claiming more than the value of the assured item . Also you cannot insure someone elses assets either .

      Both these scenarios are considered insurance fraud aren’t they ?

      So how is it that the ultimate underwriter , the taxpayer , is on the hook for banks multiply insuring totally synthetic credit default swaps which are not even backed by actual assets , only counterparties and are by definition a zero sum game ?

      Even so the taxpayer should only be due losses caused by actual defaults on sub prime mortgages yet it appears that somehow we are expected to come up with more than this ?

      The taxpayer as the underwriter should not have entertained claims arising from such spurious “losses” and should have insisted that synthetic CDS were declared null and void by international agreement and unwound .

  6. Damien
    Posted May 1, 2011 at 11:20 am | Permalink

    Commodity price rises are not all bad news for the US especially if you hold the largest reserves of gold in the world, have enough oil and gas to be self sufficient and are the largest exporter of corn in the world (the farmers have a wide grin). Indeed I would argue that the devaluation of the dollar not only helps address the US deficit but that given 75% of their debt is covered by gold reserves they even benefit with higher gold prices.

    Contrast that with the UK and the picture is not so cheery. Gordon Brown sold the gold we are faced with a fait currency that is extremely vulnerable to devaluation and commodity inflation. When we pay over 5.5% of GDP for oil then we reach demand destruction, especially if the high price is persistent as it has been for months now. Every extended high oil price period in the 70’s 80’s 90’s and the most recent in 2008 has led to a recession. Further turmoil in the middle east and debasement of currencies encourages movement of money to commodities as a hedge.

    The services sector represent the largest element of our economy and coalition policies can help to make the UK remain an attractive place to invest.

    The money for small business entrepreneurs to start up has usually come from equity release from housing topped up by start up loans from the banks. Both have dried up and are showing no signs of improving despite what is being reported. This will undermine the policy to get britain back to work through small business growth.

    The MPC have been right to hold off any rate increases until the coalition policies begin to have traction. I cannot see much progress until the moribund housing that underpins consumer confidence becomes liquid. The stamp duty imposed by successive Labour chancellors is expensive and destructive. Much in the same way Osborne deferred an increase in the inflation increase in petrol prices he needs to reverse or suspend stamp duty on all but the top band on property. This will return some improvement in the liquidity of housing while being fiscally neutral given that under the current situation stamp duty revenues are extremely low.

    • Stuart Fairney
      Posted May 1, 2011 at 4:04 pm | Permalink

      The US has about 8,133 tonnes of gold, at $50 a gram, that’s about $400 billion, the US debt is $11 trillion not counting unfunded future liablities.

      The US imports about twice as much oil as it produces.

      How can you possibly say, any more than the MPC, what is the right rate across the economy? This is an enormous fallacy.

      • Damien
        Posted May 2, 2011 at 10:28 am | Permalink

        US gold reserves should not be calculated in terms of the spot price of gold at todays price. It is held not with the intention of selling it, and indeed if it put its gold reserves on the open market the price would instantly fall. The US holds 16 times more gold than the ECB and 8 times more gold than China. Taiwan hold more gold than the UK!.

        Ditto for proven oil and gas reserves in the US. Why use your own natural reserves of gas and oil when its cheaper to import them? The US reserves will be more valuable as the world enters peak oil.

        The MPC rate will never satisfy everyone, nor is it intended to.

        • Stuart Fairney
          Posted May 2, 2011 at 4:52 pm | Permalink

          “US gold reserves should not be calculated in terms of the spot price of gold at todays price”

          Ha ha ha…….

          Are you Ben Bernanke in disguise?

          Peak oil is a Malthusian myth, the petrochemical age will end when we invent a better technology, not when we “run out” of oil, just as the stone age did not come to an end for the lack of rocks.

  7. Gary
    Posted May 1, 2011 at 11:33 am | Permalink

    Back of an envelope calculation.

