inflation? maybe? …gold? no way!

I turned on CNBC in the middle of the day to look at the stock prices crawling across the screen below the talking heads.  I happened to hear the discussion, as well.

The topic was gold as an inflation hedge.  The back and forth sounded kind of like one of those Time Life infomercials selling the Greatest Hits of the (1960s, 1970s…) …or maybe the commercials that let you know you can get the same auto insurance as Snoop Dogg even if you have a bad driving record.

Even though the participants didn’t know much about gold (what a surprise), I find their unstated premise very interesting.  What do we do as investors if inflation comes back?

no sign of garden variety inflation 

The standard analysis of inflation is that it arises in an advanced economy during an employment boom when money/fiscal conditions are too loose.  Government policy stimulates firms to expand.  But there are no more unemployed workers.  So companies poach from each other, offering ever higher wages to lure workers from rivals.  Not the case, at least right now, in the US, where the administration’s white racism and anti-science stance have leading firms, if anything, figuring out how to leave.

developing world variety, though…

This is the situation where a corrupt or inept government favors politically powerful industries of the past, borrows heavily–especially from foreigners–and shows itself unwilling or unable to repay what it owes.  The local currency begins to slip as this picture becomes clearer–evidenced by government budget deficits–and foreign investors head start to pull their money out.  This raises the price of imported goods and starts an inflationary spiral.

Trump has recently invited this framing of the US situation by hinting that he will punish China by defaulting on a portion of the $1 trillion+ Beijing has lent to Washington.  He also seems to have suggested the possibility of a more general default  during his presidential campaign.

In the case of the US, past bouts of inflation have been fueled by domestic fixed income investors fleeing Treasuries much faster than foreigners.  My guess is that this would already be happening, except for two factors:

–the gigantic amount of debt the Fed is buying, and

–there’s no obvious other place to go.  Japan is a basket case, the EU isn’t much better, Brexit dysfunction rules the UK out and the renminbi isn’t a fully convertible currency.

guarding against inflation

For currency-induced inflation, the winning equity stance is to have revenues in the strong currencies and costs in the weak.  For wage-cost inflation, the economic remedy is to tighten government policy, that is, raise interest rates.  That hurts all financial instruments.  Least badly hurt would be traditional defensives.









inflation and stocks

wage inflation in the US?  …finally?

In my earlier post today, I didn’t mention that in the Employment Situation report from the Labor Department a week ago Friday, the annual rate of growth in wages rose from the 2.5% at which it had been stuck for a very long time, despite declining unemployment, to almost 3%.

an aside

Inflation in general is about prices in general increasing.  Deflation is when prices in general are actually falling.  Deflation is scarier than inflation both because it’s less common/harder to treat and because we have the object lesson of Japan, where a quarter-century of unchecked deflation has moved that country from penthouse to basement among world economic powers.

curing inflation

In developed countries, inflation is always about wages.

The garden variety, which seems to be what the Employment Situation may be signaling, is easy to cure.  …a little painful, but easy.

Raise interest rates.

The idea:  businesses want to expand.  To do that they need more workers.  But everyone is already employed somewhere.  So firms have to offer big wage boosts to poach workers from rivals.  Raising interest rates (eventually) stops that.  It increases the cost of expansion and also slows down demand.

Also nipping incipient inflation in the bud prevents consumer behavior from becoming all about defending oneself from it.

who wasn’t expecting this?

For years, economists have been anticipating a rise in inflation.  The first (false, then) alarms sounded maybe six years ago.

But, as they say, nothing is ever fully discounted until it happens.  In addition, Washington is arguably compounding the problem by enacting fiscal stimulus almost a decade too late–making it more likely that rates will go up sooner and more rapidly than if Washington had done nothing.  (Where did the deficit hawks disappear to?)

two types of inflation?

two forms

Back in the 1970s, when inflation actually was a serious global economic problem, economists tried to distinguish between two types of inflation:


demand-pull is what we typically think of as inflation today.  It’s the situation where an economy is at full industrial capacity and full employment but is still growing strongly.  The only way to find new workers to staff business expansion is to lure employees away from rivals.  How to do this is?  …offer them more money.  An intercompany bidding war for talent ensues. Salaries rise.

Newly flush workers want to spend on goods and services.  But these are also in limited supply because industry is capacity constrained.  How to get the stuff we want?   …bid higher prices.

Voilà!   …rip-roaring inflation.

This problem can be laid squarely at the feet of too-loose money policy.


cost-push.  This is the idea that the price of one or more key agricultural or mineral commodities rises by a lot (think;  the two oil shocks of the 1970s, when crude doubled or tripled in price).  Such a price increase is passed on to manufacturers and to consumers, causing the overall price level to rise.

