Thankful For Their Skepticism

By Kevin Muir

I have been banging on the inflation drum for so long I feel that even Todd Rundgren would be sick of hearing from me. While a couple of years ago, the majority of pundits were not talking about inflation – most were focused on the Fed’s inability to create rising prices in anything except financial assets – recently the market has awoken to the risks that accompany a decade of bat-shit-crazy central bank monetary policies.

With the current popularization of warnings about the coming inflation, I don’t know if I can add any value rehashing the points filling financial airwaves. The market seems to have finally caught on. Inflation is coming. In fact, it’s already here. And it will get a lot worse.

Instead of writing yet another piece reiterating my beliefs about why inflation will be a problem in the coming decades, I have decided to explore how market inflation expectations have changed over the past couple of years.

At the start of 2016, the market was pricing in a 1% 5-year breakeven inflation rate. That meant inflation had to average less than 1% for the next five years for nominal bonds to outperform TIPS (Treasury Inflation Protected Securities). Stop and think about that for a moment. The Federal Reserve has an inflation target of 2%. Yet the market did not believe they could achieve an inflation rate of even half their target.

The three Ds (deflation, demographics, and debt) were on everyone’s lips. It made little sense to invest in inflation-protected securities when everyone knew there could be no inflation.

Continue reading Thankful For Their Skepticism

Central Banking Tragedy: The Case of Japan

By Michael Ashton

Today I want to talk about one of the real tragedies of monetary policy and inflation: Japan.

The tragedy is that the mystery of the deflation in Japan is no mystery at all. The cure also was no mystery. So the tragedy is that these were both treated as mysteries by the central bank, which stumbled on the right response and then stumbled right back out of it again.

The chart below shows the money supply and core inflation history of Japan going back into the 1990s. Core inflation is in red (I’ve interpolated through the sales-tax-induced spike) and M2 growth is in blue. The cause of the disinflation is pretty plain: between 1998 and 2013, year/year money growth in Japan never exceeded 4%. From 1999 to 2013, Japanese M2 rose 38% in aggregate; in the US it rose 138% over the same period. It is very hard to get inflation, especially in an environment of declining interest rates, if the money supply is increasing at or somewhat less than the rate of potential GDP growth.

However, in the middle of 2013 Japanese Prime Minister Shinzo Abe persuaded Bank of Japan governor Haruhiko Kuroda to promise to double the money supply in two years, by pursuing massive QE. Although that turned out to be an exaggeration, M2 growth did peek out from behind 4%, and inflation started to perk up as well. It wasn’t a lot, but inflation in 2013 reached new 14-year highs and the economy was officially out of deflation. While QE made very little sense, at least the QE2 and later versions, in the US where inflation was positive and money growth was adequate, it made a ton of sense in Japan. In fact, if Japan had been the only country pursuing QE, I can make the argument that the yen would have likely depreciated substantially and caused inflation in that country.

Continue reading Central Banking Tragedy: The Case of Japan