The Fed is concerned if inflation
Remains too low then this great nation
Will have trouble growing
And so they’re foregoing
All thoughts that less money they’ll ration
Economics . a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency (opposed to deflation ).
Sometimes I think it is useful to go back to the basics and remember what we discuss each day. According to Dictionary.com, this is the definition of inflation, and I think it does a very good job of highlighting the two aspects of why inflation is seen as a problem. Rising prices lead to the devaluation of money. Now other than the fact that I buy things and see how prices change, I am no expert in inflation. (If you want an expert in inflation, read my friend Mike Ashton’s blog E-piphany, http://mikeashton.wordpress.com or follow him on Twitter, @inflation_guy). However, I have been giving it some thought lately since every economist will agree that high inflation reduces the value of a currency. This value needs to be considered as both the value of the goods one can purchase with a given amount of money as well as the relative value of one currency vs. another. Now mostly I write about the latter, relative values, but this morning I wanted to register my annoyance at Chairman Ben with regard to the first point.
Yesterday the Fed left policy completely unchanged and the accompanying statement modified the growth outlook from “moderate” to “modest”. But it also said the following: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.” Now I understand that they measure inflation by the Core PCE Deflator, which is currently the lowest reading out there. But I look at things a bit differently. Consider what the Fed’s Financial Repression is doing for you these days. If, after a lifetime of hard work, you save $1,000,000 as your nest egg, the idea was always that you could then earn a low risk interest rate in the long term of something around 5%-6%, which would generate $50-$60k of annual income without touching your principal. Certainly not a fortune, but enough to help you live in retirement. However, this option is no longer available to you with the Fed’s current activities. In fact, you can only earn 2.5% nowadays in 10 year Treasuries, and less via CD’s and other savings instruments. (I saw a bank offering 5-year CD’s at 1.01% yesterday!) So despite all your hard work, the Fed has effectively cut the value of your savings in half, from $50k per year to $25k per year. While the government may not measure inflation that way, I’m pretty confident this counts as a devaluation of your currency holdings. A 50% reduction in purchasing power over the course of the past 5 years seems to me like inflation is pretty high, (something like 15% per year) regardless of how the Fed measures it.
You may ask how this impacts the FX markets. Well, since the Fed is not the only central bank engaging in these policies, the relative value of the dollar has held up remarkably well vs. the other countries that are also engaged in Financial Repression. But not every country is so engaged. And if you look at Poland or Mexico or the Czech Republic, where central bank policies remain more standard, those currencies have outperformed the USD over the past year. In the G10 space, it has been the Euro and the Danish Krone that have been best. Of course the Danes track the euro and the ECB has only more recently begun its own efforts at Financial Repression, so it hasn’t yet built up the momentum or track record of the Fed. The yen, on the other hand, has 20 years of experience at Financial Repression, and it has doubled down lately, leading to the weakest currency performance in the world over the past 12 months.
But on to more immediate concerns. The BOE left policy completely on hold, as expected and there was no ensuing statement. Next week, Governor Carney will release a report on the BOE’s analysis of other monetary tools, like forward guidance, which has obviously had an impact on their actions. It has become increasingly clear that central bankers around the world have become enamored with the idea of forward guidance because it seems to help them without spending any actual money or adjusting their respective balance sheets. Carney pioneered this idea at the Bank of Canada and it was taken up enthusiastically by Bernanke. Now, Draghi and his ECB buddies are on board, as are the BOJ and SNB. Even the RBA is toying with it through the discussions of scope for further rate cuts. I wonder what they’ll do when this tool wanes in effectiveness. Meanwhile, the ECB also left rates on hold, also as expected, and Draghi has not yet met with reporters so we don’t know what he will say. But today’s data showed that Manufacturing PMI’s in Europe were generally stronger than expected as well as higher than last month. In the UK, the number was actually quite robust at 54.6. However, the euro has been unable to gain any traction this morning and is a bit softer, while the pound has responded positively to the data and bounced a bit. Later this morning we get the ISM Manufacturing data here (exp 52.0) but first Initial Claims (345K). And of course, tomorrow is payrolls, so I doubt today’s data will foster too much more activity. Unless Draghi says something completely new, it appears that markets will remain more or less rangebound until tomorrow morning.