    Global Assets $200T
    of which Global Debt “assets” $150T

    Debt Financed at an historical average of 6%
    Annual interest/usury payable on debt $9T

    Global economy(GDP) =$60T
    US Economy (GDP) is 25% of global economy = $15T

    So , the required rate of growth of the world to just cover the debt payments, outside of the US is 9/60=15%

    There is no chance of that. We have reached debt saturation, and now we face debt contraction on a scale so huge that the Central Banks will not be able to supply enough liquidity

    With rising unemployment and diminishing marginal productivity of debt(aka pushing on a string), be prepared for a very painful future years or decades. Fractional Reserve banking and debt usury have destroyed us. No amount of regulation will change that short of abolishing this system , writing off the debt and starting again with honest money.

    Numbers courtesy of Gordon Long at:

    http://www.financialsense.com/contributors/gordon-t-long/debt-saturation-and-money-illusion

  8. Martin
    Posted May 1, 2011 at 11:52 am | Permalink

    The American system is way too biased in favour of lawyers. America needs domestic oil. Drill an oil well in the USA – something goes wrong – get sued for Billions. Drill in another country – no American legal costs.

    As well as your focus on taxes there is also overbearing legal costs which don’t help.

    • lifelogic
      Posted May 3, 2011 at 10:03 pm | Permalink

      Not just the lawyers the president will attack you in a pathetic and childish (and anti British way too) as BP discovered. Still at least Obama seems less socialist than Cameron.

  9. oldtimer
    Posted May 1, 2011 at 11:59 am | Permalink

    It is difficult to see how Western Europe is going to dig itself out of the hole it is in. The political class has committed itself to policies which will not deliver the recovery needed to achieve recovery. The only “solution”, if that is the word, will be devaluation in the face of more dynamic and efficient emerging markets. This is even more true of the UK than of the EU. The UK appears committed, for example, to policies which cannot be delivered technically and which are likely to beggar the nation.

  10. Javelin
    Posted May 1, 2011 at 12:09 pm | Permalink

    I heard the phrase “get real” on radio 4 yesterday and that chimed with me.

    It was on the tail end of a program on how India had come on so much in the past 10 years. They have got real and changed their education to focus on competing globally. We are not “real” at the moment. Politicians borrowing not to dissapoint the electorate at the polls is not reality.

    So how can Cameron “get real”. For a start he needs to make the debt real. He needs to link taxes to the deficit. At the end if the tax year when he spent too much the public need to feel that directly in their pockets. He needs a deficit tax – which if the deficit is zero we don’t pay. Perhaps link it to VAT. If there is a deficit add that to the 15% is to pay off the deficit and if they spend less VAT will be below 15%.

    • Javelin
      Posted May 1, 2011 at 12:24 pm | Permalink

      Thinking about it a little more I think a VAT deficit tax is a great idea. Imagine the Chancellor every year announcing the effective national bonus – especially when the deficit goes down. Every time people go to the shops they will “feel” the deficit. It will be real to them. Economically it’s good because the inflationary deficit is automatically countered by a deflationary tax. It provides another means of checking inflation – other than the BofE. Politically a deficit is progressive and VAT is regressive so that’s balanced out as well. It basically brings the public into the macro economic “loop” at a micro economic level. We all become stakeholders in the good financial management of the UK. Also it kind of formalises the VAT yo-yo-ing of the past 5 years. The markets will like the certainty that it brings. Something needs to replace interest rates as they aren’t really controlling inflation. Linking taxes to Government spending is a good idea because it closes the loop and makes spending read.

  11. forthurst
    Posted May 1, 2011 at 12:41 pm | Permalink

    In the USA, monetary policy is aimed at supporting the Dow and the almost entirely parasitical financial sector. When the Dow crashed 1000 points on May 6th, however, this was not as a consequence of Bernanke threatening to stop debauching the currency, but a consequence of “quote stuffing” or a barrage of flash orders seeking prey to front run. Neither front running nor flash trading has been specifically outlawed which of course they should, although market manipulation is outlawed, this apparently only applies if is observable to a casual onlooker, so it seems strange that the authorities are ‘interested’ in this event, rather than the billions of dollars gained and lost through mortgage-based fraud.

