Showing posts with label inflation. Show all posts
Showing posts with label inflation. Show all posts

Monday 24 July 2023

Political revolt and Food prices

There is never one cause of a political revolt, but food prices have played a role in many.  


Consumer prices have been intimately connected to the cycle of political crisis, revolt and reform.

1.  The Revolutions of 1848 targeted European monarchies and followed the spread of democratic ideas on the continent.  Spiking food prices was identified as the main catalyst too.

2.  In recent decades, Latin America has been a cauldron of inflation driven unrest.  Between 1946 and 1983, 15 governments fell in Latin America, and in 13 of those cases, from Mexico to Argentina, the regime change followed a sure in the annual rate of consumer price inflation to 20% or more.

3.  Rising prices for wheat and other grains also contributed to the 1989 fall of Communism in the Soviet Union.


Inflation fell in most emerging nations but occasional flare-ups continued to topple leaders.  

There was a strong link between food prices and unrest in many countries between 1990 and 2011.

1.  Inflation helped oust regimes in Brazil, Turkey and Russia (again) in the late 1990s.

2.  In 2008, World Bank warned that at least 33 countries faced a risk of social revolt sparked by food prices, which had risen 80% in the previous 3 years.

3.  Food prices did help spark revolts worldwide in 2011, including the Arab Spring.  

4.  In India before the 2013 election, the voters were complaining about price of onions.  The Congress Party lost to Modi's Hindu nationalist party, and polls showed that inflation had played a major role in the Congress government's downfall.


Conclusion:

High or rapidly rising consumer price inflation threatens economic growth directly and indirectly, because it can provoke destabilising social unrest.  

Watch for leaders who understand this inflation threat, and how to use the weapons that can control it.

High inflation for consumer prices is almost always a threat to growth but deflation is not.

For the eight centuries beginning in 1210, the world's average annual inflation rate was only 1%, according to the Global Financial Database.  For  most of that period, however, the long-term 1% average concealed sharp swings between inflation and deflation.

In early 1930s, deflation disappeared, for reasons that remain mysterious but include the spread of the banking industry and the wider availability of credit, with consequently more money chasing the available goods.

The end of the gold standard in the 1970s made it easier for central banks to print money, which also tends to fuel inflation.

The result was that deflation disappeared completely on the global level, and bouts of deflation - particularly longer ones - became much less common within individual nations as well.  


Though deflation has largely vanished, worldwide, it continues to surface in isolated pockets.  

Japan is the only major country to have suffered a multiyear case of deflation in the postwar era, but many countries have suffered a single-year bout.  

Again, however, these periods did not have a consistent impact on growth, for better or worse.


No clear evidence that consumer price deflation is bad - or good- for economic growth.

In early 2015, the Bank for International Settlements (BIS) looked at the postwar record for 38 countries.  In all, these countries had seen more than 100 years in which prices fell.  

  • On average, GDP growth was higher by a statistically insignificant margin during deflationary years, at 3.2%, than during inflationary years, at 2.7%.   
  • The cases in which deflation was accompanied by strong growth occurred from Thailand and China to the Netherlands and Japan.  
The BIS concluded there is no clear evidence that consumer price deflation is bad - or good- for economic growth.


High inflation for consumer prices is almost always a threat to growth but deflation is not.

How can you tell when consumer price deflation is the good kind, driven by growing supply, or the bad kind, driven by shrinking demand?  

This task requires parsing conflicting forces of supply and demand, often with unclear results.  

The takeaway is simply that while many analysts now assume that any hint of deflation is worrisome, this assumption is not borne out by the evidence.  

High inflation for consumer prices is almost always a threat to growth but deflation is not.


Sunday 23 July 2023

Understanding Real Inflation Threats

When may inflation be too high?

These are still very useful averages as benchmarks for judging when inflation may be too high:

  • Any emerging nation with a rate of inflation much above 4%, or 
  • any developed nation with a rate much above 2%.

Any country with high inflation has cause for concern.


High consumer price inflation is a growth-killing cancer.  

This still holds true.  

  • In the short-term, rapidly rising prices compel central banks to raise interest rates, making it more expensive for businesses and consumers to borrow.  High inflation also tends to be volatile, and its swings make it impossible for businesses to plan and invest for the future.   
  • Over the longer term, inflation erodes the value of money sitting in the bank or in bonds, thus discouraging saving and shrinking the pool of money available to invest in future growth.


Actions of central banks post crisis of 2008

In the slow growth-environment that took hold after the crisis of 2008, central banks often worry that inflation may be too low, not too high.

In developed countries, instead of raising rates to make sure inflation doesn't increase to far above a target of 2%, they now cut interest rates when inflation is falling too far below 2%.  

Their big fear is that low inflation will lead to outright deflation - the dreaded but overblow "Japan scenario".


"Bad deflation" and "Good deflation"

History, in fact, shows that neither low inflation nor deflation are necessarily bad for economic growth.   

Japan suffered a rare bout of "bad deflation" after the collapse of its stock and housing bubbles in 1990Consumer demand dried up, prices started to fall and shoppers began delaying purchases in the expectation that prices would fall further.  The downward spiral depressed growth for 2 decades.  

However, deflation can also follow a new tech or financial innovation that lowers production costs and boosts economic growth.

If inflation is too high, it is almost always a threat to growth but the same cannot be said of low inflation.  Even if low inflation threatens to devolve into deflation, it could be good for growth if falling prices are driven by new innovation and expanding supply rather than by depressed demand.


Need to control inflation in both consumer markets and financial market

Perhaps, the deepest flaw in traditional thinking, however, is that it still focuses on the kind of inflation that has largely disappeared.   

  • After the central banks won the war on high consumer price inflation, they cut interest rates to levels that have fueled a massive run-up in prices for financial assets, including stocks, bonds, and houses.  
  • And in recent decades, as we have seen, stock market and housing bubbles have been increasingly common precursors to financial crisis and recessions. 


