J. Anthony Boeckhs book, The Great Reflation(2010), is well worth a read if you have a curiosity about economic/financial trends from an investors point of view, and want one of the clearest and most insightful analyses of past, present and future developments. Boeckh knows his stuff: he was chairman and editor-in-chief from 1968 to 2002 of BCA Publications, an advisor to institutional clients on economic and financial trends.
In my previous post, I gave a brief overview of the book. In this post, I would like to look at Boeckhs discussion of inflation.
The near collapse of the financial system in 2008 occurred because central bankers were focused on fighting the last war. After the near hyperinflation of the 1970s, they thought their job was simply to keep the Consumer Price Index (CPI) low. So money and credit creation was allowed to run loose and respond to every bump in the road during the 1990s and 2000s because the low CPI signaled everything was OK. But the extra money and credit was puffing up asset bubbles that were later to go bust.
The latest episode of bust and reflation is just another stage in the age of inflation. At the root of the persistent tendency to inflation, instability and debt upheavals is a lack of an anchor on the monetary system, which in bygone days was the gold standard. Without it, governments lean on central banks to print money and keep the party in the economy going on as much as possible and invariably end up overdoing it.
Yet, Boeckh refrains from recommending the reinstatement of the gold standard. The heyday of the standard, in the 19th century did do an admirable job of keeping the price level unchanged for nearly a century (although with some volatility output and prices along the way). However, it worked then because of conditions that no longer exist now, claims Boeckh.
First, governments in the 19th century were small and fiscally conservative. They did not run budget deficits in peace time and nor take responsibility for full employment and business conditions. Second, wages, the largest cost component of inflation, were relatively flexible. The necessary deflationary adjustments could be performed without political turmoil. Nowadays, wages are rigid thanks to unions and government support, so prolonged unemployment and output declines are the result.
Boeckh does not see a solution right now. Unfortunately, no one has come up with a practical, acceptable alternative to the gold standard ., he writes. Thus, we appear to be condemned at this time to being buffeted by the gyrations of the age of inflation. But the accumulation of debt will eventually reach at point — likely within the next decade — where there will be no way to reflate out of it.
Over time, it is evident that crises have become more severe, Experience shows that it has taken increasing amounts of money, credit and fiscal deficits to generate each recovery.
The implication is that eventually we will get to an end point and experience both inflation and deflation together. The monetary and fiscal levers wont be able to pull us out.
It is likely the Age of Inflation will remain in tact for at least one more cycle. How fast and how far it goes can only be conjecture, but it is not likely to last long, because the economic underpinnings are not solid.
Investors will be playing a cat and mouse game with the Fed. As investors expectations of inflation heat up, pushing asset prices higher, the Fed will be tempted to stop it The reality is the Fed has little or no room to maneuver . The problem is too much debt . Debt got us into the crisis, and it is has not come close to being sufficiently liquidated to avoid another one.