"The new art of inflation mongering
One of the biggest debates concerning the current crisis has focused on whether the world is heading towards a deflationary or inflationary environment. But it appears there’s a new ‘big’ debate emerging: rising yields - proof of an inflationary environment or just normalisation?
Paul Krugman, professor of economics and international affairs at Princeton University, joins that discussion with a rigorous attack at the world’s “inflation-mongers”, who he suggests are only in it for the politics.
Writing in New York Times, Krugman says (our emphasis):
Suddenly it seems as if everyone is talking about inflation. Stern opinion pieces warn that hyperinflation is just around the corner. And markets may be heeding these warnings: Interest rates on long-term government bonds are up, with fear of future inflation one possible reason for the interest-rate spike. But does the big inflation scare make any sense?
Basically, no - with one caveat I’ll get to later. And I suspect that the scare is at least partly about politics rather than economics.
He goes on to remind us that it’s deflation that is actually “the clear and present danger”.
As for suggestions that the practice of ‘printing money’ might eventually lead up to an inflationary environment, he suggests:
Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.
But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all.
And for those who might suggest they might stop sending that money back to the Fed as soon as recovery is underway, leading to an ultimate inflation danger at the key turnaround point — Krugman says there is no modern economic precedent for such a thing happening. It certainly didn’t happen in Japan.
And while Krugman acknowledges some economists may disagree with his assessment, he concludes the political explanation is the best one to make sense of the current spell of inflation mongering:
Well, as you may have noticed, economists sometimes disagree. And big disagreements are especially likely in weird times like the present, when many of the normal rules no longer apply.
But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.
We at FT Alphaville have also pondered to what degree rising yields are indicative of the Fed losing control of rates. Interestingly, on Friday CNBC’s Steve Liesman (H/T Clusterstock) provides us with the Fed’s own view on the matter: apparently they “were never trying to set credit market rates anyway.”
As Clusterstock reports:
Their spin — courtesy of CNBC’s Steve Liesman (natch) — is that the Fed was never trying to force down mortgage rates or “set” rates. Rather, by stepping in and purchasing bonds, the Fed is merely trying to “support” the credit markets.
Frankly, we’re not sure that there’s a difference between the two statements. “Supporting” credit markets is another way of making sure that interest rates aren’t getting out of hand. And to the extent that the credit markets need that Fed support is not very promising.
So there you have it.
Faber: Hyperinflation coming to the USA - FT Alphaville
Napier: Higher yields do not mean normalisation - FT Alphaville
“The adjustment in the US Treasuries market is THE story in financial markets” - FT Alphaville
Is the Fed losing control? - FT Alphaville
1) Low short term interest rates, to give a disincentive to buying govt bonds and, instead, investing in stocks or corporate bonds. Intended to attack the Fear and Aversion to Risk.
2) Rising Long Term rates, signaling an end to deflation fears and a recovery going forward. Attacks Fear and Aversion to Risk with Long Term Confidence.
It's working. Down the line, the risk is, of course, interest rates going too high, but that is not where we are. It's a sign of recovery that some investors are worried about inflation. From my point of view, avoiding a Debt-Deflationary Spiral at all costs was the correct decision.
Once again, down the line, inflation will be our problem. But it doesn't have to be, and avoiding debt-deflation will be a major victory.
I don't agree with Krugman, though. Inflation is a reasonable worry and possible scenario.