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Where’s All the Inflation Coming From?
And Where's It Going?
By blackhedd Posted in Economy | federal reserve | inflation — Comments (35) / Email this page » / Leave a comment »
It’s getting harder and harder to ignore the steady drumbeat of stories about inflation, particularly food-price inflation, around the world. Where is it all coming from, and who is it going to hurt?
Among the drivers for record-high grain and oilseed prices are uncooperative weather in many regions of the world, and increased demand from Asian nations that now have enough money to start consuming more calories and more protein.
But at the end of the day, the only way to get inflation, especially the pervasive inflation that’s showing up in industrial commodities as well as grains, and more recently in European wages, is to have too much money chasing too few goods.
With some exceptions, we know there aren’t too few goods, because economic production is up everywhere in the world except for the US. So where’s the extra money coming from?
It’s coming from us.
More…
I’ve noted many times that the US is suffering far less from inflation than nearly every other country. Consumer prices for staple foodstuffs and gasoline are running well-above trend, but housing prices are going the other way. Media misrepresentation to the contrary, our inflation is enough to make people grumble, but not enough to cause real pain.
Elsewhere, however, there are real problems. Europe is seeing the beginnings of a wage-price spiral as German labor unions are seeking, and getting, wage increases nearing 10% in some cases. The oil-kingdoms of the Middle East are thinking hard about decoupling their local currencies from the dollar. China’s inflation rate is now running about 8%, even as their economic growth slows along with ours.
And worst of all, many nations in Africa may be nearing major social unrest and destabilization, because they can’t afford to import enough rice and other grains.
Global commodity markets run largely in US dollars. And even if they didn’t, the US economy is still so large and tightly-integrated into the world economy, that misbehavior by the dollar will necessarily impact all markets.
And we have been running an extremely accommodative (“easy”) monetary policy since last September. So it’s easy to blame the Federal Reserve for this burst of global inflation.
Except that it’s not entirely true. European monetary aggregates like M2 and M3 (that’s how they measure inflation in Europe; in the US we use measurements largely derived from prices) have been running above trend for well over a year now.
That (and other things) tells me that a lot of inflation is originating from the same vast oversupply of global credit that also caused the US housing bubble. Part of it comes from financial innovation (the “shadow banking system”) that reduces friction in capital markets. And some comes from the extreme conservatism of the central banks in the emerging Asian economies, who are holding extraordinary amounts of foreign reserves.
So why on earth aren’t we getting painful inflation here in the US?
Because inflation happens when there is too much money in the local banking system. Well, isn’t the Fed printing dollars like they were going out of style?
Yes and no. For one thing, ever since mid-March, the Fed have quietly but aggressively been reducing the permanent money supply.
But there’s something else too. The Fed creates “base money” (reserves), which appears in the banking system. But banks then write loans (create credit), which results in a much larger amount of “bank money.” That’s the money that appears in your checking account when you deposit your paycheck.
And no matter how much base money the Fed creates, you’re not going to see massive US inflation unless the amount of bank money rises rapidly. Which isn’t happening because banks have become extremely reluctant to lend money.
So where’s all of our money going? It’s going overseas. And not just to purchase foreign goods, either. It’s also going out in the form of foreign direct investment.
That’s because it simply makes a lot more sense to invest money in other countries. They’re growing, and we’re not.
And what do those foreign countries do with the money that they earn as a result of foreign trade? Well, remember that they get dollars in return for goods. There are two places for those dollars to go.
One place is into the monetary reserves of countries like China, Korea, Singapore, Taiwan, etc., where it can and does create monetary inflation of the local currency.
The other place is back into the US.
Now a lot of very smart economists have pointed out this is the reason we shouldn’t be concerned about trade imbalances. Because we have the unique ability to buy other people’s products using our money instead of theirs, there is a natural tendency for their dollars to come right back into the US, where they will be invested.
This is true, but the benefit is far overstated.
Whenever you apply capital to a place where the investment opportunities are sub-par, you either get inflation or you convert the capital to low-grade heat, essentially wasting it.
Where are the dollars that are flooding back into the US ending up? They’re getting stuffed into the front-end of the Treasury yield curve.