Traditional thinking fails to recognize the new inflation threat in the financial market

Economists have been very slow to recognize this new inflation threat, and central banks have been very slow to think outside their official mandates, which focus on stabilising the economy by controlling inflation in consumer prices only.  

But successful nations will control both kinds of inflation, in consumer markets and in financial market.

No subject in economics is more paralyzed by traditional thinking than inflation, a term that generally refers only to the pace of increase in consumer prices, a once ubiquitous threat that has largely vanished in recent decades.  

Central bankers and economists still tend to focus on consumer price inflation, even though it has largely disappeared and to ignore prices for assets like stocks, bonds and real estate, even though there is an increasingly clear link between real estate and stock market busts and economic downturns.

Friday 19 May 2023

BNM defends recent OPR hike to 3%, saying it was to avoid greater unease of higher inflation


By Priyatharisiny Vasu & Syafiqah Salim 
/ theedgemarkets.com 
12 May 2023

Bank Negara Malaysia governor Tan Sri Nor Shamsiah Mohd Yunus says the central bank wanted to guard against a situation of raising rates too little and allowing inflation to resurge, or raising them too much and causing unnecessary economic weakness.

KUALA LUMPUR (May 12): 

Bank Negara Malaysia (BNM) defended its recent position of increasing the overnight policy rate (OPR) to 3% amid widespread misconception, saying the central bank wanted to avoid keeping the rate too low for too long when economic growth was firm. 

BNM governor Tan Sri Nor Shamsiah Mohd Yunus said at the briefing on the first quarter of 2023 on Friday (May 12) that the central bank wanted to guard against a situation of raising rates too little and allowing inflation to resurge, or raising them too much and causing unnecessary economic weakness. 

“I must also correct the perception that we want growth to be slower. That is certainly not true. Which one is more kejam (brutal)? [A rise in the] OPR, or if our inflation goes out of control? 

If our inflation level heats up, all our purchasing power will be impacted regardless of whether you have a loan or not,” the governor said. 

She added that prolonged low interest rates that are not aligned with the health of the economy could have damaging effects, such as overspending and overborrowing. 

 “This could push up prices even more. When that happens, all of us will be affected, especially the poor and vulnerable,” Nor Shamsiah said. 

 It can also encourage excessive risk-taking, and speculative investments to get higher returns, and increase chances of financial scams. 

 She added that the central bank wants economic growth to be on a sustainable trajectory, and as such, it is focused on ensuring the long-term impact of its policy rate decisions. “We want it to be sustainable, not just for today, but for months and years to come. We do not want to have a situation, where we just look at today’s growth numbers, but further down the road, it's not sustainable, where it leaves us in high inflation and even a recession. That is not what we are here for,” Nor Shamsiah said. 

 On May 3, BNM raised the OPR by 25 basis points (bps) to 3%, as the central bank believed the global economy continued to be driven by resilient domestic demand. The rate hike, after two consecutive pauses in early 2023 at 2.75%, came as a surprise after most economists predicted that the central bank would maintain the OPR to further assess the impact of four straight increases in the key rate last year that raised it by a cumulative 100 bps. 

 Inflation remains sticky 

 Nor Shamsiah said although headline and core inflation is expected to moderate over the course of 2023, core inflation would remain elevated. 

 Elevated underlying inflation has been more prolonged than in past episodes, the governor said, adding that it was partly owing to a strong recovery in domestic demand. 

 “While core inflation moderated to 3.9% during the [first] quarter, compared with 4.2% in the immediate preceding quarter, it remained elevated relative to the historical norm of around 2%,” she said. Core inflation is more indicative of demand pressures, she said, adding that both headline and core inflation will remain within 2.8% to 3.8% for the year as a whole. 

 “Even as cost has begun to moderate, strong economic activities have continued to generate demand-driven pressures, which have kept core inflation elevated,” the governor said. 

 She said higher core inflation could be observed beyond conventional demand indicators, such as retail trade and credit card spending data. 

 Existing price controls and fuel subsidies will be continued to partly contain the extent of upward inflationary pressures, according to her. 

 “The balance of risk to the inflation outlook is tilted to the upside, and remains highly subject to any changes in domestic policy, financial market developments and global commodity prices,” she said.

https://theedgemalaysia.com/node/666714












Friday 6 January 2023

Inflation and the Defensive Investor

Fixed income investments fare worse during inflationary periods than do common stocks.  During inflationary periods, firms can increase prices, profits, and dividends causing their share price to increase and offsetting declines in purchasing power. 

There is no underlying connection between inflation and the movement of common stock earnings and prices.  Appreciation does not result from inflation, but rather from the re-investment of profits.  The only way for inflation to increase common stock values is to raise the rate of earnings on capital investment, which it has not done historically.

Economic prosperity usually is accompanied by slight inflation, which does not affect returns.  Offsetting factors include rising wage rates that exceed productivity gains and additional capital needs that cause interest rates to increase.  

Graham describes alternatives to common stocks as a hedge against inflation.  These alternatives range from gold and diamonds to rare paintings, stamps, and coins.  Gold has performed poorly, far worse than returns from savings in a bank account.  The latter categories, such as paying thousands of dollars for a rare coin, can not qualify as an “investment operation.”  Real Estate is still another alternative; however, its value fluctuates widely, and serious errors may be made when purchasing individual locations.  

Again, the defensive investor is best served by purchasing a portfolio of carefully chosen common stocks and bonds.


