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Most of us are gathered at the station, watching for
the Inflation Express to come rumbling in. But we've been waiting for a while
now. Just when should we expect the big locomotive to arrive and start
pushing the prices of most things uphill?
We'd all like to know the exact date, of course, but
no one can know for sure. Not even a careful reading of the Mayan calendar
will help. What we can do is estimate a time range for price inflation to
show up, and that alone should have some important implications for investment
decisions.
Why It's Expected
The reason for expecting price inflation is the
recent, rapid growth in the money supply and the deficit-driven likelihood
that more such growth is coming.
As of July, the M1 money supply (currency held by
the public plus checking deposits) had grown 17.5% in a year's time. That's
not just unusually rapid, it's extraordinarily rapid. Since 1959, M1 has
grown more rapidly in only one other 12-month period - and that was the one
ending last June, when the M1 money supply jumped 18.4%. Even in the
inflation-plagued 1970s, growth in M1 never exceeded 10% in any 12 months.
Dropping large chunks of newly created money into
the economy leads to price inflation, because the recipients are likely to
find themselves overprovisioned with cash. As they
try to unload the excess, they bid up the prices of the things they buy,
whether it be stocks, shoes, gasoline, silver coins, or granola. The sellers
of those things then find themselves cash rich and start doing some buying of
their own, and so the wave of excess money and the bidding it inspires
propagate through the economy.
The process isn't instantaneous. It takes time. Just
as each player in the economy has a sense of how much of his wealth he wants
to hold in the form of money, everyone will move at his own speed to make
adjustments when his actual cash holdings seem to be off target.
And the process can seem to stall, especially when
fear is growing. When people are worried or otherwise feel a heightened sense
of uncertainty, they will gladly hold on to abnormally large amounts of cash
- for a while. But when fear abates, as it will when the economy begins to
recover from the recession, that temporary demand for extra cash will also
fade, and the hot-potato process of trying to pare down cash balances will
emerge to do its inflationary work.
But when?
The speed at which the public tries to unload excess
cash and the timing of the effects have actually
been measured, in the work of the late Milton Friedman and his monetarist
colleagues. The method was indirect and roundabout, and so the results,
unsurprisingly, were nothing as precise as nailing down the value of a
physical constant.
What the monetarists (or the first of them to be
equipped with computers) found was that when the growth rate of the money
supply rises:
- The initial
effect is on the prices of bonds and stocks, an effect that comes within
a few months.
-
- The peak
effect on the growth rate of economic activity comes about 18 to 30
months after the pick-up in the growth rate of the money supply.
-
- The peak
effect on the rate of consumer price inflation comes about 12 to 18
months after that, which is to say it comes 30 to 48 months after the
peak growth rate in the money supply.
As Friedman famously put it, the lags in the effects
of changes in monetary policy are "long and variable." He might
have said, "It's a big, wide blur, but we're sure we've seen it."
And even that picture exaggerates the precision
that's available to us. The emergence of money substitutes, such as NOW
accounts and money market funds, has added its own muddiness to the picture
of how growth in the money supply translates into growth in the level of
consumer prices. It is only because the recent episode of monetary expansion
has been so extreme that we can look to the results just listed for an
indication of what's to come.
If you apply the findings of the monetarists to the
present situation, here's what you get. The peak growth rate in the money
supply occurred last December, so based on the general monetarist schedule:
- Some of the
effect on stocks and bonds should already have been felt.
-
- The peak
effect on economic activity should come between the middle of 2010 and
the middle of 2011.
-
- The peak
effect on consumer price inflation should come between the middle of
2011 and the end of 2012.
-
A More Particular Schedule
This time around, should we expect things to move
more rapidly or more slowly than average? My bet is on slow, which would push
the peak inflation rate out toward the end of 2012. One reason for slow is
that the government's rescue packages are delaying the process. Rescuing
banks that are choking on bad loans postpones the day of reckoning for both
the banks and the loan customers. It retards the pace of foreclosure sales
(whether of real estate or other collateral) and puts the deleveraging that
has been going on since last fall into slow motion. A wilting of the recent
stock market rally would confirm this.
Investment Implications
The big plus about the Mayan calendar is that, right
or wrong, it is very definite about things. Human civilization will come to
an end, I'm told, on Dec. 21, 2012 - not on the 20th and not on the 22nd.
There was no room for monetarists in those step-sided pyramids, but there
still are few what-to-do implications from the monetarist findings.
- When you
hear would-be opinion leaders cite the current absence of rising prices
at the supermarket as proof that all the new money isn't a source of
inflation, don't believe them. It is much too early for the inflation
bomb to be going off, even though the powder has been packed and the
fuse has been lit.
-
- If the large
and growing federal deficits and the Federal Reserve's unprecedentedly
easy policies tempt you to leverage up on inflation-sensitive assets,
such as gold, give the idea a second thought. It likely will be a year
or more until price inflation becomes obvious and undeniable (which is
what it would take to bring the general public into the gold market). In
the meantime, your inflation-sensitive assets could get paddled rudely
as the deleveraging that began last year continues.
-
For at least the next year, the simple,
fire-and-forget strategy is 50-50 gold and cash - gold for what looks to be
inevitable but on its own schedule, cash to be ready
for the bargains that may show up while we're waiting for the inevitable to
arrive.
The
editors of The Casey Report keep
their ears to the ground, listening for the first rumblings of the inflation
stampede coming in. But you can bet on rising inflation – and interest
rates – right now and be way ahead of the investing herd. To learn more
about investing in this all but inevitable trend, click here.
Terry Coxon
The
Casey Report
Also
by Terry Coxon
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