Then use the headline rate. That's how the CPI is calculated and it includes food and energy.
Only a goldbug would believe the rate of inflation is really 10-14%.
Posted on 11/25/2007 5:15:20 PM PST by Travis McGee
Judging by the behaviour of world markets last week, investors are now convinced the credit squeeze is harming the real economy. In other words, in terms of a question I posed last week, they think this crisis is more like 1989 than the more benign one of 1998. So let us give the screw one more turn. What price 1973?
Anyone with memories of that time will shudder at the comparison. In the UK, the FTSE All-Share index plunged more than 70 per cent in the space of two years. By 1975 inflation rose to 27 per cent, at which time UK Libor stood at an astonishing minus 16.4 per cent in real terms.
Some investors will find that notion simply irritating. Inflation is subdued in all the main developed economies. Why create a problem where none exists?
But this, it turns out, is the crux of the matter. Wall Street is screaming at the US Federal Reserve to cut rates.
As Merrill Lynch put it rather crossly last week, "the Fed still does not grasp the severity of the real estate deflation and credit crunch". In the futures markets, the probability of the Fed not cutting next month is now put at zero.
But the Fed is genuinely worried about inflation, as is the Bank of England.
If it is forced to cut rates, it will presumably be more worried again. What we have here, as Morgan Stanley remarks, is a disconnect that will not go away soon.
Some would say severe inflation is today impossible, since central bankers have learnt better. That was certainly the view around 1970, after 20 years of non-inflationary growth - rather similar to the so-called Great Moderation of the past two decades.
As a result, investors were continuously behind events. One sign of this was that during 1975 real yields on US Treasuries averaged minus 3 per cent and real gilt yields minus 11 per cent.
As to what might spark inflation this time, there is no shortage of theories.
Perhaps the most weighty is that proposed by Alan Greenspan: that after years of exporting deflation, China and India may now start exporting inflation instead.
But perhaps we should examine parallels with 1973 on a broader front. Ian Harnett of Absolute Strategy Research puts the case as follows.
In the early 1970s, the central problem was that the US was engaged in a costly war that it could not afford. One result was a weakening of the currency which - at a time of fixed exchange rates - chiefly expressed itself in a fall of the dollar versus oil and gold.
As a result, the exchange rate system collapsed. That left countries with a choice: whether to peg their currencies to the dollar and import inflation, or float and import recession. And this, of course, is the choice now facing China and the Arab oil-producing states.
Indeed, Mr Harnett suggests, they may come to face a more perilous choice again - whether to put their surplus reserves into less risky currencies, meaning those with current account surpluses.
In that case, presumably, so much the better for Japan and Switzerland - and so much the more expensive for debtor countries such as the US and UK.
Inflation would make it more expensive again. Here, there is a direct contrast with 1973. Then, savers had no direct experience of inflationary conditions.
The result was a massive shift of wealth from savers to borrowers. The smart move, it turned out, was to buy a house on the biggest mortgage possible - or, for governments, to issue the maximum amount of self-liquidating debt.
Today, those in late middle age will make no such mistake. In 1973, as I can attest, spasms of panic could be induced by the simple act of visiting the supermarket and checking the prices against a few weeks before.
That is not an experience one forgets. Investors of that age, whether amateur or professional, are now in the driving seat. If inflation takes hold - indeed, if it simply becomes more volatile - the result will be an inflationary risk premium. And in a savers' market, it will be the turn of borrowers to suffer.
Of course, we are not there yet and may never be. All that is happening now is a worsening 1989 scenario, with Goldman Sachs - for instance - arguing last week that US house prices have 13 to 14 per cent more to fall, or 35 to 40 per cent in the case of California.
I am not, after all, seeking to propound any vulgar fallacies about history repeating itself. The point of such exercises is rather to expand our conception of the possible.
In that spirit, a seasoned stockbroker of my acquaintance dismisses my 1973 comparison. The true parallel, he says, is 1929.
But that, surely, is going too far.
BTTT
After debt settlement, invest in land, food and firearms. Not necessarily in that order.
This is an interesting analysis.
~~Harvard Economic Society, October 19, 1929
“Several brokerage houses tumbled; blue-sky investment companies formed during the happy bull market days went to smash, disclosing miserable tales of rascality; over a thousand banks caved in during 1930, as a result of marking down both of real estate and of securities; and in December occurred the largest bank failure in American financial history, the fall of the ill-named Bank of the United States in New York.”
~~Only Yesterday: An Informal History of the 1920’s by Fredrick Lewis Allen
"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."
~~Ludwig von Mises
Some are stuck on stupid. Anything is possible in our economy. I, however, am bullish, buy, buy, buy.
Congratulations, you have just become the 1,000,000th fear-monger to involk comparisons to 1929. Every crisis since the 1930's brings about such cries from the chicken little crowd.
I’m just glad that my house is paid off and I ignored the hucksters who said I should sell, take out a big loan and find a bigger and better house.
Telling your sitcom-watching neighbors about a hurricane warning doesn’t mean one is “for hurricanes.”
Conversely, ignoring hurricane warnings won’t provide any safety to the wearers of rose-colored glasses.
Sorry, but there is always some expert proclaiming its 1929 all over again. It really hard to take them seriously. We have solid growth, low interest rates, low inflation, high employment. The housing/financial crisis is serious, but it ain’t 1929 or even 1973.
Interesting read. Was it Asimov’s Seldon Plan that dictated “when in danger, hesitate?” Perhaps the Fed should also.
If you are worried about inflation, why pay off debts early? How would you like to be holding a 30 year note at 6% with an inflation rate of 17%?
Seldon was the Foundation series. I don't remember that saying from those books. Not my favorite series either....
Glad to see you’re a fan of Mises. I’m afraid his wisdom falls on deaf ears.
Just in case no one thinks we’re in some trouble, a couple of weeks ago, a dear friend attempted to cash in a CD to buy a motor home. It took two weeks to actually get the cash! another-—recently I withdrew a small amount of money from a passbook savings account and recieved a nasty letter from the bank saying I could only make a with drawal twice in a quarter. Yikes! This was a PASS BOOK Savinigs account I use only for emergencies that only pays .70 percent interest!!!
Can’t remember the economist, but recently learned the Fed has now skipped printing all the money. Probably the reason the Ded no longer report M3 money supply. they just add the requisit number of zeros to the computers and now only print five percent of the cash they’re stoking the economy with. Anyone know about that???
What if you have no job due to inflation’s impact?
“...low inflation rate...”
Were you aware the touted inflation rate is only the “core” inflaation rate. Food and energy were taken off the table since they were “too volotile?”
Many of us only spend our money on food and energy. The actual inflation rate is closer to 10-14 percent, or more.
The dollar has lost a third of it’s value in the last three years. That’s really your true inflation rate.
Huh?? I have never heard of such a thing. I have to ask what fine institution did this occur.
Then use the headline rate. That's how the CPI is calculated and it includes food and energy.
Only a goldbug would believe the rate of inflation is really 10-14%.
I could’t transfer money on Saturday, excuse, account is showing up as dormant. Buh By bankie.
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