Ref:  Intelligent Investor by Benjamin Graham

Sunday 28 November 2021

Everything You Need To Know About Money, Inflation. How The System Works

 


Everything You Need To Know About Money, Inflation | How The System Works | Business Documentary While the world comes out of economic recession due to the pandemic, a lot of things are changing. High inflation, stimulus packages, interest rates. All these words are popping up on the news, but it’s hard to figure out how does the whole system work. In this video, we explain all of that and more. Chapters: Hyperinflation Fiat Currency System Explained What if the dollar was still pegged to gold Why we might have high inflation soon Zombie companies

Inflation and Value of Bitcoin


Peter Schiff on Biden's Dysfunctional Economy, Inflation Concerns, and the Value of Bitcoin

Thursday 7 January 2021

Bitcoin's Bull Should Fear Its Other Scarcity Problem

As the value of this asset class rises, generating price spikes becomes increasingly difficult.


The Theory behind Bitcoins

The supply of Bitcoins was set from the start at 21 million.

That means, in the words of its pseudonymous founder Satoshi Nakamoto, it should ultimately be "completely inflation free" - making it a far better store of wealth than assets whose real value declines over time.

That's in theory, at least.


Digital currencies are still a tiny share of the world's investments

With the price of Bitcoin climbing as high as $34,792 Sunday (3.1.2021) and putting the value of all coins in circulation at around $647 billion, there is a different scarcity problem looming larger.



It is easier to think about this in terms of asset allocation.

World equity and bond markets  = $217 trillion

World equity markets = $103 trillion

World bond markets = $114 trillion

Bitcoins = 18.6 million coins = $647 billion.

Cryptocurrencies = $884 billion

Investment Gold = $3 trillion


If investors in aggregate decide to put just 0.1% of their stock and bond portfolios into Bitcoin right now, that represents an additional $200 billion or so, chasing the same pile of 18.6 million coins that have been mined to date - enough to push the price well over $40,000.

In that sense, the roller--coaster ride that Bitcoin has ridden in recent years looks almost sedate.

At current prices, all the digital Bitcoins in circulation are equivalent to about 0.6% of the $103 trillion market capitalization of the world's equity markets.

That is higher than the 0.4% allocation when the crypto price last peaked on Dec. 18, 2017 and much higher than levels shy of 0.1% that have prevailed at times since then - but it looks a whole lot less dramatic than the 79% run-up in coin prices from their last peak.


The success of cryptocurrencies tends to eat itself

The problem for digital bulls is that the success of cryptocurrencies tends to eat itself. 

As the value of the asset class rises, the shifts away from more conventional investments needed to provoke price spikes get larger and larger.


Bitcoin versus Gold

Bitcoin on its own is worth about 6 times the 56 million ounces of metal represented by all the contracts outstanding on the Comex 100-ounce gold contract.   

The world's biggest gold ETF, SPDR Gold Shares, holds about $72 billion of the yellow metal.  

Add in other forms of private investment gold and you've got about $2.87 trillion worth of metal -  but much of that is in the form of bars and coins that aren't easily liquidated when investors want to tweak their portfolios.


Turnover of digital coin derivatives 

Turnover of digital coin derivatives in the September quarter came to $2.7 trillion, according to Tokeninsight, a research company.  

That is not all that far behind the run rate of the world's biggest equity markets.    

The value of all shares traded in Japan in 2019 came to just $5.09 trillion, according to the World Federation of Exchanges, enough to make it the third-largest equity market on that basis.



Hedge Maze

Far from looking like a hedge against equity markets, the correlation between Bitcoin and the S&P is stronger than for many stock indexes.


Why would you choose to allocate a slice of your stock and bond holdings into a digital currency, instead of more conventional assets?

Once momentum stops driving the price higher, as it inevitably will, the best argument is still the hope that it might balance out the swings in your broader portfolio.  The prospect of Bitcoin becoming that sort of negative beta asset is the most promising way for it to become something more useful than a dice game for investors.

Unfortunately there is still little sign of that happening.  These days it looks not so much like a hedge against the gyrations of the equity market as a leveraged bet on the same movements.

  • The correlation between Bitcoin and the S&P 500 index was 0.767 over the past year - somewhat closer than the link between the S&P and the FTSE 100 index, and substantially tighter than that between U.S. and Hong Kong stocks.  
  • Gold's correlation with the S&P 500 was a far lower 0.299, while the Bloomberg Barclays U.S. Treasury index of total sovereign bond returns posted a prized negative beta of minus 0.036.

Crypto will only grow up if and when it finds a different driving force to the animal spirits that govern equity markets.  If it really wants to be an alternative asset to stocks and bonds, it needs to start behaving  like one.


https://www.bloomberg.com/opinion/articles/2021-01-04/bitcoin-price-surge-creates-a-different-scarcity-problem

January 4, 2021 by David Fickling

Bitcoin Price Surge Creates a Different Scarcity Problem - Bloomberg

Bitcoin’s Bulls Should Fear Its Other Scarcity Problem

As the value of this asset class rises, generating price spikes becomes increasingly difficult.






Saturday 19 December 2020

The main tool for fighting uncontrolled inflation: reduce the money supply

The main tool for fighting uncontrolled inflation is for the government and local monetary authorities to reduce the money supply.

Since most easily accessed money is in the form of bank deposits, the most efficient way for a central bank to control the money supply is by regulating 

  • bank lending and 
  • reserve requirements.

Essentially, when banks have more money to lend to customers, the economy grows  And when banks reduce their lending the economy slows.

The reason central bank monetary policy works so well is because of the multiplier effect.

Inflation versus Deflation

Inflation and hyperinflation

By the time the popular Venezuelan government called for next economic measures to end rampant hyperinflation at the end of 2018, the local currency had become virtually worthless.

After 80,000% inflation over the previous year, it took more than 6 million bolivars to buy a loaf of bread - that is, if you could find a store that had a loaf of bread in stock.

After more than a decade of economic mismanagement, the financial meltdown has become so bad that by the late 2010s, clean water distribution had slowed to a trickle, and gravely sick citizens were dying in make-shift hospitals, unable to get the treatments that were keeping people alive in almost every other country in the world.