We’re seeing an enormous amount of capital flight from the US, an effect that is masked by inflows into risk-free debt instruments. This is an unsustainable situation. You can’t have economic growth unless you take risk.
The only real way to resolve this situation is for true economic growth to return to the US.
The way to get the US economy growing again is not by reducing interest rates. It’s by increasing the real rates of return on capital in the US.
We need to sharply reduce tax rates on capital and on high incomes (the kind of incomes that are earned by successful risk-takers). We need to reduce the misallocation of capital that comes from excessive government spending. And we need to make the regulatory environment far more conducive to new business formation.
This is what John McCain really needs to be saying about the economy. And he should point out that the Democratic Presidential candidates, who are both proposing far higher taxes and regulations, are truly the ones who want to give us more of the failed economic policies of the past eight years.
We have to get the animal spirits roaring in the US again. Otherwise there won’t be an end to global inflation.
-Francis Cianfrocca (“blackhedd”)
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Where’s All the Inflation Coming From? 35 Comments (0 topical, 35 editorial, 0 hidden) Post a comment »
should read
by Joliphant
I have to agree that too much money is certainly contributing
"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777
Re: food pricing
by GordonTaylor
Being in that business at the wholesale end, prices are rising every single day. I can't even publish a printed list for my customers any longer, as it changes from week to week.
There are several factors I see driving the price up:
1. Delivery costs are soaring, tied to oil (not the biggest however)
2. Overseas demand has at least quadrupled in the last year for chicken. With the effects of the bird flu being felt widely overseas, the demand for chicken is huge. I belong several wholesale food business groups, and not a single day goes by without several emails from serious buyers wanting to set up weekly deliveries of frozen chicken, we are talking 100 Metric Tons minimum per week.
3. Demand for Halal certified meats has gone through the roof. As the Muslim population continues to grow, so does the demand for Halal certified meats and although many other countries offer it, i.e. New Zealand, Australia, Brazil, they want U.S. produced meats for several reasons. As this demand grows, more and more US and Canadian processors are switching to Halal certification, some partly and some completely.
4. China is putting a huge drain on our food supply chain, I mean huge, and lots of other developing nations, Viet Nam, and all the 'Stans....
The old supply and demand are what's driving prices, much more then oil.
Fascinating points
by blackhedd
If supply-pressure in grains and foodstuffs were the whole story, however, then you'd be seeing non-food prices recede, as spending on food displaces other spending.
You might just be able to make the case that this is happening in the US. (I hear every day that people in economically-marginal parts of the country are forgoing all kinds of other spending in order to keep buying food and gasoline, but anecdotes are not data, and I don't necessarily believe all of it.)
But in the rest of the world, the inflation is real and unmistakable, so there has to be a monetary factor at work too.
Thanks I needed the reality check
by Joliphant
You know how it is, when you have a hammer the world starts to look like a nail.
"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777
I just can't buy it.
by LibertarianHawk
There may be some "growing pains" associated with all of this. I'm not discounting what you're saying so much as I am thinking that it doesn't explain the whole story.
Monetary economics is a subtle thing. I think most semi-intelligent people have a working grasp of the impacts of supply and demand, taxes and tariffs, the impact of overhead costs like transportation, etc.
And it doesn't escape me that roughly 1/3 of the world's population resides in two countries and that both of those countries have been experiencing some pretty robust economic growth in recent times. And logic would dictate that this growth would put a magnified strain on commodity markets as these billions of people become more able to afford food, transportation, and the like.
But I've read warnings from some economists about some chickens finally coming home to roost regarding an extended period of loose monetary policy and a massive current account deficit combined with the limited capacity of global supply to keep up. So I think there's more here than robust demand resulting from growth.
As blackhedd said: the supply of dollars has been growing faster than the supply of the goods they're chasing.
Our answer here is real growth -- not merely a priming of any monetary pumps, but real investments of risk capital.
But nothing says that this capital has to be domestically-sourced. The infusion of foreign capital is a wonderful thing -- and it's insane that we're talking about trade policies which would endanger that. It's also insane that we're talking about doubling the capital gains tax rate at the very time we need as much growth-focused capital as we can get.
Priming the pump
by blackhedd
Our capital is going overseas in search of higher returns.