This type of inflation is no longer talked about, for several reasons:

—-monetarists have successfully argued that oil shock inflation was caused more by the decision of central banks to soften the blow by rapid money supply expansion than by the price increase itself.  It was, they said, accommodation that caused the inflation, not oil.  After all, falling oil prices in the 1980s didn’t cause deflation.

—-wages are no longer routinely indexed for inflation for the vast majority of workers, so a key pass-through mechanism is no longer operating

—-advanced economies are much more involved in providing services that use intellectual resources, which are less subject to the physical constraints of plant, mine or farm capacity.

—-globalization has put significant upward pressure on commodities prices, but has also created downward pressure on wages in industries making tradable goods.  Of course, in the internet age, a lot more stuff is in the tradable category, too.

—-advanced economies, particularly the US, have evolved to the position where labor costs are perhaps three-quarters of the total economy, and therefore effectively the only thing that matters.

cost-push making a comeback?

I think so.

Japan recently depreciated the yen by 20%.  This has caused a surge in profits for export-oriented manufacturing, and a tsunami of Asian tourists seeking to buy, among other things, heated Toto toilet seats.  Prices have shifted from falling to rising.

But wages haven’t gone up at all.  So, yes, the depreciation has created inflation, but most individuals are worse off than they were before–because they’re paying 20% more for imported items like fuel and food.  (This isn’t quite correct.  There’s a substitution effect along with the income effect, meaning that people shift what they consume in order to lessen the harm to their well-being from higher prices.  They, say, eat tofu instead of beef or get clothes from a consignment store instead of Uniqlo.)

There’s also the effect of price rises on the long-term unemployed in the US or the EU.  It’s not quite the same thing, but it’s certainly different from the demand-pull world, where everyone is better off–but tricked by the fact nominal (but not necessarily real) wages are rising into thinking they’re better off than they are.

investment significance?

I’m not sure, other than to take a trip to Japan before the place falls apart.

But I do think that the failure of wages to rise, either in Japan or the US, despite highly stimulative monetary policy is a potentially explosive social/political issue.   It may reach a tipping point where big social changes are demanded.




is chronic inflation on the way?

I’m going to write about this topic in two posts.  Today will cover background; tomorrow will ask/answer where we stand now.  In a way, these posts are a follow-on to writing about the employment situation in the US.


What is it?

Inflation is a general rise in the level of prices–in other words, in the cost of stuff–that continues over a period of time.

…in a service economy

In a service economy like the US, the largest element in the cost of most things–from financial advice to medical care to computer hardware/software to restaurant meals, and on and on–is the wages paid to the people providing the public with services.  Goods, too.  Because of this, inflation in the US is all about continual rises in wages.

Increases in industrial raw material prices can end up creating inflation here, but only under a number of conditions:

–the price increases for materials can’t be just one-off.  They have to keep on coming.

–manufacturers/ distributors have to pass these cost increases on to consumers by raising their prices, not just absorb them themselves, and

–consumers have to pass the extra costs on to their employers by demanding–and receiving–steady wage hikes.

don’t get inflation started!

Like a lot of things in economics, inflation is partly a state of mind.  A Fed study done when I was just starting out in the stock market demonstrated that at that time consumers’ expectations about future inflation corresponded almost exactly to what actual inflation had been over the prior five years.  It’s not all that surprising that people should extrapolate from recent past experience (what else would you do?), but a problem nonetheless.  If everyone gets it into his head that prices are rising at, say, a 5% annual rate and demands a wage increase that keeps him whole.  So inflation can get institutionalised, as it did in the late 1970s, and become very hard to eradicate.

Multi-year labor contracts may stipulate that wages are automatically increased for inflation–and the define inflation through an index like the Consumer Price Index, which systematically overstates the effect of price rises on the cost of living.  Not a huge issue for today’s US, though.

In addition, inflation tends to feed on itself and starts to accelerate.  In the late 1970s, when an extra-loose money policy sparked inflation, which went from 3% in 1972 to well over 10%–with widespread conviction that inflation would continue to rise–before Paul Volcker stepped in in the early 1980s.

money spigots now wide open again around the world

It’s certainly true in the US and in Japan, and increasingly so in the EU.

The idea is to make the cost of money very low so entrepreneurs will invest and, at the same time, to make the returns low enough on “safe” investments that savers will feel compelled to provide capital.  Why do this?   …to counter the huge economic contraction set off by the near-collapse of the world banking system five years ago.

The risk to this strategy is that, at some point, more productive capacity will be added than there are workers to man it.  If so, labor-short companies will start to poach workers from other firms by offering very large salary increases.  Voilà!  Inflation–always about wages in the developed world–is kindled.

More tomorrow.