It is nearly impossible to index prices and salaries in the chaotic world of hyperinflation, and consequently, no one is left untouched by uncontrolled inflation. 

  • From the top 1% to the poorest of the poor, an economy in crisis eventually hurts virtually everyone.  
  • But it's the most vulnerable who suffer the most.  When the cost of a loaf of bread exceeded the total monthly minimum salary in Venezuela, those at the bottom of the economic ladder had to face the worst aspect of economic hardship:  starvation.  Millions ended up fleeing across the border as economic refugees to Colombia and Brazil.

Hyperinflation has ravaged countries as diverse as Germany, Mexico and Argentina - even China during the Yuan dynasty, where too much paper money in circulation led to uncontrolled inflation.  In Germany's postwar Weimar Republic, in 1923, inflation became so bad that the government had to resort to issuing postage stamps worth fifty billion marks and people had to use wheel barrows to carry enough cash to make simple household purchases.


Deflation

The economic crisis in Japan at the beginning of the twenty-first century was marked by severe deflation, where a chronic decline in prices led to decades of sluggish economic growth.

When deflation was accompanied by a sharp decline in consumers - with the total population in Japan expected to decline precipitously by 2050 - the crisis in Japan appeared to be just as intractable as the inflationary crises in Venezuela and other parts of the world.  

  • In a country with persistent deflation, consumers will simply stop buying goods and services as prices decline expecting to get a better price at some point in the near future.  
  • Likewise, companies also tend to delay investments in new plants and machinery when they think prices for their products will soon decline.  
  • In deflationary environments, companies try to find ways to reduce input costs, often leading to a reduction in salaries.  The lower salaries then translate into even lower consumer spending, completing the vicious circle of deflationary economic crisis.


The solution is to change long term expectations

The problem with too much deflation, just like to much inflation, is that growth screeches to a halt because of the economic uncertainty both problems create.

In periods of crisis, however, central banks are often unable to change the perception in the minds of consumers and business-people that there will be no end to the vicious cycle of inexorably rising or declining prices.  

The solution for deflation, as for hyperinflation, essentially involves finding a way to change long-term expectations - not an easy task in an economy out of control.


Neither too hot nor too cold

Like the Three Bears' porridge, an economy should be neither too hot nor too cold.  

Neither acute inflation nor acute deflation are positive for sustainable economic health.

Despite the desire of some populist leaders to have a high inflation rate of 3 or even 4%, most economists recommend a "just right" inflation rate of about 2% per year.

Fighting excessive deflation once interest rates have been reduced to zero

Fighting excessive deflation is in some ways more difficult than fighting hyperinflation.

During inflationary times, there is basically no limit to how much central banks can raise interest rates.

But in the battle against deflation, once interest rates have been reduced to zero, there is little that central banks can do to stimulate further growth.  

The two things that can be done once interest rates reach zero are:

  • negative interest rates or 
  • quantitative easing.

Wednesday 16 December 2020

Measuring and Monitoring Overheating economy and Slowing economy

Interest rates and Money supply

Interest rates and money supply are the major tools the Fed and other central banks have traditionally used to control economic growth; the key is in how the tools are applied.

A country's economy is regulated by its money supply, which determines interest rates.  And each country's money supply is controlled by its central bank.  These quasi-public institutions are set up by governments but are then given the independence to keep an economy under control without undue interference from dabbling politicians.


How to measure and monitor growth and inflation in an economy?

Despite the tendency of the media to concentrate on the latest major economic statistic, such as GDP growth or unemployment, there is no one single indicator that tells us 

  • how fast an economy is growing or 
  • if that growth will lead to inflation down the road.

In addition, there is no way to know how quickly an economy will respond to changes in monetary policy.  

  • If a country's central bank allows the economy to expand too rapidly - by keeping too much money in circulation, for example - it may cause bubbles and rampant inflation.  
  • But if it slows down the economy too much, an economic recession can result, bringing financial turmoil and severe unemployment.  
  • When economic stagnation coincides with high inflation, sometimes referred to as stagflation, a worst-case scenario is created.

Central bankers, therefore, need to be prescient and extremely careful - keeping 

  • one eye on inflation, which is usually a product of an overheating economy, and 
  • one eye on unemployment, which is almost always the product of a slowing economy.

In the twenty first century, with the amount of capital flowing around the world dwarfing many countries' money supplies, it is almost impossible to know with certainty what the effect of any one monetary decision will have on a local economy, let alone on the world.


Fiscal policy or Massive deficit spending

Given the extremely low inflation rates in the 2010s, some have called for alternative methods for controlling economic growth.  Instead of using the central banks' authority to raise tor lower interest rates, referred to as "monetary policy," another solution would be to use "fiscal policy" to alter the money supply - essentially allowing governments to circumvent central banks by printing massive amounts of money to increase the money supply, for example.  

The use of a government's ability to issue new currency to influence economic growth, commonly referred to as Modern Monetary Theory (MMT), is not unproblematic in that inflation can come roaring back at a moment's notice.  

Many governments may misuse the power of MMT to pay for massive deficit spending in ways that lack the prudent guidance provided by the world's central banks.


Unforeseen and unpredictable events

Sometimes financial crises are caused by - and sometimes solved by forces -  entirely unconnected to the original problem.  

Most of the recent financial meltdowns, 

  • from the stock market crash of 1987, 
  • to the bursting of the dot-com bubble in 2000, 
  • to the market collapse following the terrorist attacks of September 11, 2001, 

were exacerbated by economic and sociopolitical forces well outside the control of any one country and greatly affected markets around the world.



Thursday 10 December 2020

The Real Inflation Threats

Inflation generally refers to the pace of increase in consumer prices.


1.  Historical inflation data

1970s

Consumer prices were rising at a double-digit pace and wreaking economic havoc all over the world.  

