There is apparently a new economic danger out there. It is called “very low inflation” and the eurozone is evidently at great risk of succumbing to this menace. “A long period of low inflation – or outright deflation, when prices fall persistently – alarms central bankers”, explains The Wall Street Journal, “because it [low inflation, DS] can cripple growth and make it harder for governments, businesses and consumers to service their debts.” Official inflation readings at the ECB are at 0.7 percent, still positive so no deflation, but certainly very low.
How low inflation cripples growth is not clear to me. “Very low inflation” was, of course, once known as “price stability” and used to invoke more positive connotations. It was not previously considered a health hazard. Why this has suddenly changed is not obvious. Certainly there is no empirical support – usually so highly regarded by market commentators – for the assertion that low inflation, or even deflation, is linked to recessions or depressions, although that link is assumed to exist implicitly or explicitly in the financial press almost daily. In the twentieth century the United States had many years of very low inflation and even outright deflation that were not marked by recessions. In the nineteenth century, throughout the rapidly industrializing world, “very low inflation” or even persistent deflation were the norm, and such deflation was frequently accompanied by growth rates that would today be the envy of any G8 country. To come to think of it, the capitalist economy with its constant tendency to increase productivity should create persistent deflation naturally. Stuff becomes more affordable. Things get cheaper.
“Breaking news: Consumers shocked out of consuming by low inflation!”
So what is the point at which reasonably low inflation suddenly turns into “very low inflation”, and thus becomes dangerous according to this new strand of thinking? Judging by the reception of the Bank of England’s UK inflation report delivered by Mark Carney last week, on the one hand, and the ridicule the financial industry piles onto the ECB on the other – “stupid” is what Appaloosa Management’s David Tepper calls the Frankfurt-based institution according to the FT (May 16) -, the demarcation must lie somewhere between the 1.6 percent reported by Mr. Carney, and the 0.7 that so embarrasses Mr. Draghi.
The argument is frequently advanced that low inflation or deflation cause people to postpone purchases, to defer consumption. By this logic, the Eurozonians expect a €1,000 item to cost €1,007 in a year’s time, and that is not sufficient a threat to their purchasing power to rush out and buy NOW! Hence, the depressed economy. The Brits, on the other hand, can reasonably expect a £1,000 item to fetch £1,016 in a year’s time, and this is a much more compelling reason, one assumes, to consume in the present. The Brits are in fact so keen to beat the coming 2 percent price hikes that they are even loading up on debt again and incur considerable interest rate expenses to buy in the here and now. “Britons are re-leveraging,” tells us Anne Pettifor in The Guardian, “Net consumer credit lending rose by £1.1bn in March alone. Total credit card debt in March 2014 was £56.9bn. The average interest rate on credit card lending, [stands at] at 16.86%.” Britain is, as Ms. Pettifor reminds us, the world’s most indebted nation.
I leave the question to one side for a minute whether these developments should be more reason to “alarm central bankers” than “very low inflation”. They certainly did not alarm Mr. Carney and his colleagues last week, who cheerfully left rates at rock bottom, and nobody called the Bank of England “stupid” either, to my knowledge. They certainly seem not to alarm Ms. Pettifor. She wants the Bank of England to keep rates low to help all those Britons in debt – and probably yet more Britons to get into debt.
Ms. Pettifor has a highly politicized view of money and monetary policy. To her this is all some giant class struggle between the class of savers/creditors and the class of spenders/debtors, and her allegiance is to the latter. Calls for rate hikes from other market commentator thus represent “certain interests,” meaning stingy savers and greedy creditors. That the policy could set up the economy for another crisis does not seem to trouble her.
Echoing Ms. Pettifor, Martin Wolf flatly stated in the FT recently that the “low-risk-seeking saver” no longer served a useful purpose in the global economy, and he approvingly quoted John Maynard Keynes with his call for the “euthanasia of the rentier”. “Interest today rewards no genuine sacrifice,” Keynes wrote back then, obviously in error: Just ask Britons today if not spending their money now but saving it for a rainy day does not involve a genuine sacrifice. Today’s rentiers do not even get interest for their sacrifices, thanks to all the “stimulus” policy. And now the call is for an end to price stability, for combining higher inflation with zero rates. It is not much fun being a saver these days – and I doubt that these policies will make anyone happy in the long run.
Euthanasia of the Japanese rentier
What the “euthanasia of the rentier” may look like we may have chance to see in Japan, an ideal test case for the policy given that the country is home to a rapidly aging population of life-long savers who will rely on their savings in old age. The new policy of Abenomics is supposed to reinvigorate the economy through, among other things, monetary debasement. “In as much as Abenomics was intended to generate strong nominal growth, I have been a big believer,” Trevor Greetham, asset allocation director at Fidelity Worldwide Investment, wrote in the FT last week (FT, May 15, 2014, page 28). “Japan has been in debt deflation for more than 20 years.”
