Thursday, October 11, 2018

Manageable Inflation Again Deemed The Desirable Goal

Our Goal Is 2% Inflation
In a recent interview with Bloomberg the French economist who served as President of the European Central Bank from 2003 to 2011, Jean-Claude Trichet, opined about his outlook for the global economy and monetary policy it was not surprising that he repeated the line declaring 2% inflation the desirable goal of intelligent central bankers and everything is "data dependent" which translates into the central banks will squash inflation if it begins to run too hot. Much of the interview was based on his feelings about the economy, near-term. Staying within the "established lines" he stated everything looked good for the next year or so. Trichet then warned that "over-leverage that exceeds levels from before the financial crisis" will if not addressed cause problems down the road.

Warnings stated by former and current bankers and contained within their talks adds an air of thoughtfulness and caution to the discussion reinforcing their image of being prudent. The fact is all these heads of central banks, past and present, seem to say the same thing. and tend to reinforce the impression that any real problems ahead should be out at least a year. This allows the speaker to hide in clear sight by simply appearing cautiously optimistic. More notable than the musings of the former ECB President were statements from FED Chairman Powell in a speech recently which was considered a bit more hawkish than the market preferred.

Our Goal Is 2% Inflation
Chairman Powell confirmed the jobless rate is running at 3.9 percent (on Friday the jobs report lowered the number to 3.7) and inflation is around the Fed's goal of 2 percent. Powell is now confronted by the fact that historically, low unemployment has fueled inflation and sometimes has forced the Fed into hiking interest rates rapidly. "While these two top-line statistics do not always present an accurate picture of overall economic conditions, a wide range of data on jobs and prices supports a positive view," Powell told economists in Boston conference. "In addition, many forecasters are predicting that these favorable conditions are likely to continue."

The manageable inflation goal of 2%. has become the "holy-grail" of central bankers, however, the 2% inflation target central banks have deemed optimum is not economically valid and is "based only on their opinion" of what conditions will best allow the economy to flourish. For a long time, the ECB and other central banks have claimed deflation drives or allows their QE policy to remain and is central to their ability to stimulate. The moment inflation begins to take root and become solidly entrenched to where it becomes a self-feeding loop their flexibility in policy is lost. What makes the future inflation argument more relevant than usual is that the average American has witnessed in the last 30 years, a growing gap between government reporting of inflation, as measured by the consumer price index (CPI), and the actual cost of living.

What the central bankers have conveniently brushed aside is that the formula that generates the numbers governments pump out was skewed in the 1990s when political Washington moved to change the nature of the CPI in an effort to reduce the federal deficit so nobody in Congress would have to register a vote that would harm the image of Social Security. For proof as to the real cost of inflation just look at the surging replacement cost resulting from recent storms and natural disasters. I further contend that inflation would be much greater if more money was flowing into tangible goods rather than paper investments and promises.

It might be wise not to become too trusting or complacent to the idea that inflation can be contained at 2% especially while deficits explode, debt builds, and central banks continue to stimulate the economy by printing money or that the economy looks good for the next year or so. In the past, I have put forth the theory that inflation could rule the day even if central banks are unable to keep the wheels on the bus and the economy suddenly collapses which is in truth beyond their control. If inflation does not become the flavor of the day the future may unleash, its sister, the powerful force known as stagflation which is also a threat to the average citizen and will devastate those improperly invested for its arrival.

Footnote; Links for the two articles related to this subject, the first about the CPI and the second focusing on inflation can be found below.

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