In early 1980s, they began to recede under pressure from rising global competition and a concerted attack by central banks.  

Raising interest rates to painful heights, central banks choked off money flows and won the war on inflation just about everywhere.


1981 to 1991

The average rate of inflation in developed nations fell from 12% to just 2%, where it remains today.

Meanwhile, in emerging nations, the average rate of inflation peaked at a staggering 87% in 1994 and reached the hyperinflationary triple digits in major countries like Brazil and Russia.  Then, over the subsequent decades, it receded to its current, much calmer rate of just 4%.


2.  Average inflation rates today

Any emerging nation with a rate of inflation much above 4% or any developed nation with a rate much above 2%, has cause for concern.  

In a world where double- and triple-digit consumer price inflation is a rare threat, the outliers are worth watching closely because they are out of balance and seriously at risk.



3.  Traditional thinking focuses on consumer price inflation only

High consumer price inflation is a growth-killing cancer

In the short term

  • rapidly rising prices compel central banks to raise interest rates
  • making it more expensive for businesses and consumers to borrow.  
  • High inflation also tends to be volatile, and its swings make it impossible for businesses to plan and invest for the future.

Over the longer term

  • inflation erodes the value of money sitting in the bank or in bonds, thus discouraging saving and 
  • shrinking the pool of money available to invest in future growth.


4.  Post crisis of 2008 slow-growth environment fears outright deflation

The central banks are now fighting a very different war.  

Central banks often worry that inflation may be too low, not too high in the slow-growth environment that took hold after the crisis of 2008.  

In developed countries, instead of raising rates to make sure inflation doesn't increase too far above a target of 2%, they now cut interest rates when inflation is falling too far below 2%.  

Their big fear is that low inflation will lead to outright deflation - the dreaded but overblown "Japan scenario."



5.  Low inflation and deflation can be bad (depressed demand) and can be good (driven by new innovation and expanding supply)

History, shows that neither low inflation nor deflation are necessarily bad for economic growth.


"Bad deflation"  

Japan suffered a rare bout of "bad deflation" after the collapse of its stock and housing bubbles in 1990.  

  • Consumer demand dried up, prices started to fall and shoppers began delaying purchases in the expectation that prices would fall further.  
  • The downward spiral depressed growth for two decades.  


"Good deflation"

However, deflation can also follow a new tech or financial innovation that 

  • lowers production costs and 
  • boosts economic growth.


High inflation is always bad for growth, deflation maybe neither bad nor good

If inflation is too high, it is almost always a threat to growth but the same cannot be said of low inflation.  

Even if low inflation threatens to devolve into deflation, it could be good for growth if the falling prices are driven by new innovations and expanding supply, rather than by depressed demand.


6.  Post 2008 low interest rates environment

After central banks won the war on high consumer price inflation, they cut interest rates to levels that have fueled a massive run-up in prices for 

  • financial assets, including stocks, bonds and 
  • houses.  
In recent decades, stock market and housing bubbles have been increasingly common precursors to financial crises and recessions.


7.  The Real Inflation Threats

Economists have been very slow to recognize this new inflation threat, and central banks have been very slow to think outside their official mandates, which focus on stabilizing the economy by controlling inflation in consumer prices, only.  

But successful nations will control both kinds of inflation, 

  • in consumer markets and 
  • in financial markets.


Conclusions

The general rule is that strong growth is most likely to continue 
  • if consumer prices are rising slowly or 
  • even if they are falling as the result of good deflation, driven by a strengthening supply network.

In today's globalised economy, cross-border competition tends to 
  • suppress prices for consumer goods but 
  • drive them up for financial assets (stocks, bonds and houses).  
Thus watching consumer prices is not enough.

Increasingly, recessions follow instability in the financial markets.  

To understand how inflation is likely to impact economic growth, you have to keep an eye on stock and house prices too.

Thursday 8 October 2020

Is Inflation Good for Stocks?








Conclusions:  

Back-tested data does not show any significant relationship between inflation rates and stock market returns.

Stock valuations may be negatively impacted by higher-than-normal inflation (due to increase in the risk-free rate which makes short-term Treasuries more attractive relative to equities).

Stocks may not be as good a "hedge" against inflation as the theoretical argument may suggest, this may be limited to SHORTER-TERM stock market movements.   

LONG-TERM investors in the stock market should take comfort in the fact that the S&P 500 has steadily outpaced inflation with an annualised real (inflation adjusted) return of 3% between 1871 and 2009.

 



Notes:

1.  Deflationary fears amidst weak economic growth have led to much liquidity being injected into the financial system by various central banks around the world.

2.  Motto:  "Deflation:  Making sure "it" doesn't happen here."

3.  Fundamentally, there appears to be a strong case for stocks to perform under inflationary conditions.  
  • When raw material costs rise, companies can raise selling prices and pass on the increased costs to the consumer.  The goods and services produced by companies make up the composition of the CPI, and it is not unreasonable to expect selling prices to rise in tandem with the CPI.
  • Also, companies hold real assets like property and land which can rise in nominal value over time.  Thus, investors in such companies should benefit over an inflationary period as the underlying assets increase in nominal value.

4.  The threats of deflation to economic prosperity are perhaps more obvious to investors who look to the beleaguered Japanese economy as a prime example.  
  • An economy where consumers postpone spending as items become cheaper in the future is certainly not an ideal one, especially for stock investors whose companies suffer from declining revenue and shrinking asset values.



Back-Testing the S&P 500

Monthly historical inflation and stock market returns

1.  Inflation in the US has historically been represented by year-on-year changes in the CPI and this is reported on a monthly basis.  

2.  We looked at monthly stock market returns based on the S&P 500 and compared the historical stock market returns to different levels of inflation.