    In the UK apparently we are followingthe Japanese model in which the whole economy is frozen for years in order to protect the banks’ portfolios of property collateral and the overextended borrowers. The best solution is to allow the market to achieve equilibrion as soon a possible, so that the economy can move forward again, even if some banks will require further injections, a far better alternative than generalised loose money and stasis.

  12. Lindsay McDougall
    Posted May 1, 2011 at 1:19 pm | Permalink

    The normal pattern is that if you procure economic growth by inflationary processes, the high growth lasts for one year only. Thereafter, you get stagflation. I humbly suggest that the US has already had its year of high growth. Now comes the reckoning.

    As for this country, the prophets of doom such as Liam Halligan and myself are the ones most likely to have got it right. You can’t budget for real GDP growth greater than the long term average of 2.1% pa compound and if that is the rate of growth over this parliament, an additional £13 billion of cuts and/or tax increases will be needed by 2014/15. Plan B is TOUGHER than plan A, not easier.

  13. sm
    Posted May 1, 2011 at 1:23 pm | Permalink

    So when QE2 ends as planned, what will happen to the $ and T bond prices?
    Probably higher interest rates (worldwide) with consequent falls in US spending and imports.

    If QE2 is allowed to continue what happens to the $ and inflation?
    Probably higher worldwide commodities and undermining of international trade based in US dollars unless US imports collapse first.

    It will become a barter economy pay in Gold or exports. This because the transaction utility of the $ becomes outweighed by its wealth destruction risk.
    The death of money.

    Of course Mr Volcker may reappear multiplied.

  14. Gary
    Posted May 1, 2011 at 1:33 pm | Permalink

    For argument, the back of the envelope calculation can be simplified to merely global govt debt, and according the Economist that currently stands at $40T,(http://www.economist.com/content/global_debt_clock) so assuming a 6% interest rate over time, the total interest payments are $2.5T per annum.

    So we require a global growth rate of about 4% just to tread water(zero real growth) and cover the interest on the global govt debt. In the 120 year period 1889-2009, the fastest growing country on the world over this period was the US , and that annual average US GDP growth was 3.4%.(Source : The Economist)

    Anyway you slice this default and hard times loom.

  15. StevenL
    Posted May 2, 2011 at 3:25 am | Permalink

    “… authorities have to set a monetary policy which avoids a further collapse of asset prices … They also have to avoid printing money which generates inflation or asset bubbles.”

    So authorities need to maintain the asset price bubbles and at the same time prevent asset price bubbles? Are we talking about US government bonds or UK house prices here?

    I think what the USA is actually doing is playing a dangerous game of chicken. They reckon they can force China to revalue via their currency peg and other nations via interest rate rises before they have to tighten themselves.

    10% inflation and say 6% wage growth for a few years will deleverage the consumer and repair their competitiveness – this is the game Bernanke is playing.

    • Stuart Fairney
      Posted May 3, 2011 at 3:46 pm | Permalink

      How can Bernanke halt inflation at 10%? Once the genie is out of the bottle….

  16. Conrad Jones (Cheam)
    Posted May 2, 2011 at 1:04 pm | Permalink

    In order to tackle Government spending you have to realise that their is an alternative concern which focuses on the dwindling money supply when fewer loans (Business, Private and Public ) ar taken out.

    When Private borrowing drops, the money supply falls as loan payments are made thereby cancelling the initial principal from the Banks ledger. Inorder to maintain the money supply the Government has to create money to maintain the money supply through Public Spending. The way they do this is by selling more Treasury Bonds, thereby increasing the Public Tax Payer debt to feed the money supply.

