US inflation came in a tad higher than expected this week. Which absolutely hammered markets in the US. Europe is in for a miserable winter of inflation too. And Australia is far from immune.
But just how bad will inflation get?
The answer is: I’m not sure. Which doesn’t sound very helpful. Until you read about why, below.
But first, let’s explore something important that you should keep in mind: governments and central banks are still causing inflation, not fighting it.
Sure, central banks are hiking interest rates like never before. Australia’s Reserve Bank hiked rates by half a percent last week. The European Central Bank by 0.75% — its biggest hike ever. Which would be impressive if the rate hadn’t been 0% before the hike, while inflation closes in on double digits.
The Bank of England announced its largest rate hike in 27 years last month. And, in January, Bloomberg summed it up: ‘Fed Kicks Off Most Aggressive Global Tightening in Decades’.
But do higher interest rates ease the cost of living? Or do they make the cost of living worse?
In Austria and the US, governments have launched stimulus spending to help people with inflation — an oxymoronic policy of ‘Yes, prime minister’ proportions.
Bloomberg: ‘Austria Offers 1,000 Euro Handouts to Quash Inflation Discontent’. This is like the old saying, ‘the beatings will continue until morale improves’. The government spending will continue until inflation improves…
In the US, the Inflation Reduction Act will not reduce inflation, according to the government’s own figures, but it could increase it. I think it’ll increase it substantially.
The Americans are also busy forgiving student loans — a blatantly inflationary policy. The monetisation of debt is pretty much the most direct way of expanding the money supply.
Not to be outdone, the Bank of England is bailing out energy companies with their own balance sheet — practically the definition of inflation.
Causing inflation by lending to the government just isn’t inflationary enough anymore. The central bank is now lending to the private sector too.
In Australia, the government has been busily bidding up the property market in order to solve the unaffordable housing crisis. Read that again carefully if you’re not weeping or laughing about it, depending on whether you own a house.
Enough journalists and economists called the government’s ‘first homeowner grant’ the ‘home vendor grant’ for there to be no excuses. Everyone knows government programs are the cause of the unaffordable property in the first place. But politicians tend to own homes…
Having pushed property to an unaffordable new level with past programs, the latest scheme from the Australian Government takes things to a whole new level. They’re offering to take a 40% equity stake in the homes of new buyers! As if that won’t just increase prices by the corresponding amount.
Another good example was beautifully exposed in a Milton Friedman-esque way. When the Inflation Reduction Act promised EV credits of US$7,500 for new cars, car companies promptly raised prices by almost as much…
The energy crisis is behind a lot of the inflationary spike. Are governments making dramatic moves to allow more energy production? Or are they still constraining supply?
It seems to me that European governments are still busily waging economic war against the continent’s key energy supplier. Price caps, sanctions, refusing to open Nord Stream 2, and plenty more. No wonder energy isn’t flowing from Russia.
Governments are also busy shutting down nuclear power plants in Germany, avoiding gas production from the Groningen gas field in the Netherlands, and trying to stop places like Hungary from securing energy deals with Russia.
Another problem has been producer price inflation — the prices that industry pays for raw materials. Well, is Europe’s shut down of its manufacturing base to save energy for winter going to make producer price inflation better or worse?
Companies across Europe that produce things like aluminium, chemicals, and steel are having to close their doors or reduce production because of energy costs. Which means less of what they produce is available. And that means higher prices for those using the goods.
According to the European non-ferrous metals association, ‘50% of the EU’s aluminium and zinc capacity has already been forced offline due to the power crisis’.
It’s not just industry, though. Is shutting down Dutch greenhouses over energy bills going to help food prices? The Dutch are the second-largest exporter of food in the world…
What about reversing Quantitative Easing (QE) to bring down inflation? Have central banks reversed their policies that increased the money supply? Are they actively reducing that money supply — Quantitative Tightening (QT)?
Not really. The ECB plans to end its QE program this month. With a new one ready in the wings to bail out Italy. And such sovereign bailouts are, historically speaking, when inflation really gets out of hand.
Bloomberg covers the US’s attempts at QT: ‘The overall size of the Fed’s balance sheet isn’t much different today, at $8.9 trillion, than when it started tightening monetary policy back in March’. It has since kicked in…marginally.
The Bank of England has announced its QT program will depend on market conditions. It doesn’t want to crash the government bond market by selling its vast holdings. But it’s crashing already.
Strangely enough, even central bankers admit that their rate hikes are not yet reducing inflation. They’re just pushing it up less than before. ‘We need to have somewhat restrictive policy to slow demand and we’re not there yet’, Federal Reserve Bank of New York President John Williams recently said. The Fed Chair himself called US rates ‘neutral’.
All this suggests two things: First, higher inflation in the future. Unless there’s a financial crisis to crash everything. Secondly, we can expect more tighter monetary policy. Until it causes a financial crisis.
Central bankers may well be behind the curve on inflation. But they’ll be at the forefront of the next financial panic. And that’s why markets fell so badly on higher US inflation. They’re anticipating a crash.
The inversion of the yield curve only further proves the point. Markets now expect the Federal Reserve to cut interest rates in 2023. Why would they do that? Well, either inflation disappears, or there will be a financial crisis within the next nine months, which solves the inflation problem too.
Take your pick.
Until next time,
Editor, The Daily Reckoning Australia Weekend