3.  The majority of monthly historical inflation data was below 4%, with a surprisingly huge number of periods where inflation was negative (14.4%).

4.  Instead of the expected poor returns in periods of deflation, the S&P 500 actually averaged a 1.1% monthly return where the CPI posted year-on-year declines.

5.  The best average monthly return was logged in months where inflation was between 7% and 8%, but this accounted for only 18 of the 1150 months, less than 2% of the data tested.

6.  On the other hand, inflation rates higher than 8% saw negative average monthly returns.

7.  Inflation between 1% and 4%, more moderate levels of inflation, saw an average return of 0.8%.



Extension of the study to annual inflation and stock market returns.

1.  A large proportion (61%) of the annual inflation rates fell between 0 and 5%.

2.  There appeared to be little correlation between high/low inflation rates and stock market returns.

3.  The high or low inflation rates resulted in both positive and negative stock market returns.



Theoretical Benefits of Inflation May Not be Reflected in Stock Returns

This evidently does not show up in back-tested data for the S&P 500, where our results indicate a lack of any observable correlation.

Why? 

1.  Both company specific and industry-specific factors can play a huge role in determining the ability of a company to raise prices.

2.   The uniqueness of a company's product or its extent of substitutability can determine whether the company is able to raise prices without hurting demand.  If there are many substitutes available, the company may be forced to keep prices low to remain competitive.

3.  Companies whose business models depend on being low-cost producers will find it difficult to do well in an environment where raw material prices rise without a corresponding increase in selling prices.

4.  In certain highly regulated industries like the utilities or fixed-line telecommunications sector, regulatory authorities may prevent companies from raising selling prices, resulting in a price ceiling which caps profits.  

5.  Ultimately, a higher input cost which cannot be passed on to the tend consumer means lower profit margins and smaller profits.

6.  Recognizing the inflationary pressures faced by companies, it would appear that the benefits of inflation (rising asset prices, higher nominal revenue and profits) may take a significant period of time to occur.

7.  Industry consolidation and technology breakthroughs may also take place to counter the short-term negative impact of inflation, with surviving companies reaping the benefits while others go out of business.



Impact of inflation on valuations

1.  Inflation between 2% and 3% saw a wider range of valuations over the past nine decades (1950s, 1960s, 1990s and 2000s).

2.  Valuations of the 1920s and 1930s are perhaps less meaningful, as they encompass the Great Depression where unprecedented corporate bankruptcies could have skewed market earnings and thus valuations.

3.  More noteworthy are the decades with higher average inflation (1940s, 1970s and 1980s) were met with lower valuations.  How can this anomaly be explained by the impact of inflation on valuation metrics for the stock market?    

-  Periods of high inflation are generally met with interest rate hikes (as a means to subdue inflationary pressure), which make short-term treasuries more attractive relative to equities.  
-  Inflation normally results in an increase in the risk-free rate, which raises the required return on equities.  
-  The resulting impact on the stock market lowered valuations.  


Wednesday 10 June 2020

Deflation vs. Disinflation: What's the Difference


By STEVEN NICKOLAS
Updated Apr 19, 2019

Deflation vs. Disinflation: An Overview

Although they may sound the same, deflation should not be confused with disinflation.

Deflation is a decrease in general price levels throughout an economy, while disinflation is what happens when price inflation slows down temporarily.

Deflation, which is the opposite of inflation, is mainly caused by shifts in supply and demand.

Disinflation, on the other hand, shows the rate of change of inflation over time. The inflation rate is declining over time, but it remains positive.


KEY TAKEAWAYS

Deflation is the drop in general price levels in an economy, while disinflation occurs when price inflation slows down temporarily.

Deflation, which is harmful to an economy, can be caused by a drop in

  • the money supply, 
  • government spending, 
  • consumer spending, and 
  • corporate investment.

Central banks will fight disinflation by

  • expanding its monetary policy and 
  • lowering interest rates.

Disinflation can be caused

  • by a recession or 
  • when a central bank tightens its monetary policy.





***************************************************

Deflation

Deflation is the economic term used to describe the drop in prices for goods and services.

Deflation slows down economic growth.

It normally takes place during times of economic uncertainty when there is demand for goods and services is lower, along with higher levels of unemployment.

When prices fall, the inflation rate drops below 0 percent.


Deflation (and inflation) rates can be calculated using the consumer price index (CPI). This index measures the changes in the price levels of a basket of goods and services. They can also be measured using the gross domestic product (GDP) deflator, which measures the price inflation.

There are several different factors that can cause deflation, including a drop in the money supply, government spending, consumer spending, and investment by corporations.

Business productivity can also lead to a drop in prices.

  • When a company uses more advanced technology in its production process, it may become more efficient, thereby reducing its costs. 
  • These cost savings may then be passed on to the consumer resulting in lower prices.


Consider the case of mobile phones. Cellphone prices have dropped significantly since the 1980s due to technological advances. This has allowed supply to increase at a faster rate than the money supply or demand of cellphones.

But bonds can perform well during times of deflation.   More investors end up flocking to quality assets that promise a safer investment vehicle.

By contrast, it can have a negative effect on the stock market. A drop in prices—and, therefore, supply and demand—will hurt the profitability of companies, leading to the erosion of share value.

In order to deal with deflation, a central bank will step in and employ an expansionary monetary policy. 

  • It lowers interest rates and increases the money supply within the economy. 
  • This, in turn, boosts demand for goods and services. 
  • Lower interest rates mean an increase in the spending power of consumers. 
  • More spending means price inflation and, therefore, higher demand for goods and services. 
  • Higher prices lead to higher profits for businesses.


Disinflation

Disinflation occurs when price inflation slows down temporarily. 

This term is commonly used by the U.S. Federal Reserve when it wants to describe a period of slowing inflation. 

Unlike deflation, this is not harmful to the economy because the inflation rate is reduced marginally over a short-term period.

