Is Inflation An Issue Or Did The Fed Mess Up?

The Fed has been trying to create the illusion that inflation is an issue. The guys from the hard money camp also maintain that inflation is an issue and to a point they are right. Their definition of inflation is an increase in the money supply. The Fed, on the other hand, defines inflation as an increase in prices. The real definition of inflation is an increase in the money supply; rising prices are just the symptom of the disease. This article from mises.org summarises this concept quite succulently

Inflation, therefore, means an increase in the amount of receipts for gold on account of receipts that are not backed by gold yet masquerade as the true representatives of money proper, gold.

The holder of un-backed receipts can now engage in an exchange of nothing for something. As a result of the increase in the amount of receipts (inflation of receipts) we now also have a general increase in prices.

We are not going to spend time dwelling on this point as the crowd has bought the line the Fed has sold them and so the above point is moot. This article will focus on the price factor and not money Supply factor.

In numerous articles published over the last twenty months, we stated that Fed would be playing with fire if they raised interest rates as this economic recovery is based on “hot money”. We went on to state that if they raised rates, it would be a temporary ploy to buy them more wiggle room. Yellen recently confirmed that the Fed’s Hawkish bias might be coming to an end. She acknowledged that Inflation was below the Central bank’s target of 2%

Yellen, as she has in other statements recently, told lawmakers that she expects low inflation to be transitory. "Temporary factors appear to be at work. It's premature to reach the judgment that we're not on the path to 2% inflation over the next couple of years,” Yellen said. "As we indicate in our statement, it's something we're watching very closely, considering risks around the inflation outlook.”

Based on the factors we are going to list below, Yellen, might have to wait a very long time before inflation hits the Fed’s target rate of 2%. All we need to do is look at Japan; they have been trying to generate inflationary forces for decades without any success. They continue to inject billions into the economy hoping for change, but inflation remains stubbornly low. Our economic recovery is not real; remove the easy supply of money, and the economy will collapse.

Former Bond King Bill Gross seems to concur:

Gross said most destructive leverage occurs at the short end of the yield curve as the cost of monthly interest payments increase significantly to debt holders. "While governments and the U.S. Treasury can afford the additional expense, levered corporations and individuals in many cases cannot," he said.

Since the Great Recession, more highly levered corporations, and in many cases, indebted individuals with floating-rate student loans now exceeding $1 trillion, cannot cover the increased expense, resulting in reduced investment, consumption and ultimate default, Gross said. "Commonsensically, a more highly levered economy is more growth sensitive to using short-term interest rates and a flat yield curve, which historically has coincided with the onset of a recession," he said. Yahoo

In inflation was an issue, central bankers worldwide would be raising rates; instead, we find that many of them are lowering rates.

BOJ stated that they had no intention of raising rates in the near future

The Bank of Japan's policy meeting ended Thursday with no change to its injections of trillions of yen (hundreds of billions of dollars) into the economy each year through government bond purchases. The BOJ said in a statement that it forecasts inflation at 1.1 percent in 2017, below its 2 percent target and also its earlier outlook for a 1.4 percent rise in the consumer price index. But while central banks in Europe and the U.S. begin winding back stimulus measures taken to counter the fallout from the global financial crisis, Kuroda has said the BOJ will persist until it can achieve its inflation target — now not expected until 2019. Full story

South Africa’s Central banker’s surprise markets with a Rate cut

The South African Reserve Bank surprised markets with an interest rate cut on Thursday. While most economists have been expecting the bank to move towards a cut‚ it was not expected to come quite so soon. The Bank cut the repo rate to 6.75% from 7%. Full story

Inflation Appears To Be Decreasing On Worldwide Basis

Even though Canada raised rates, the data indicated that a rate increase was not warranted. The July rate increase might be a short lived stint. They might mimic the Fed’s footsteps and then back away.

May saw an increase in CPI when unadjusted, but it was well below the Bank of Canada (BoC) target. CPI rose 1.3% year-over-year in May, slipping even further than last month’s 1.6%. Statistics Canada claimed the decline was mostly due to a drop in food and energy costs. The BoC targets a rate of 2% for a well-balanced money supply.

According to FT, Inflation in Germany (Europe’s largest economy) fell to 1.4%; a low for 2017

A surprising tumble in Germany’s closely-watched inflation rate. Annual consumer price growth in the eurozone’s largest economy has fallen to 1.4 per cent from 2 per cent in May – the lowest level of the year.

Brazil’s Inflation Falls To A Decade Low

Consumer prices in June decreased 0.23% over the previous month, which contrasted May’s 0.31% increase. The drop came on the back of falls in a number of categories across the index, including lower prices for housing, transport, and food and beverages. Inflation continued to drop in June, falling to an over decade low of 3.0% (May: 3.6%). The result was below the Central Bank’s target range of 4.5% plus/minus 2.0 percentage points and is good news for the battered economy. The sharp fall will give the Central Bank space to continue with its easing cycle to support a recovery and should help support household spending.

