In 1966, Alan Greenspan, a recent Chairman of the Federal Reserve, contributed to Ayn Rand's newsletter "Objectivist", writing "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation." In his 18 years at the helm of the Fed, Greenspan's policies were on the side of an inflation hawk. Equally, although in a much different time, Paul Volcker was serenely focused on monetary supply and keeping inflation in check. One of his major efforts as Chairman of the Fed was the taming of the high inflation experienced in the early 1980's, triggering a recession to cool economic activity.
Volcker has also expressed his opinion in the past few years, expressing his concerns over potentially inflationary Fed policies. In November, 2010, he spoke in Singapore about his concerns over the potential emergence of inflation associated with quantitative easing policies being led by Ben Bernanke.
In 2011, Volcker wrote an Op-Ed in the New York Times, further expanding on his concerns about reduced vigilance against inflation on the part of the Federal Reserve and the Obama administration. He also recognized, however, the "desperation" that essentially all the fiscal and monetary tools have been exausted to no great effect, other than saving the economy from going off a cliff, but not leading to even a moderately robust recovery, writing:
"There is great and understandable disappointment about high unemployment and the absence of a robust economy, and even concern about the possibility of a renewed downturn. There is also a sense of desperation that both monetary and fiscal policy have almost exhausted their potential, given the size of the fiscal deficits and the already extremely low level of interest rates."
"Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work."
Our current economic circumstance in the United States is quite troubling, with millions out of work, and job creation and incomes at levels abysmally short of prior levels and what people need and expect. The Obama administration did a remarkable job addressing the great recession, keeping the global economy and financial system from collectively going over the credit cliff. As it is, we are remain reeling from the effects of severe credit correction, with a economy wide shoring up of balance sheets, with all the concomitant reduction in credit availability. There are, however, more pernicious and troubling undercurrents which are slowly and inexorably sinking developed economies below the surface.
The undercurrents to which I refer are the sources of value within the economy, sources of value which have in the past ten years shifted away from the United States economy. Since 1980, there has been a 40% reduction in the number of manufacturing jobs in the United States, one symptom of intense price pressures associated with globalization. The increased cost of many commodities, including oil, leading up to the 2008 great recession, all contributed to putting economic pressures throughout the economy, from households to businesses. Strangely, oil prices did pull back after the 2007 peak, but did rebound back up to over $100 per barrel in 2011.
The normal factors which drive inflation up have not been working their magic in recent years. Wages have been stagnant and demand for goods and services has not strengthened since the recession. Outsourcing manufacturing to other countries along with intense price competition across the economy, with underutilized capacity, has resulted in a price driven recovery, instead of demand driven. Demand is just not rebounding.
On the credit side, interest rates have been extremely low, and the Fed has been injecting funds into the banking system through quantitative easing. Normally, this vast injection of liquidity into the economy would result in a lowering of the barriers to making investments, essentially a lowering of the hurdle rates for capital allocation,which presumably would increase the aggregate number of capital projects approved. If, however, there is no demand for goods and services, there is no fundamental reason for expanding capital projects. In addition to the lack of fundamental demand, banks have increased their credit requirements, and have been shoring up their own balance sheets, with increased capital reserves, reducing risk exposure, and writing down and jettisoning under performing portions of their loan portfolios. In the housing market, there has been a rebound of prices and sales of existing homes. This rebound has resulted in increased prices for housing stock but has not caused an up swell in the prices for labor and materials associated with new construction.
In classical terms, the definition of the cause of inflation is when too many dollars are chasing too few goods and services. This infers that the extent of the Fed's policies on lowering interest rates and providing liquidity to the banking system through the succession of quantitative easing, would normally of resulted in increased inflation. In looking at inflation in the last 40 years, there is a very high correlation between United States inflation levels and the inflation adjusted price of crude oil, as seen in the chart below.
In every period of inflation, there occurs an increase in the price of oil. Accordingly, it is an exogenous factor, oil pricing, that influences inflation. In 2013, the price of oil was above $100 per barrel for most of the year. Also in 2013, the global economy, especially in North America, Europe and emerging economies in Africa and South America have experienced lower growth rates than in 2011 and 2012. The United States is looking at a GDP growth rate for 2013 of 1.5%, significantly lower than the 2.8% in 2012. This reduced growth in the global and United States economy is putting downward pressure on oil demand and oil prices.
Because of this downward pressure on oil demand and prices, we are not likely going to see a rebound of oil prices until 2015, after oil prices have dipped below $60 per barrel and two things happen: (1) the global economy perks back up, and (2) investment in oil drilling pulls back. These two factors lead to a demand resurgence at the same time there has been a pull back in the more expensive drilling activities, which will result in a run up in oil prices. At that time, in 2015, there will be a resurgence of inflation in the United States, and not before.
Caveat - there is a good chance that oil prices will continue to buoyed by global demand factors, given that the Asian economies have lower elasticity of demand to price than European and North American economies. As such, there are likely to retain higher demand for oil in a variety of oil price regimes. This may mean that the global economy is not as whipsawed as it has been in the past with oil demand and price swings creating global economic instability, and less likely cause of a resurgence in inflation in 2015.
Another perspective on the the impact of oil prices on our economy is to look at the relationship between oil price movements and the value of the dollar. The basic premise of the analysis in this blog is that oil is an underlying factor, driving economic activity, influencing inflation and the value of the dollar. The opposite perspective would carry if oil prices were lower, there had been a pull back in oil drilling activity, and there was an up swelling in global economic activity. None of these conditions is true today, as such, we are not going to see a resurgence of inflation until 2015 at the earliest.
No comments:
Post a Comment