This generates higher returns (perhaps 12% or more on foreign direct investment by Americans overseas), and it also generates enormous growth in dollar-denominated sovereign wealth held by foreign governments.
Where does all of that money go? Here. What does it buy? The 2-year Treasury note.
That's the problem. Regardless of where capital is sourced (and it really doesn't matter where, since capital is capital), the American problem is that it currently makes no sense to invest in risk-bearing activities here.
Combine that with abnormal risk aversion from the credit crisis, and you get slow US growth, perhaps for years to come.
LH, I don't pretend to have all the answers...
by GordonTaylor
I am simply relaying anecdotal evidence as to what I am seeing in the wholesale end of the food industry, and what I am being told the reasons are.
There are many, many factors involved in the rising costs of goods and services, and the common thread is fuel prices. They account for most of the rise in non-foods.
I know the food side pretty well, and we are being told the biggest factors are fuel, grain and foriegn demand.
Over time, we'll increase the supply to meet the demand, it's the short term that is causing the increase. And once prices go up, it's tough to bring them back down.
Same with the grain problem, while it is short supply now, we have millions of acres lying fallow and they can be returned to production within a realitively short time frame.
The fuel factor is the one that will be with us for a while, we don't need to re-hash that old story, i.e. refining capacity...
A little over a month ago I attended a conference in Philadelphia and the keynote speaker was the CEO of Sav-A-Lot foods. They have over 900 stores, all independantly owned. He told the group there will be a 30% across the board jump in wholesale prices by the end of May, 2008.
30% is a huge jump and this info is coming from an industry leader. Hold on to your hats, that 30% is coming to a store in your neighborhood very soon.
China has been using their hoarded dollar denominated securities to loan money abroad on a fractional reserve basis. They have been trying to grow their financial industry the same way they have grown their other industries.
There is nothing we can do about this inflation.
"Nothing works like freedom, Nothing succeeds like liberty"
Kyle
Is that true???
by blackhedd
What's your source for that information?
According to my information, China has been increasing reserve requirements on their banks like crazy. It's well over 15% now. With very few exceptions, China's banks are not permitted to do business overseas.
Who's doing the lending you're talking about?
They're supposedly sitting on a bunch of bad debt.
by LibertarianHawk
Of course, so are our banks. :(
But, wow, a 15% loss reserve? I'm not in the banking industry, but that sounds incredibly high.
As a rule, Western banks don't sit on bad loans
by blackhedd
They write them off. If they have to, they fire their CEOs first. (Ask Chuck Prince and Stanley O'Neal.)
Asian banks sit on bad loans. If we have a recession for any amount of time, it looks like China is going to be bleeding with bad debt. This is one of the reasons they isolate their banking sector from the rest of the world. They want to be able to spread the pain around as they see fit, without having free markets force their hand.
Yes, the reserve requirement for Chinese banks is now about 15.5%. They've raised it seven or eight times in the last twelve months.
You're right, blackhedd...
by mikefisk
The last things I've been reading on China's banking system has been that they're slamming on the brakes incredibly hard (to an extent that would be unprecedented to the point of panic-inducing in the US financial market). After all, reserve requirements here are hardly ever touched, and when they are it's in the slightest of increments. Not in China.
There's not much lending going on over there.
"No matter how much lipstick you put on the taxation pig, it's still a pig... and it's currently snout-down in your wallet." - Michael Fisk
Not much lending, really?
by blackhedd
Where did you hear that? I'm hearing that they're still overbuilding manufacturing plants at double-digit rates.
Maybe you're right, and I'm hearing about projects that were already in the pipeline.
I don't see how they can slow down credit formation without making their already-large unemployment problem much, much worse.
The real bridge to nowhere- Wall Street
by streetwise
In theory, Wall Street is supposed to channel capital investment into enterprises that have the best potential real rates of return, which in turn will power economic growth.
In practice, the Street has been captivated by get-rich-quick schemes that revolve around asset bubbles- dot-coms, LBO's and real estate. The spectacle of moguls like Stan O'Neill and Jimmy Cayne golfing and playing bridge while their companies vaporize shareholder wealth will live in infamy.
We need better capitalists!