Credit Suisse goes on to state that Global inflation risks remain low in the following article

Global inflation trends remain quite benign. In most of the major advanced economies, headline inflation peaked in the first quarter once the positive base effects from energy price developments had faded. In the major emerging markets, inflation is also mostly in decline, with the recovery of their currencies combined with still weak domestic demand the most important drivers in countries such as Russia and Brazil. Looking ahead, we see good reason for this benign global environment of relatively low inflation to last for longer

Why are these central bankers not running out and raising rates? These countries cannot play with fire; their currency is not the World’s reserve currency, so they have limited room to manoeuvre. They are not going to risk a recession when they are fully aware this economic recovery is an illusion. Remove the cash infusions, and the economies of the world will collapse.

Take a look at the US retail sector; the entire sector is imploding due to players like Amazon that continue to push prices lower and lower. Bloomberg estimates that 8640 stores are set to close by year end. We think this estimate might be conservative and that the final tally could be north of 9,000.

Extrapolating out to the full year, there could be 8,640 store closings in 2017, Buss said. That would be higher than the 2008 peak of about 6,200.Retail defaults are contributing to the trend. Payless is closing 400 stores as part of a bankruptcy plan announced on Tuesday. The mammoth chain had roughly 4,000 locations and 22,000 employees -- more than it needs to handle sluggish demand.

With Amazon’s purchase of Whole Foods and Lidel’s entry into the US market, a massive grocery war is underway; this price war will trigger another set of deflationary forces. Lidl has stated that they would price groceries up to 50% below US rivals.

"This is the right time for us to enter the United States," Brendan Proctor, chief executive officer for Lidl U.S., told Reuters at a media event in New York late on Tuesday. "We are confident in our model. We adapt quickly, so it's not about whether a market works for us but really about what we will do to make it work."

Aldi the other German company that has been here for some time already offers prices that are below Wal-Mart’s prices; the upside here is that the consumer gets good priced lower than those at Wal-Mart, but the quality is far superior. Analysts estimate that by 2020 Lidl will have over 300 stores in the US. Aldi already has 1600 stores in over 35 states plans to open another 900 stores within the next five years. Aldi and Lidl are a formidable duo; they have already sent shockwaves through Britain's Grocery Retail Market, hurting old timers such as Tesco Plc and the ASDA Supermarket chain.

Artificial Intelligence (AI) and Technological breakthroughs will continue to drive prices lower. Look at how much pricing power the consumer has today compared to a decade ago; this trend will continue to gain traction.

There is another factor “ the velocity of M2 money stock” it indicates that inflation is not an issue. The velocity of M2 money stock in the US has been plunging for years and shows no signs of letting up; if inflation were an issue the velocity of M2 would be trending upwards and not downwards. We will examine this in more detail in a follow-up article.

The Bond Market Does Not Buy The Inflation Argument

Bonds should have continued to plunge, but notice that bonds bottomed in April and have started to trend higher. After the July rate hike, bonds should have taken out their April lows, but they did not. Instead, they went on to put in a series of higher lows; higher lows are usually indicative of higher prices. Furthermore, the stock market hardly reacted to the last rate hike; after a very mild reaction, it has continued to trend higher.

We tend to focus more on the technical and psychological outlook, and both are indicating that inflation is still not an issue. The Gold market is also indicating that inflation is not an issue. Last July Gold traded past $1400; at that time rates were lower and the US dollar was trading at higher levels. But today rates are higher today, and the dollar is trading lower than it was in 2016, but Gold instead trading at or above $1400 can’t even trade above $1300 for sustained period.

Conclusion

The psychological factor does not support higher prices; the economy is not doing well as the consumer is not spending wildly. Consumer confidence is increasing, but consumer spending is not marching in tandem with consumer confidence. Income growth is weak; the rise in incomes and net worth has primarily benefited high income and high net worth households. These are the same individuals that have the most money invested in the stock market which has tripled since its March 2009 lows.

We have listed a plethora of factors that illustrate that inflation is not an issue; at least not yet.

Even James Bullard, president of the Federal Reserve of St Louis went seems to be in agreement

“Low inflation has been the major surprise of the era,”

He also went on to state that he was still waiting for inflation to return to the 2% ranges and would not support any increases in the Fed’s benchmark rate until 2018 to allow inflationary forces to recover. He might have to wait a lot longer than that. AI and technology, in general, are going to continue to fuel lower prices. The retail sector is in freefall; the remaining players battle it out, and price wars will continue for the foreseeable future. Food prices are going to plunge due to the price war that new entrants like Lidl and Amazon have triggered.

The bond market is not supporting the higher inflationary outlook, in fact by all measures the bond market appears to be building momentum to trend higher.

Government is the only institution that can take a valuable commodity like paper, and make it worthless by applying ink. - Ludwig Von Mises