What's likely to happen is deflation for most of the population (shrinking income, falling RPI) combined with inflation (rising interest rates and commodity prices) on the markets.
This is possible because the real and the financial economies are now frighteningly disconnected. The expectation of future inflation in the Common Wisdom is enough to create inflationary effects in the financial markets, even when the real economy is somewhere between wounded and in a death spiral.
Eventually the inflation will work down in the form of higher RPI and domestic interest rates, and then everyone will be screwed - again - because real spending will shrink even further.
A piece of research by Goldman Sachs which I came across in the Financial Times Alphaville "walled garden" today had much to say on the subject of consumers' fear of inflation and discussed whether or not this could itself drive inflation. One assumption was:"Suppose every firm and consumer in the economy woke up one morning to expect 5% inflation"and one conclusion was:"A shift up in household inflation expectations could ignite a broad-based surge in inflation, but we see no sign that this is under way".This reminded me of my long standing conviction - from my admittedly untutored perspective of Coarse Economics - that such inflationary expectations are yet another example of an assumption which is complete bollocks but which conveniently justifies the otherwise unjustifiable.Now one of the key reasons for the property bubble was the completely pervasive view that house prices can only ever go up. So it has demonstrably been the case that the average punter has inflationary expectations in respect of land prices (since buildings depreciate). By definition, inflationary expectations underpin all asset bubbles, which have with few, if any, exceptions been driven since John Law's Mississippi Bubble by excessive creation of credit by credit intermediaries aka banks. But retail prices are another matter altogether. The people who inhabit the real world outside neoclassical economics do not tend to think:"Hmmm.....I expect that retail prices will rise by 5% in the next year, therefore I will ask for a 5% pay increase plus a bit."They think"Bloody hell, prices have gone up 5% and I need a pay rise to keep pace, plus a bit".In other words, if prices do not rise much - or even fall, and of course deflation would be a wonderful thing if only our money did not consist of interest-bearing debt - then there would be little or no pressure for much more than modest wage increases. But we have drummed into us that employees/consumers do not think this way. The inflationary expectations of employees could lead to inflationary wage increases, and must therefore be beaten out of them at all costs. But then on Planet Neoclassical there is never a good time for wages to increase. In a growing economy, wage increases may choke off growth; in a level economy, wage increases will prevent growth; and in a recession of course, wage increases are unthinkable, because they will make the recession worse. Bollocks again. Capitalists like Henry Ford knew that if he paid his workers poorly then they could never afford his cars. That piece of economic common sense appears to have been forgotten.I have never understood why it is that to increase wage costs is inflationary; whereas to increase interest rates from 2% to 3% (which is a 50% increase in a financial cost) is not only not inflationary of retail prices but is in fact, the Voodoo Economics cure for such inflation. It gets worse, though.If a manufacturer raises prices either because he has the "pricing power" to do so (through a monopoly or cartel) - or simply because he is able to maintain an arbitrary profit margin - then such price increases are by definition inflationary. Well, actually in the fantasy world of Neoclassical Economics such maintenance or increase of the return to Capital is apparently not inflationary, although increasing the return to Labour is.Strange, that.In case you hadn't gathered, conventional Economics has nothing whatever to do with the real world we inhabit and everything to do with justifying an outcome convenient for the owners of financial capital. As JK Galbraith memorably put it:"Modern conservatives engage in one of man's oldest exercises in moral philosophy: the search for a superior moral justification for selfishness".
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and we got along famously offline as well. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Yes indeed. In financial assets there is a fixed supply, but in production and real economy? There the supply should increase. Unless it is stagflation.
Actually, the high long yield must also pay for the higher risk of default in nominal terms, since the cash flow of states will not inflate along their liabilities.
Banks will be all right as long as there is a gov policy of rolling all of their outstanding debt, or repo'ing all their assets. But they will have no other business than clearing of payments and deleveraging, no lending.
- Oil is going up because everybody (that is mainly, China, US) is building up the strategic reserves, OPEC took several mb/d out of the market, the rest of the world is depleting, and we have exhausted the pool of "easy" demand destruction. However, in 2008 dollars, oil cannot be higher than 100$/b except for brief spikes (Deffeyes computed the ratio of oil bill to world GDP, and that tells you the story). Yet, OPEC will try to get as much as they can because they need the cash flows to maintain domestic stability.
Price implications: I expect oil has entered a trading band of 60-120 in 2008 USD. I may briefly spike above, but no more (otherwise, painful demand destruction comes quickly). Oil-related inflation will abate soon.
The only thing I remain undecided about is the USD/EUR parity. I believe it is possible that the dollar tanks (and the oil trading band would apply in euros), yet the US still experience a domestic deflation (total destruction of their foreign trade, yet no demand for domestic substitutes of foreign products, very low velocity of money, etc...) Pierre
You can't have inflation everywhere, but you can have inflation somewhere, if a currency breaks down.
However, contra RatEx theory, you can have a widepspread anticipation of broad based inflation in conditions where broad based inflation are impossible if the anticipations are based on a simplistic model of inflation that is counter to available evidence, such as a Monetarism based on a minority subset of money, and that model predicts a broad based rather than currency specific inflation.
Question 2:
Oil overshot low, and much of the price increase is the recovery to a more sustainable long term supply price for current demand conditions. Some of the price increase may be actual hedge/speculative purchase, if (AFAIU) inventories are up. The prospective downside risk is modest, maybe 10% or 20%, and the prospective upside gain is massive, for either the oil price shock scenario or the currency break down scenario.
Question 3:
By lying. Abandoning mark to market is responsible for a healthy slice of reported bank profits. The question is, of course, whether there will be a strong enough recovery to turn a substantial portion of those present lies into future truths. I am dubious that there will be without policy changes. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
Irrespective of whether inflation is feasible in the real world, financial markets are not time-telescopes. They do not read from the future, but only from present anticipations of the future. So if a flawed model is prevalent, it will show up as inflationary expectations.
IOW, when there's smoke, there's fire ... but sometimes its not smoke, its just a dust cloud. I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