    Our money supply is a big Colander full of water – the water represents money created from loans. The colander has to be continually topped up with money and the only way to do that is through borrowing more.

  17. Conrad Jones (Cheam)
    Posted May 3, 2011 at 1:33 pm | Permalink

    “To avoid a second phase to the Credit Crunch the authorities have to set a monetary policy which avoids a further collapse of asset prices, undermining bank loans and threatening the stability of the weaker institutions. They also have to avoid printing oney which generates inflation or asset bubbles. ”

    The Solution to this is either:

    1. Peg the US Dollar (or UK Pound) to Gold or some other unprintable commoditie that Banks cannot create out of thin air.

    OR:

    2. Prevent Banks from creating our money supply from our own debt and maintain a constant money supply through a MPC decision making authority monitored by Parliamentary Select Committee. Allow Banks to set their own interest rates.

    —————————————————————————-

    The manipulation of the Bank of England setting interest rates sends out completely false signals to Businesses.

    When interest rates are low, this should send out the signal that people are not spending, but saving instead, with a glut of money sitting around not doing anything.

    In our current situation, low interest rates actually indicate a Lack of money, and a lack of savings available for investment in new Business Enterprises.

    We have conservative and New Labour politicians all pretending to be Market savvy while they are promoting the centralist, communist ideals that Stalin would have been proud of. The “We know best” arrogance of a controlling Government, partly sucked into the vortex of a dwindling money supply caused by reducing debt replacement.

    “Give us a stable money supply and keep out of our business”, should be the rally call of the Conservatives – not deeper entanglement, sucking out Tax Payers money that only ends up in Swiss Banks Accounts – or other offshore accounts.

    End the monopoly of a Banking System that controls the money supply and you will end the mounting debt problem.

    Do nothing about this – and it will end in tears, or worse.

  18. Conrad Jones (Cheam)
    Posted May 3, 2011 at 1:52 pm | Permalink

    “The truth is that all too many western governemnts are still borrowing too much. This makes their budget strategies risky. The West has to wean itself off so much debt, and find new ways to supply goods and services on a bigger scale that the rest of the world wants to buy”

    ~This is only partly correct.

    -“western governemnts are still borrowing too much” – yes agreed.
    -“The West has to wean itself off so much debt” -yes agreed
    – “find new ways to supply goods and services on a bigger scale that the rest of the world wants to buy” – are you sure about this. This helps big corporations, but totally ignores the advatgages of localised diversity. If you are serioous about this global markets, the ‘bigger the better’ stuff ; doesn’t this consign the Third World Controls to even more debt and dependency on the IMF and World Bank? Won’t this increase the appeals for aid to these countries, forcing debt on their economies a greater taxes on the wealthier Countries?

    This bigger is best has injected enormous resource ineffieciencies into UK Farming. The smaller Farms cannot compete with the giant Agri-Businesses that can maintain cash flows and serice it’s debts. They create distribution, packaging, marketing networks and centers are sell there produce to supermarkets at 20% of the selling price. Specialisation of Farmland to produce only one product means that instead of using the by products of other Farming activities, artificial manures and Cattle Feeds have to be transported in. This centrlaisation of certain products means that greater transportation costs are incurred. Enormoous waste is created which could not be tolerated by a smaller Farmer supplying local communities. Highly mechanised productivity might be money efficicent but it isn’t resource efficient. Food quality has also fallen over the last fifty years. That is why the local butcher and greengrocer still provide better quality but Town Centers are designed to limit parking and thereby prevent local businesses from being successful.

    It would be nice to hear a Conservative MP speak out FOR the small businesses for a change, instead of ALWAYS supporting international corporations all the time.

    The debt problem will not be solved by turing the whole planet into one big Factory controlled by one dominant corporation. That’s called slavery. The debt problem is caused by money backed by debt.
    Please make an attempt to understand this before we all die of old age.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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