“stable prices” = rising prices

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. (Federal Reserve Act)

Krishna Guha is the chief U.S. economics correspondent for the Financial Times.  I have noticed he has a striking ability to forecast Fed moves before they happen.  He appears to have sources inside the central bank.

Today he writes “Fed officials set sights on explicit target for inflation”.

Support is building within the Federal Reserve for a move to establish a de facto inflation target in order to shore up inflation expectations and reduce the risk of deflation.

A growing number of top Fed officials, including longtime sceptics, are coming round to the idea that an explicit numerical inflation objective would be a valuable bulwark against a shift towards expectations of price declines.

Meanwhile, Peter Boone and Simon Johnson have written a guest post for the WSJ economics blog.

The problem is not that this stimulus is too large, but rather that the entire Obama strategy now seems to be insufficiently bold.

So what would a truly bold plan look like? A fiscal stimulus, roughly of currently planned proportions, makes sense, but it needs to be urgently supplemented with three additional elements.

First and most important, there should be substantial further easing of monetary policy. The Federal Reserve is already heading in this direction but it needs to pick up the pace, and the president needs to get on board. The Fed should announce that it will create inflation in 2009, i.e., it will do whatever it takes to make sure that wages and prices rise, rather than fall, in the next 12 months.

Hm.  Sounds oddly familiar.

More importantly, lower inflation means higher real interest rates, which means lower disposable income for borrowers. Let’s say your mortgage rate is 6%, which is roughly the average mortgage rate for the U.S.

A year ago, if you said the U.S. will ultimately pay its public and private debts with printed money, you would be called a “gold bug” (or “the iTulip guy”).  Today, you could be the chief economist of the IMF.  OK, OK, former chief economist.

The other benefit of recreating positive inflation expectations is that it would put downward pressure on the dollar and thus push our major trading partners to cut interest rates and engage in their own forms of monetary expansion — or face appreciation of their currencies and a fall in exports.

I see.  So the Fed needs to get busy destroying our currency because that’s the only way to force the rest of the world to destroy their currencies, too.

Anybody know the best way for a retail investor to buy TIPS in the secondary market?

5 comments to “stable prices” = rising prices

  • snoopy

    I don’t know of a way to buy TIPS on the secondary market. I’ve been looking into buying individual TIPS for my IRA. I’ve been trying to decide on what maturity to buy. Will probably look at 5-year and 10-year maturities. 20-year just seems too long of a horizon. :-)

    BTW Nemo, what is your view on GLD? Is it worth getting some now?

  • I have two problems with owning gold. The first is that I am worried about being early. Hugh Hendry points out that gold prices halved from 1974 to 1976. Can you imagine owning gold while inflation was raging and seeing your investment cut in half in NOMINAL terms? It was only after enough people threw in the towel that gold started rising again, increasing eightfold in the next four years. Hendry thinks this will happen again. He might be right. Retail investors like you and me are notoriously good contrary indicators, historically speaking.

    My second problem is that I think the global economy is shrinking. Less stuff being produced + same amount of gold = gold worth less. Therefore, as a currency, gold will not even retain its purchasing power; it will simply do better than the fiat currencies. Assuming the fiat currencies are going into the trash heap, which I think is true but I do not know is true.

    So my play is to make leveraged bets, but not with my entire portfolio. I own $90 GLD LEAPS expiring in 2010 and 2011 in modest amounts (15% of my IRA). I intend to increase this to 30% over the next 12-24 months, using the longest-dated options available. I am prepared for these to go to zero, in which case I figure I will still have a job because the economy will be OK.

    The future is more uncertain now than at any point in my lifetime. We might face a quick recovery, a slow recovery, or no recovery… The only thing (I think) I know for certain is that we will not have sustained deflation in dollar terms. So I am positioning my portfolio to survive anything else. Trouble is, we might face deflation for the next couple of years… So I am still 50% cash and moving into these positions slowly.

    A year or two from now, I expect to be 30% gold LEAPS (the “hyperinflation” bet) and 70% equities (the “world not ending after all” bet).

  • snoopy

    Thanks for sharing. I guess I’ll just keep sitting on my hands then. I get impatient because I’ve been in all cash in last Feb and have no clue what to do. After reading iTulip & Mish, it doesn’t look like getting into stocks is good either. So, aside from TIPS, which I’m still investigating, I’m out of ideas. Since I don’t own a house, I was thinking of getting one. If the dollars become worthless, then so will the mortgage!

  • snoopy

    BTW, try hard as they might, I don’t see how inflation can be induced in this environment. You can get inflation of product prices due to shortages, but you cannot force inflation of asset prices because unemployed people simply don’t have the money. If a banker making a significant six figure income loses his/her job, how does Obama’s plan replace that income? This banker will probably sit on unemployment for a year or so depending on his/her state of residence getting a fraction of what they were previously earning and then try to figure out what career switch to make. And that career switch will not replace all that income either. Forcing inflation in this fashion is legalized robbery. The uber-rich will buy all the assets for cheap, hire workers for cheap, and the workers that they hire won’t be able to afford half of what they could previously. Unless one is in the uber-rich category, one is about to be screwed big-time.

  • ThatLeftTurnInABQ

    As a long time lurker, first off let me say “thanks” to Nemo for putting together what has become por moi a must-read blog.

    Now for commentary – Snoopy asks “You can get inflation of product prices due to shortages, but you cannot force inflation of asset prices because unemployed people simply don’t have the money.”

    Unless I’m misunderstanding the question, this basically boils down to “If you only have the price half of a wage-price spiral, it is really inflation?”. Right now broadly speaking labor has little negotiating leverage due to a combination of long term sectoral shifts in the US economy, global wage arbitrage, and a near moribund organized labor movement, so even if prices rise, wages are unlikely to follow, at least not broadly across many sectors.

    It seems to me that there is an exit path from this dilemma (whether we would be well advised to take it or not, that is a different discussion), but one that is little thought of or commented on (especially on econ blogs) because doing so involves using dirty words which we have been trained and conditioned to instinctively avoid. Those dirty words are “Protectionism” and “Class Warfare”. We have tended to forget how much of our economic system is based on arrangements which while of long standing are essentially the results of past politics, which can be and may be revised at some point in the future. Perhaps it is time to bring back the term “Political Economy” to remind us of that.

    If what the gents at iTulip call “KA-POW” economics come to happen, then prices will rise steeply as the dollar loses its value. Domestic wages will fail to follow only for as long as it takes our political system to react by dismantling the free trading regime which we’ve enjoyed the fruits of since 1945. There is nothing to prevent Smoot-Hawley version 2.0 (or something even more extreme) from being put into place, other than our present inability to imagine it being done. To paraphrase Dr. Johnson, the prospect of a hanging expands the imagination wonderfully, and lots of people who vote in our elections (and some who run in them) are going to get rather imaginative in a hurry if the fertilizer hits the fan blades in a big way.

    Then you will have classic inflation as prices and wages race each other, so at least that is my prediction – price inflation followed by protectionism and autarky, followed by a classic inflationary spiral. Other bad things probably come along as part of the package, but I’m not going to speculate along those lines just yet – Magic 8-ball says “Situation unclear, try again later”.

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