Maybe half of Wall Street's profits come from...
by blackhedd
...proprietary trading, rather than from underwriting risk. Another big slice comes from fees from structured finance.
As far as shareholder wealth is concerned, keep in mind that all of the big Wall Street firms were once private partnerships. After they became public, they contrived to retain pretty much the whole compensation structure that pays huge cash bonuses to the senior people. The public shareholders are at the bottom of the totem pole. These organizations are still financed largely with short-term money from the repo market.
There is a rumor, probably reliable, that
by streetwise
Goldman sold a good deal of its "hot" proprietary trading portfolio to Merrill shortly before the big blowup in 3-4Q 2007.
The huge cash bonuses in light of dismal performance do seem to constitute a governance problem of the highest order.
Many of the structured finance vehicles are dimly understood by the people who buy them and then lose money on them. The problem: the buy side is too stupid to ask, and the sell side is too smart to tell!
Sorry, blackhedd, it's Monday, & tax time, and I'm crabby and in need of more caffeine.
We have better ones. They just keep quiet (nt)
by Neil Stevens
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"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater
The irony about the political dialogue right now...
by LibertarianHawk
...is that Democrats are calling GWB "Hoover" and saying that McCain's response to financial problems is to look the other way.
There's a method to this madness. The left has convinced a whole lot of people that Herbert Hoover's sin, in response to the bursting bubble, was indifference borne of a slavish devotion to free markets and their vagaries. That is: he was a modern-day Nero, fiddling whilst Rome burned. It's a clever broadside against laissez-faire capitalism.
It's also patently untrue. Hoover got two things wildly wrong:
1) He raised taxes
2) He signed a protectionist trade bill
If these things weren't responsible for the onset of The Great Depression (which many economists now believe was the result of insufficient monetary controls), they certainly proved to be the wrong medicine.
But look who's talking about what on the campaign trail. Both Democrats are talking about "ending the Bush tax cuts" -- which is to say: they're promising to raise taxes. They're also both employing varying kinds of protectionist rhetoric, particularly in places that have felt the brunt of our comparative disadvantages with trade partners.
This gives McCain an incredibly opportunity, if he's smart enough to grasp it. If he's not, then we could well be looking at something of a redux of that awful period in American history -- economically and politically.
You're right: we need to foster real growth. And a super-loose monetary policy not only isn't enough to do that, it also comes at a steep, but largely hidden, price.
His problem is that a whole lot of people blame the war for our economic woes. I think that's irrational -- but it's no less the case.
And if you are a student of history
by The Gadfly
that should really worry the bleeping-expletive out of you. Because after the wrong medicine was applied to the problem, what got us out of the depression wasn't a government works program, it was a world war. Of course, back then we didn't really have the power to vaporize the planet in 24 hours, so it was marginally safer to engage in such a war.
Very good thoughts...
by Shiheng Zeke
I am glad to see this situation being discussed now. I have been following the credit crisis/housing bubble mess for several years now. I am property investor whom has been out of the market since the late 1990's because of the crazy pricing in the U.S.A.
What really scared me was the magnitude of the housing bubble burst followed by a world wide credit meltdown. I really don't think words like "epic" or "disaster" do what I saw justice. We were facing the end of a financial system of the likes never before seen.
The interesting part has been that I personally believe that the Federal Reserve actually did OK given the scope of the problem.
The worry for me now is "What next?". As you noted, some of the cause and effect of what the Fed has done is rippling around the world and changing things is ways no one could have predicted.
I personally believe that the "housing crisis" will start to moderate by mid summer 2008 and by the end of 2009, we should see a fairly stable market again. I DON'T believe we will see housing prices go up for many, many years due to the after effects on the credit markets and damage to credit scores.
The U.S.A. needs to invest in itself as a capitalist system. We need smarter people, we need new products, we need new ideas, and we need to prove to ourselves and the WORLD that we are not number #1 for nothing. I am tired of people being happy with what we have. We need to be happy with the future.
I need to remind you that we are NOT Europe with it old thinking and creaky governments. We are NOT China with human rights abuses and a "controlled" capitalist economy. I have been on the ground in these places and they are not the future. The U.S.A. can remain great and become even greater but we have to want to do it.