Really? – In March 2013, when Mr. Abe installed Haruhiko Kuroda as his choice of Bank of Japan governor, and Abenomics started in earnest, Japan’s consumer price index stood at 99.4. 20 years earlier, in March 1994, it stood at 99.9 and 10 years ago, in March 2004, at 100.5. Over 20 years Japan’s consumer prices had dropped by 0.5 percent. Of course, there were periods of falling prices and periods of rising prices in between but you need a microscope to detect any broad price changes in the Japanese consumption basket over the long haul. By any realistic measure, the Japanese consumer has not suffered deflation but has enjoyed roughly price stability for 20 years.
“The main problem in the Japanese economy is not deflation, it’s demographics,” Masaaki Shirakawa declared in a speech at Dartmouth College two weeks ago (as reported by the Wall Street Journal Europe on May 15). Mr. Shirakawa is the former Bank of Japan governor who was unceremoniously ousted by Mr. Abe in 2013, so you may say he is biased. Never mind, his arguments make sense to me. “Mr. Shirakawa,” the Journal reports, “calls it ‘a very mild deflation’ [and I call it price stability, DS] that had the benefit of helping Japan maintain low unemployment.” The official unemployment rate in Japan stands at an eye-watering 3.60%. Maybe the Japanese have not fared so poorly with price stability.
Be that as it may, after a year of Abenomics it turns out that higher inflation is not really all it’s cracked up to be. Here is Fidelity’s Mr. Greetham again: “Things are not as straightforward as they were….The sales tax rise pushed Tokyo headline inflation to a 22-year high of 2.9 percent in April, cutting real purchasing power and worsening living standards for the many older consumers on fixed incomes.”
Mr. Greetham’s “older consumers” are probably Mr. Wolf’s “rentiers”, but in any case, these folks are not having a splendid time. The advocates of “easy money” tell us that a weaker currency is a boost to exports but in Japan’s case a weaker yen lifts energy prices as the country is heavily dependent on energy imports.
The Japanese were previously thought to not consume enough because prices weren’t rising fast enough, now they may not consume enough because prices are rising. The problem with going after “nominal growth” is that “real purchasing power” may get a hit.
If all of this is confusing, Fidelity’s Mr. Greetham offers hope. We may just need a bigger boat. More stimulus. “The stock market may need to get lower over the next few months before the government and Bank of Japan are shocked out of their complacency…When domestic policy eases further, as it inevitably will, the case for owning the Japanese market will be compelling once again.”
You see, that is the problem with Keynesian stimulus, you need to do ever more of it, and make it ever bigger, in an effort to outrun the unintended consequences.
Whether Mr. Greetham is right or not on the stock market, I do not know. But one thing seems pretty obvious to me. If you could lastingly improve your economy through easy money and currency debasement, Argentina would be one of the richest countries in the world today, as it indeed was at the beginning of the twentieth century, before the currency debasements of its many incompetent governments began.
No country has ever become more prosperous by debasing its currency and ripping off its savers.
This will end badly – although probably not soon.
What does it all mean? – I don’t know (and I could, of course, be wrong) but I guess the following:
The ECB will cut rates in June but this is the most advertised and anticipated policy easing in a long while. Euro bears will ultimately be disappointed. The ECB does not go ‘all in’, and there is no reason to do so. My hunch is that a pronounced weakening of the euro remains unlikely.
In my humble opinion, and contrary to market consensus, the ECB has run the least worst policy of all major central banks. No QE thus far; the balance sheet has even shrunk; large-scale inactivity. What is not to like?
Ms Pettifor and her fellow saver-haters will get their way in that any meaningful policy tightening is far off, including in the UK and the US. Central banks see their main role now in supporting asset markets, the economy, the banks, and the government. They are positively petrified of potentially derailing anything through tighter policy. They will structurally “under-tighten”. Higher inflation will be the endgame but when that will come is anyone’s guess. Growth will, by itself, not lead to a meaningful response from central bankers.
Abenomics will be tried but it will ultimately fail. The question is if it will first be implemented on such a scale as to cause disaster, or if it will receive its own quiet “euthanasia”, as Mr. Shirakawa seems to suggest. At Dartmouth he claimed “to have the quiet support of some Japanese business leaders who joined the Abe campaign pressuring the Shirakawa BoJ. ‘One of the surprising facts is what CEOs say privately is quite different from what they say publicly,’ he said….’in private they say, No, no, we are fed up with massive liquidity – money does not constrain our investment.’”
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