In April 2009, the world’s most powerful people were in a tight spot. Shey met in London to come up with a plan. You see, the world economy was not meant to have blown up the previous September. And the lawyers, central planners, politicians and central bankers of the G20 needed to be seen to have things under control.
They were backed into a corner, so they decided the only way out was to print loads of money. These guys were willing to ‘roll the dice’ – they decided to print the money and pray to God that inflation wouldn’t rip the world economy apart.
Almost five years later, they’re still at it. The major central banks have printed $5trn and counting. And it looks like their gamble might have paid off.
A little bit of poison does you good
Inflation is the key variable when it comes to macroeconomics. It determines how much stuff your investments will buy you, and it’s the number the central bankers base their monetary policy on.
In fact, in the USA, policy makers are now concerned that inflation is too low, having settled at around the 1% mark.
What’s wrong with low inflation, you may well ask?
Well, for Janet Yellen, the newly appointed chair of the Fed, this figure has considerable implications.
You see, Janet Yellen was instrumental in adopting the Fed’s 2% inflation target. It is officially an aim of the Fed to target and maintain 2% inflation. Though runaway inflation isn’t the goal, it seems that a little bit of poison does you good.
If you ask me, all this is really about eroding the value of debt. But they make some other spurious arguments about how it helps the employment market.
Anyways, despite the heroic efforts of money-printing central bankers, inflation has stayed low. And that’s a very interesting turn of events.
You see, over recent months, the US jobless figures have been improving. The economy seems to be ticking up. Now, normally one would expect inflation to pick up too. But it hasn’t happened, and it’s left many policy makers “baffled”.
Well, perhaps, they shouldn’t be so taken aback. After all, energy prices have been falling because of the shale gas revolution. The dollar has been pretty stable, and as we see in the UK, consumer prices are subject to massive discounting.
Shale’s a big part of the story. The internet is another. The internet is thrusting competition into just about every aspect of the consumer market. As the headlines about an awful Christmas season for retailers suggest, there’s a lot of downward pressure on prices.
In fact, inflation is falling in much of the Western world. Last week, the European Central Bank reported core inflation is down to 0.7%. Even here in the UK, inflation has gradually come down to 2.1%. Crumbs, we’re almost on target.
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My timing was off
I have to confess, I hadn’t expected things to turn out so well. Yes, it’s probably true that the reported figures are manipulated to some degree. Whether the statisticians are improving statistical technique, or just changing what they want the stats to show, is a moot point.
The crucial point is this: in the good old days, before these bold central bank experiments, it was taken as a given that dovish policy (low rates and a growing money supply) would always lead to inflation. If you like, inflation kept central banks on the straight and narrow.
But if, in the light of falling inflation, the bankers now feel emboldened to continue, or improve upon this ultra-dovish policy, then surely they will do so.
Many readers have been surprised by a relatively benign outlook on the economy; indeed, on the markets themselves.
But if you really want to know why I’m so convinced that the status quo will follow through in the coming year (if not further out than that – but we’ll get to that nearer the time), then it all comes down to inflation.
Yellen, and her ilk want to gee up inflation. That means looser policy, not tighter. Yes, I know that the Fed is talking about tapering. But in the scheme of things, this taper is just a tiny tightening. There’s room for the fed to loosen off in other places. And indeed, they have been keen to get across the message that rates are staying low – and for a long time.
As for Europe, well, despite near on depression in many of the southern states, the stock markets have continued to improve. And why not? With no inflation, money supply propped and interest rates stuck to the floor, exactly where is one supposed to put all this cash?
Of course, there will come a day when inflation does begin to take off. I suspect that when it does, it’ll baffle the boffins at the central banks to an even greater extent that today’s subdued figures do.
The truth of it is, nobody has a clue why inflation behaves like it does. Though they threw plenty of time, effort and money at the problem, communism never really got to the bottom of how an economy works. Why? Because you cannot plan economies. You cannot possibly know how they react to events. Inflation will spill out onto the streets one day.
The only thing is, I don’t think it’ll be this year. On the contrary, this year the central banks will continue to fight perceived deflation.
And this should be good news for the markets.
Next time, we’ll look at the trading figures I promised you on technology company Iomart.