Unlike inflation and deflation, disinflation is the change in the rate of inflation.

  • Prices do not drop during periods of disinflation and it does not signal an economic slowdown. 
  • While a negative growth rate—such as -2 percent—indicates deflation, disinflation is demonstrated by a change in the inflation rate from one year to the next. 
  • So disinflation would be measured as a change of 4 percent from one year to 2.5 percent in the next.



IMPORTANT:  Disinflation isn't necessarily bad for the stock market, as it may be during periods of deflation. In fact, stocks can perform well when the inflation rate drops.



Disinflation is caused by several different factors.

  • A recession or a contraction in the business cycle may result in disinflation. 
  • It may also be caused by the tightening of monetary policy by a central bank. When this happens, the government may also begin to sell some of its securities, and reduce its money supply.


Disinflation

By WILL KENTON
Updated Sep 12, 2019


What is Disinflation?

Disinflation is a temporary slowing of the pace of price inflation.

It is used to describe instances when the inflation rate has reduced marginally over the short term.

It should not be confused with deflation, which can be harmful to the economy.


KEY TAKEAWAYS

Disinflation is a temporary slowing of the pace of price inflation.

Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.

A healthy amount of disinflation is necessary, since it represents economic contraction and prevents the economy from overheating.


Understanding Disinflation

Disinflation is commonly used by the Federal Reserve to describe a period of slowing inflation. 

Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.

Although sometimes confused with deflation, disinflation is not considered problematic because 
  • prices do not actually drop, and 
  • disinflation does not usually signal the onset of a slowing economy. 


Deflation is represented as a negative growth rate, such as -1%, while disinflation is shown as a change in the inflation rate from 3% one year to 2% the next.

Disinflation is considered the opposite of reflation, which occurs when a government stimulates an economy by increasing money supply.

A healthy amount of disinflation is necessary, since it

  • represents economic contraction and 
  • prevents the economy from overheating


As such, instances of disinflation are not uncommon and are viewed as normal during healthy economic times.

Disinflation benefits certain segments of a population, such as people who are inclined to save their earnings.


Causes of Disinflation

Several main reasons can cause an economy to experience disinflation.

  • If a central bank decides to impose a tighter monetary policy and the government starts to sell off some of its securities, it could reduce the supply of money in the economy, causing a disinflationary effect. 
  • Similarly, a contraction in the business cycle or a recession can also cause disinflation. For example, businesses may choose not to increase prices to gain greater market share, leading to disinflation.


Disinflation Since 1980

The U.S. economy experienced one of its longest periods of disinflation from 1980 through 2015.

During the 1970s, the rapid rise of inflation came to be known as the Great Inflation, with prices increasing more than 110% during the decade. The annual rate of inflation topped out at 14.76% in early 1980. 

Following the implementation of aggressive monetary policies by the Federal Reserve to reduce inflation, 
  • the increase in prices slowed in the 1980s, rising just 59% for the period. 
  • In the decade of the 1990s, prices rose 32%, 
  • followed by a 27% increase between 2000 and 2009, and 
  • a 9% increase between 2010 and 2015.

Stock Performance During the Period of Disinflation from early 1980 to 2015

During this period of disinflation, stocks performed well, averaging 8.65% in real returns between 1982 and 2015.

Disinflation also allowed the Federal Reserve

  • to lower interest rates in the 2000s, 
  • which led to bonds generating above-average returns.


The Danger of Disinflation

The danger that disinflation presents is when the rate of inflation falls near to zero, as it did in 2015, raising the specter of deflation. 

Although the rate of inflation turned negative briefly in 2015, concerns over deflation were dismissed because it was largely attributed to falling energy prices. 



[Some economists view the near-zero rate of inflation in 2015 as a bottom, with the expectation, or hope, the rate of inflation will begin to rise again. As of Jan. 2018, the rate of inflation stands at 2.1%, with projections for an increase to 2.38% later in the year.]


https://www.investopedia.com/terms/d/disinflation.asp

Wednesday 27 May 2020

Tug of war between Deflation and Inflation: the most Challenging Investment Climate today

A Central Banker’s Worst Nightmare


#Inflation and Deflation

From a mathematical perspective, inflation and deflation are two sides of the same coin.

  • Inflation is a period of generally rising prices. 
  • Deflation is a period of generally falling prices.


Both are deviations from true price stability, and both distort the decisions of consumers and investors.

  • In inflation, consumers may accelerate purchases before the price goes up. 
  • In deflation, consumers may delay purchases in the expectation that prices are going down and things will be cheaper if they wait.


To investors, inflation and deflation are bad in equal, if opposite, measure.

But, from a central banker’s perspective, inflation and deflation are not equally bad. 
  • Inflation is something that central bankers consider to be a manageable problem and something that is occasionally desirable. 
  • Deflation is something central bankers consider unmanageable and potentially devastating. 



#Central banks fear deflation more than inflation

Understanding why central banks fear deflation more than inflation is the key to understanding central bank monetary policy today.

1.  Central bankers believe they can control inflation by tightening monetary policy. 

  • Generally, monetary policy is tightened by raising interest rates
  • Since rates can be raised to infinity, there is not limit on this tool. 
  • Therefore, no matter how strong inflation is, central banks can always tame it with more rate increases.
  • The classic case is Paul Volcker in 1980 who raised interest rates to twenty percent in order to crush inflation that had reached thirteen percent.  
  • Central bankers feel that if the inflation genie escapes from the bottle, they can always coax it back in. 

2.  Central bankers also believe that inflation can be good for an economy.  

This is because of something called the Marginal Propensity to Consume or MPC.   The MPC is a measure of how much an individual will spend out of an added dollar of income.
  • The idea is that if you give a poor person a dollar they will spend all of it because they struggle to pay for food, housing and heath care. 
  • If you give a rich person a dollar, they will spend very little of it because their needs are already taken care of, so they are more likely to save or invest that dollar.  
  • Based on this, poorer people have a higher MPC. 