If you want to hear my politics, here it is. The Democrats are NOT the party of new ideas. They have not had a new idea since someone passed around a book by Marx between bong hits. Clinton and Obama are the two sides of the current Democratic party. Left and more left. More Government and taxes or more taxes and Government. This is NOT the way.
John McCain, please look at what has worked in the world. Look at the new Eastern Europe, look at Ireland, and look at ourselves. We have lost our way but we are NOT lost. We can get back on top with a smart plan and old fashion GUTS. You have the GUTS, now build a plan and shout it out. We need a new Contract with America. Call it "America: We are Back and Ready for Business".
I agree with basically all of this
by blackhedd
To the point about the Fed: the behavior of the bond markets and the overnight repo markets (in the US, anyway) are indicating that the fear of global meltdown has abated significantly in the last week or two.
I saw that also...
by Shiheng Zeke
I guess when I saw what looked like fear abatement, I gave the Fed credit for "hitting the right switch in the dark."
I have really not seen the other central banks going to the lengths the Fed has to address what seems like to me a systemic shock.
I think given the Fed chairman's interest in the Great Depression and how the system reacted (or failed to react) to the credit crisis at the time has something to do with what is happening.
Of course, this is not the same environment as the 1920's-1930's but a worldwide credit crisis looks the same.
What I noticed from all the data is that "whatever" the Fed did on the weekend of the Bear Sterns meltdown made a solid difference in the marketplace. It could be they restored confidence by going to mat to prevent a meltdown or it could be they did something so extrodinary that people said "If they are THAT serious about the problem, we might be OK."
If you notice, the international banking community started working more like a team after that weekend instead of inching toward protectionism like they were doing before.
You make an excellent point re foreign central banks
by blackhedd
The Bernanke (and Geithner) Fed jumped all over the credit crisis, and I really think you're right when you say that Bernanke, an expert on the Depression, saw the problem for what it was: a liquidity trap, rather than a solvency or credit-quality problem.
Meanwhile, Mervyn King and Jean-Claude Trichet (and the less-important central bankers in France, Italy, Germany and Spain) have just been sitting around jerking off for all these months. But the overnight repo market in London is just as frozen as ever. In Japan, they can't even agree on someone to run their central bank.
I don't know how closely you watch the US money markets, but the really big problem since the Bear collapse has been an extreme shortage of short-dated US Treasury debt. That shortage started to abate about 10 days ago, right after the Fed's TSLF auction. That's the major sign of a step back from extreme crisis conditions. (We're not anywhere near normal yet, but at least we're going in the right direction now.)
I totally agree
by Shiheng Zeke
What really kills me is that people are walking around thinking that super smart people are controlling The System and that they are So Very Smart that everything they do works perfectly.
When I saw the reaction of the european bankers and asian bankers to this problem, I thought: "Ok, they are going to get together to talk about what is happening and come up with a plan." After a month I thought "Well, the plan MUST be coming out soon! This is 5-alarm problem now."
Nope. They stayed in the firehouse and played with their hoses. :-)
This is why I had to at least give SOME credit to the Fed for acting. They could have done the same thing and "protected the dollar" and asked the Brain Trust in Congress to come up with a plan. Nope. They moved quickly and tried SOMETHING. When that did not work as planned, they tried something else.
The important part of this was they KNEW they had a problem and they KNEW it was a monster. And if it got out of control...
Finally, they pulled out the biggest guns they could find and did something I thought they would never do. They acted like cowboys and stood up for the right reasons and said "You may kill us, but the town WILL be saved."
I know this sounds dramatic but you have to think about what bankers are SUPPOSED to do. They are supposed to be Ultra-Conservitive and avoid risks at all cost. Thank heavens they decided to roll the dice this time.
Yup, agreed
by blackhedd
Remember at that birthday party for the late Milton Friedman a couple of years back, when Bernanke (not yet the Fed Chairman) apologized tongue-in-cheek on behalf of the Fed for starting the Great Depression?
If he pulls this off, Helicopter Ben may go down in history as the best central banker since Benjamin Strong.
