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Price inflation approaching

There is some evidence in the UK of a pick-up in consumer spending, probably echoed elsewhere. There are two likely factors behind this, the first perhaps being seasonal, aided by the fine weather. The second is less obvious, but combines with the first to encourage purchases of big ticket items; and this is cheap consumer finance coupled with growing expectations of higher interest rates in the future.

Interest rate expectations are therefore fuelling demand for big-ticket items, such as autos and electronic goods, where the cost of credit has been cut to maintain sales. There also appears to be growing demand for fixed-rate mortgages, and thanks to banks willing to borrow short and lend long there are some very tempting refinancing deals available. In summary, low financing costs plus a decent summer is the basis for kick-starting economic optimism.

Economists are already revising their GDP growth expectations upwards. However, there is likely to be a growing tendency for prices to rise due to capacity constraints in companies that have bolstered their profits by withholding investment for the last three or four years. Consequently price rises will be greater than generally expected.

The situation in the US is similar, with an added factor. US consumers are more responsive to confidence in stock markets and property prices than in the UK, and here the news has been bullish. Interest rates are low, and they will rise, so buy those big-ticket items now. The cost of buying and financing the average house purchase has already risen an estimated 40%.

Governments and economists will think they have the recovery they have wished for. Unfortunately it will almost certainly be marred by price inflation greater than the increase in demand suggests. So while nominal GDP growth rates will turn out to be somewhat better than currently expected, the talk will be of temporary capacity constraints.

The end result is that while central banks will realise that price inflation is a growing problem they will be reluctant to use higher interest rates to choke off inflation. And if consumers see central banks are behind this curve, further consumer borrowing will be encouraged.

This leads into the second phase of inflation. The first was expansion of cash and deposit money and the second is its mobilisation. The price effect is likely to be dramatic as money shifts from Wall Street to Main Street (or in British terms, from the City of London to the high street). However, there is an additional currency effect which few economists factor in: markets begin to discount the future purchasing power of paper currencies, bringing anticipated and higher prices forward in time, while central banks appear to be reluctant to raise interest rates. The Volcker remedy of raising interest rates to choke off inflation is simply not a policy-maker’s option.

The central banks are bound to be more focused on the damage from rising bond yields to government deficits and bank balance sheets. They will also be acutely aware of the effect higher borrowing costs has on today’s high levels of consumer debt.

The conclusion is that the central banks’ inflationary response to the banking crisis five years ago is going to get considerably more difficult in the coming months as monetary inflation morphs into price inflation.

This article was previously published at GoldMoney.com

7 comments to Price inflation approaching

  • Paul Marks Paul Marks

    Governments (and Central Banks) remain obsessed with “maintaining a stable price level” which, in practice, means maintaining the BUBBLE in such things as the housing market.

    This thinking as crippled Japan for more than 20 years (just as it did in the 1920s – when the Japanese government refused to allow the bust of 1921 to clear out malinvestments) and it is keeping a “zombie economy” in place in many major countries.

    The correctly (the clearing of markets – the end of the malivestment bubble economy) must come – but governments (and Central Banks) are doing all they can to drag out the agony for as long as possible.

    For example, yesterday President Barack Obama denounced Fannie Mae and Freddie Mac (good – but he “forgot” to mention that the government created both of them), however he then (de facto) said that government would FORCE banks to lend money to people to buy houses (repeating the folly of the insane “Community Reinvestment Act” pushed by Carter, Clinton and, of course, Cloward and Piven).

    In short the folly in the United States continues – and the present “recovery” (apart from in oil and gas production – which is real) is a government credit bubble farce.

    “And the British situation?”.

    The situation in the United Kingdom is too absurd to be worth much comment.

    At least Mr Barack “Cloward and Piven” Obama knows what he is doing (undermining “capitalism” in order to destroy “bourgeois” society), people such as Mr Cameron and Mr Osbourne have no such objective – they just do not know that they are doing.

  • Paul Marks Paul Marks

    By the way – Mr Mark Carney has just signalled that Bank of England interest rates are going to remain at (close to) zero for years to come.

    In short there is no link between (real) saving and borrowing in this country. The fundamental laws of Political Economy are being ignored here (in this and many other ways), but these laws can only be violated at a price.

    A very heavy price – and the people of this country will pay this price for the ignoring of reason and reality by the ruling elite (of all political parties – and none).

    • George Thompson

      Mr. Marks, I actually read through what I assume was an abridged version of whatever actually appeared on the imperial teleprompter about the emperor’s NEW plan to save the American housing industry (union jobs). The version I read was made available on Jamie Dupree’s Washington Insider Blog at 9:09 p.m. on Monday, Aug. 5, 2013 and titled “White House rolls out Obama housing plan” {http://www.wsbradio.com/weblogs/jamie-dupree/2013/aug/05/white-house-rolls-out-obama-housing-plan/} After verifying that I had indeed survived extreme torture I understood several things: 1) The progressives are incapable of learning from their mistakes and so are intent on repeating them until they are confined to padded cells, 2) the president believes himself the greatest thing since God said “Let there be light!” and that he himself is that very light which immediately appeared, and 3) The neighbors think those who run down the late night street screaming, “Make it stop! Make it stop! Make it stop!” over and over again are a bit daft. Nonetheless, now that I’ve caught my breath, I disagree that he “knows what he is doing”, as there is nothing in his track record to indicate that he has ever done anything but what he was told or knows how to do anything other than mooch dope from his high school buddies. {http://www.breitbart.com/Big-Journalism/2012/05/10/Obama-High-School-Drugs} This begs the question, “Who then is doing the telling?” I wish I knew, but I suspect it’s the favorite hedge fund manager and foreign currency manipulator of the British. If you recall, he made something like a billion dollars simply by shorting the pound. Imagine how much he could profit if he has leveraged himself to short the US dollar. It would make all his investments in leftie causes and politicians worthwhile and tax deductible.

  • chuck martel

    In the US, the negative effects on the economy of two factors, high oil prices and the increasing obsession with cell phones are ignored in favor of blaming everything on the real estate bubble. When oil prices more than double over a short period of time in an economy that literally runs on oil it’s going to take some time for adjustments to be made. The general population has given up a huge portion of its wealth in order to keep the Prius on the road. Maybe they’re satisfied with the situation but some will seek alternatives.

    Not long ago telephone service consisted of a single line to each household. Today almost every sentient being carries, and pays for, a cell-phone out of Star Wars. While there may be great benefits in having instant communication with anyone on the globe, it has come at a price. Consumers are willing to forego the purchase of other items in order to have cell phones. This expense, which never existed before, is considerable and an option that has had an effect on other discretionary spending.

    • Craig Howard

      While there may be great benefits in having instant communication with anyone on the globe, it has come at a price.

      When I was a child, each family had one car. Now, most have two or three. Has this phenomenon also harmed the economy?

      • chuck martel

        Good point. Changes in spending preferences don’t “harm” the economy but they do change it. In the case of automobile ownership, most families probably didn’t initially purchase two or more cars at the same time. They bought one, then, as time went by, added to their vehicular inventory as their requirements and income changed.

  • Paul Marks Paul Marks

    Mr Thompson – agreed.

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