3.  Inflation can be understood as a wealth transfer from the rich to the poor. 

  • For the rich person, his savings are worth less, and his spending is about the same because he has a low MPC. 
  • By contrast, the poor person has no savings and may have debts that are reduced in real value during inflation. Poor people may also get wage increases in inflation, which they spend because of their higher MPC.

4.   Therefore, inflation tends to increase total consumption because

  • the wealth transfer from rich to poor increases the spending of the poor, 
  • but does not decrease spending by the rich who still buy whatever they want. 
The result is higher total spending or “aggregate demand” which helps the economy grow.




#Deflation hurts the government in many ways

Deflation is not so benign and hurts the government in many ways.


1.  It increases the real value of the national debt making it harder to finance.
  • Deficits continue to pile up even in deflation, but GDP growth may slow down when measured in nominal dollars. 
  • The result is that the debt-to-GDP ratio can skyrocket in periods of deflation. 
  • Something like this has been happening in Japan for decades. 
  • When the debt-to-GDP ratio gets too high, a sovereign debt crisis and collapse of confidence in the currency can result.


2.  Deflation also destroys government tax collections. 

  • If a worker makes $100,000 per year and gets a $10,000 raise when prices are constant, that worker has a 10% increase in her standard of living. 
  • The problem is that the government takes $3,000 of the increase in taxes, so the worker only gets $7,000 of the raise after taxes.
  • But if the worker gets no raise, and prices drop ten percent, she still has a ten percent increase in her standard of living because everything she buys costs less. 
  • But now she keeps the entire gain because the government has no way to tax the benefits of deflation. 
  • In both cases, the worker has a $10,000 increase in her standard of living, but in inflation the government takes $3,000, while in deflation the government gets none of the gain.



#What is good for government is often bad for INVESTORS.

For all of these reasons, governments favor inflation.   It can

  • increase consumption, 
  • decrease the value of government debt, and 
  • increase tax collections. 


Governments fear deflation because

  • it causes people to save, not spend; 
  • it increases the burden of government debt, and 
  • it hurts tax collections.


But, what is good for government is often bad for investors. 

In deflation, investors can actually benefit from

  • lower costs
  • lower taxes and 
  • an increase in the real value of savings. 


As a rule, inflation is good for government and bad for savers; while deflation is bad for government and good for savers.




#Flaws in the thinking about inflation and deflation by the government and economists

There are many flaws in the way the government and economists think about inflation and deflation.

The idea of MPC as a guide to economic growth is badly flawed.

Even if poor people have a higher propensity to consume than rich people, there is more to economic growth than consumption. 


1.  The real driver of long-term growth is not consumption, but investment. 
  • While inflation may help drive consumption, it destroys capital formation and hurts investment. 
  • A policy of favoring inflation over deflation may prompt consumption growth in the short run, but it retards investment led growth in the long run. 
  • Inflation is a case of a farmer eating his own seed-corn in the winter and having nothing left to plant in the spring. Later he will starve.


2.  It is also not true that inflation is easy to control. 

  • Up to a certain point, inflation can be contained by interest rate increases, but the costs may be high, and the damage may already be done. 
  • Beyond that threshold, inflation can turn into hyperinflation.  

3.  Hyperinflation

At that point, no amount of interest rate increases can stop the headlong dash to dump money and acquire hard assets such as gold, land, and natural resources. 
  • Hyperinflation is almost never brought under control. 
  • The typical outcome is to wipe out the existing currency system and start over after savings and retirement promises have been destroyed.



#Central banks favour inflation over deflation:  Its Implications

In a better world, central bankers would aim for true price stability that does not involve inflation or deflation.

But given the flawed economic beliefs and government priorities described above, that is not the case.

1.  Central banks favor inflation over deflation because it

  • increases tax collections, 
  • reduces the burden of government debt and 
  • gooses consumption. 
If savers and investors are the losers, that’s just too bad.


2.  The implications of this asymmetry are profound.
  • In a period where deflationary forces are strong, such as the one we are now experiencing, central banks have to use every trick at their disposal to stop deflation and cause inflation. 
  • If one trick does not work, they must try another.

Since 2008 central banks have used
  • interest rate cuts, 
  • quantitative easing, 
  • forward guidance, 
  • currency wars, 
  • nominal GDP targets, and 
  • operation twist to cause inflation. 


3.  None of it has worked; deflation is still a strong tendency in the global economy. This is unlikely to change.  The deflationary forces are not going away soon.
  • Investors should expect more monetary experiments in the years ahead. 
  • If deflation is strong enough, central banks may even encourage an increase in the price of gold  in order to raise inflationary expectations.


4.  Eventually the central banks will win and they will get the inflation they want.

  • But it may take time and the inflation may turn into hyperinflation in ways the central banks do not expect or understand. 
  • This “tug-of-war” between inflation and deflation creates the most challenging investment climate in 80 years.


The best investment strategies involve a balanced portfolio of hard assets and cash so investors can be ready for both. 

Wednesday 3 October 2018

How "safe is your money? Think about money from the standpoint of what you think it will buy now and later.

"Money is (always) safe"

Money is only good for what it will buy.

Its purchasing power has been decreasing steadily over the ages.

It certainly isn't safe in the sense intended by the hoarder or the frightened widow.




"Keep your money working"

This is just as much of a fallacy in its way as thinking that "Money is (always) safe."




Middle Path

You would do best steering a middle course.

Think about money from the standpoint of what you think it will buy now and later.

If you feel it will buy more later, hang on to it.

If you feel it will buy less,

  • spend it for something you are intending to buy; or 
  • invest it if you think investments will be more costly later.


Think of money as you do of anything else that fluctuates.