Huh??
by Uma Richie
I can't imagine trying to explain this concept to the general electorate. It made my eyes glaze over, even though I want to agree with it. Can someone please translate it into something that average people will understand and be able to forward or repeat to their friends?
"Get an economics text book before you vote next time" (nt)
by Neil Stevens
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"If we want to take this party back, and I think we can someday, let’s get to work." – Barry Goldwater
5! (n/t)
by mikefisk
"No matter how much lipstick you put on the taxation pig, it's still a pig... and it's currently snout-down in your wallet." - Michael Fisk
"Higher taxes are the problem, not the solution."
by blackhedd
How was that?
Specifically capital gains taxes (which are the ones
by The Gadfly
the dems most want to raise), although in some places progressive income taxes need to be cut at the top.
And it might also help to reduce certain kinds of regulations which only add significant drag on the economy. I'm thinking specifically of Sarbanes-Oxley, but I'm sure there are others.
Stories on feeling the pain:
by streetwise
CNN Money has some very interesting tales.
Here is my favorite- gotta love this guy!
http://money.cnn.com/galleries/2008/news/0803/gallery.real_stories/34.ht...
I should have quoted this fantastic line:
by streetwise
"Now I am a clerk at a very well run food store part time at night, and I'm teaching surfing when I can. It barely is survival money, but I've discovered that sometimes that is quite okay actually."
Ron MacQuarrie - part time surf instructor
The end of two trends
by sinz52
Greenspan made an interesting point recently:
Ever since 1995, the Federal Reserve has had an expansionist monetary policy; the money supply has been increasing at an average annualized rate of 10% since then.
Yet inflation was not a problem till recently.
That's because the inflationary pressure from loose money was being absorbed by two anti-inflationary forces: Foreign competition and cheap raw materials from globalization; and the personal computer/Internet/World Wide Web revolution in productivity.
But we are now reaching the limit of the capability of those two anti-inflationary forces.
First, just about every Third World country has now become an emerging market. There are no more new emerging markets to provide new sources of low-cost labor and cheap raw materials; they've all entered the global economy now, even Vietnam. Who's left to convert to market economies, except Zimbabwe and North Korea and Cuba? So unless we can contact extraterrestrial aliens like the Klingons or the Vulcans and make trade deals with them, there are no more non-capitalist peoples left to bring into the global trade system.
Second, the Internet and personal computers are approaching saturation. In the developed world, just about everybody has access to a computer now, and there are nearly a billion more computers in the developing world. Except for the aforementioned North Korea, the whole world is now tied into the Internet. The whole world. That technological revolution is now becoming passe.
Unless there is another technological breakthrough comparable to the Internet (like that "Mr. Fusion" personal reactor from "Back to the Future"), don't look for productivity to absorb any more of the excess inflation.
So with the anti-inflationary forces of globalization and the high-tech revolution now approaching saturation point, raw inflation is now breaking through to the surface.
inflation from . . .
by mdetlh
week USD and further speculation that the USD will continue to weeken or that Bernanke will continue to lower interest rates.
Where is all the money going? Not real estate--
Equities, not really, unless selloffs are making up for the losses in real estate over the last 6 months.
commodities, absolutely, any chart of commodity related items will show an inverse relation, and it has occurred over the years, and is especially pronounced since August 2007.
No one who is in a majority position in politics wants to increase domestic oil supply. Rather they want alternative fuels, with corn lately it takes 15%of the corn crop to replace 2 percent of the oil supply. Now corn planting may be replaced by soy thanks to all the rain, and then corn can go even higher than $6/ bushel
Lets hope that Bernanke doesn't want to lower rates further, it will push more big $$ into commodities, talking up an end to lowering rates or tackling inflation next will turn the Euro -USD trade into a turned table situation, an inverse situation to 2007.
Is Trichet really fighting inflation, or trying to ensure that the Euro is established?
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You don't see the combination of bad weather coupled with new sources of demand (the biofuels mandates and subsidies) as being at least as much a driver ?
I have to agree that too much is certainly contributing. Anyone that doesn't believe its happening just has to compare Dunkin Donuts coffee pricing to Starbucks.
"Those who expect to reap the blessings of freedom must, like men, undergo the fatigue of supporting it."
-Thomas Paine: The American Crisis, No. 4, 1777