Kasriel: ‘greater risk for the global economy…is inflation’
So we can put a check by Paul Kasriel’s name for inflationistas because he has come out today with a report saying he believes it is inflation over the medium term which is the greatest risk to the economy.
I will not keep you in suspense. I believe that the greater risk for the global economy in general and the U.S. economy in particular is inflation, not deflation. I arrive at this conclusion both on secular and cyclical grounds.
For the record, I believe deflation is the greater risk right now. However, when the reflation play takes hold (and I believe it will do by Q4 or Q1 at the latest), inflation will be the real threat. So I agree with Kasriel. Think $100 oil or higher for starters. Commodities are going to be a good play all around. Kasriel identifies secular and cyclical reasons inflation is a problem over the medium-term. Secular reasons would include a higher Fed Funds rate, disappointing productivity growth, and higher defence spending. Cyclical concerns for the U.S. include the positive relationship between the output gap and inflation, and the exchange rate correlation to inflation. There are other factors too like the re-emergence of Japanese consumer demand and the rising levels of government debt.
The global markets are on to this trade as the dollar has sold off massively as have U.S. government bonds. I do think these moves are pre-mature because disinflationary or deflationary forces (household de-leveraging, the destruction of shadow banking, and the implosion of real estate valuations, both commercial and residential) still have the upper hand in the U.S. economy. Nevertheless, inflation is coming. It’s only a question of time.
Source
Greater Risk over Next Five Years – Inflation or Deflation? (PDF) – The Econtrarian, Paul Kasriel, Northern Trust
Ed – weaker domestic currency = higher domestic stockmarket.
Higher oil + the deflationary forces you mention = weaker economy = eventual market decline. Add in the bond market = a potential big constraint & a fly in the ointment of any coming inflation, which may as you say only be a question of time, but IMO you’ve omitted the word “long”, assuming the P-T-B (Powers-That-Be) have some semblance of fiscal responsibility left in their on-going attempts to right the sinking ship of the developed world’s un-propable-uppable economy.
Long term, there is real risk of severe inflation. But this scare right now is a little absurd. Gasoline is up 50+% from the low.
I think it’s the green shoots killing themselves: If we are in recovery, rates SHOULD increase and commodities too. But how does the recovery survive the 5% increased cost (in two weeks) in home ownership, or the 50% rise in gas prices?
This is taking Goldilocks to new heights…
While I agree with your deflation thesis, I don’t understand why you have such a short timeline. I would think that household deleveraging should continue until after the unemployment rate stabilizes. The savings rate is positive right now, and quite positive at that. The destruction of the shadow banking system is ongoing, and I also don’t see that being complete by Q4/Q1. The commercial real estate problem seems to be just starting, and I’m also suspect of a short timeline on that. The Option ARM recast/foreclosure wave won’t even really begin hitting for another year, and that will weigh down the middle and high end of the real estate market.
Is it that you have a more optimistic timeline on these things than I do or that you think the Fed’s printing press (or public perception, or …) will overwhelm these factors in the next two quarters?
A lot of people like Rosenberg think that inflation cannot take hold until the trend in housing, a main propeller of deleveraging, has stopped. I disagree. I think that reflation can give us “cyclical inflation” due to some of the trends Kasriel has highlighted, chief amongst them the absence of the productivity miracle and the likely uptick in commodity prices. To my mind, this sets the stage for a volatile global economy in which central banks will be constantly changing rates to meet the challenges of inflationary and deflationary forces.
Think of this as the Central Bank’s Scylla and Charybdis
Ed – you don’t mention the word, but the way you put it sounds like a recipe for stagflation, which seems to be a cop-out of the inflation/deflation debate – but maybe that is indeed where the developed world is headed.
Thanks. If such cyclical inflation were to occur, I suspect the price increases would not propagate to wage increases (unemployment too high). This would cause a sudden reversal in the savings rate, people to become extremely frugal, or both. The much-predicted-never-realized death of the consumer might actually happen.
” Cyclical concerns for the U.S. include the positive relationship between the output gap and inflation, and the exchange rate correlation to inflation. There are other factors too like the re-emergence of Japanese consumer demand and the rising levels of government debt. ”
Still a deflationist…
So do you think the Japanese would actively promote running current account deficits? Why do you think Japan will revive consumer demand? Japan is a nation that has been scared by globalization too.
I’ll believe in inflation when all the people in China and India get raptured and all the illegals in the US too… wage arbitrage still exists.
Edward, yes the market is aware of the popular reflation trade. Just out of curiosity, who is on the other side of those trades. They’re trades of course. Very rarely does the market give the crowd free money in the form of a one-way bet on the “obvious” – reflation.