Inflation or deflation – the road ahead

Housing Market Written by John Bolton, Jan 18 2017

Waiting for inflation is feeling increasingly like the quest for the Holy Grail, or as I approach 45 ‘waiting for god’. Oh, so old!

The market is viewing Trump as inflationary. The theory goes that this will be driven by fiscal stimulus. In other words, “investing” in America and pushing back on the deflationary forces of globalisation. I’m in little doubt that Trump can push back on globalisation. It seems the time is right for that politically, but I’m less sure on everything else and especially the effect of tax cuts.

To date, Reserve Banks around the world have bore the task of economic stability using monetary stimulus. They have eased interest rates and printed money. Lower interest rates have kept the party going, but the side effect has been rocketing asset prices that have exacerbated wealth inequality. Trump’s administration and the Republican Congress are anti-deficit. They are not going to sanction a big spend up, with perhaps the exception of tax cuts. Tax cuts and lighter regulation are the strategy de jure of the Right. It is annoying to see US banks already starting to lobby to unwind the Volcker rule implemented post GFC to stop banks using depositors’ funds for speculative bets on the bank’s own account. It sucks that the masters of our broken universe are the very ones benefiting from central bank policy. Back in 2010 Matt Taibbi summed it up in Rolling Stone magazine when he wrote “Goldman Sachs is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

Greater trade protectionism and fiscal deficits should be inflationary especially with the US reaching full employment. They will push up labour costs, and therefore prices. That will push up interest rates and the US dollar. A stronger US dollar will disadvantage US exporters and also stifle emerging economies that have over $3.5 trillion in US$ denominated debt.

On the other side is the unstoppable deflationary force of technology. Nowhere is this more obvious than in oil prices. Even with OPEC agreeing to reduce oil production, it arguably won’t be enough in the medium term. Firstly, they all cheat, and Russia for example is not a member. Second, shale oil production in the US and Canada (also outside of OPEC) only kicks in as the price of oil goes up. Third, is the exponential growth in alternative energy. The World Economic Forum noted in its December report that “as prices for solar and wind power continue their precipitous fall, two-thirds of all nations will reach the point known as “grid parity” within a few years, even without subsidies.”

The other constraint is the shear amount of private debt we have. In New Zealand that equates to $220 billion of residential mortgage debt and another $25 billion of consumer finance and student debt. Back in 2000 residential debt was $62 billion so it has almost quadrupled in 18 years. A lot of our economic growth has come from debt-fuelled stimulus that simply cannot continue. This becomes extremely contractionary as soon as interest rates go up. A 2% rise in mortgage rates would take $4.4 billion of consumption out of the hands of borrowers.

I’m not going to predict which way this goes as it’s unchartered. I’m swayed more towards the long-term deflationary forces and an eventual economic Armageddon. We’re kicking the can down the road, listening to music (on Spotify) with our noise cancelling cordless headphones, and missed the Mac truck.

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