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Friday, October 04, 2013

Handelsblatt asks, "Where is the inflation?"

That’s today’s front page of German daily Handelsblatt, with the headline asking “Where is the inflation?”

A stark reminder of what remains a key issue in German (and therefore European) politics. We could barely ever imagine such a front page in the UK, particularly when annual inflation is running at only 1.6% (August 2013).

Inside the paper there is a ten page section discussing the issue. Essentially, Handelsblatt is questioning why, when there has been such significant money printing and low interest rates in the eurozone, is there yet to be inflation. This is put in context with a comparison to the hyperinflation of the 1920’s Weimer Republic, another reminder that this episode in the country’s history continues remains firmly embedded in the German psyche.

The discussion itself is obviously hugely technical, but the paper’s explanations for why inflation is (yet) to show up is quite telling about the debate in Germany.

  • Central banks only measure consumer prices – the paper essentially suggests that the usual metric of inflation, the Consumer Price Index (CPI), does not fully capture the real inflation rate since it does not include things such as asset prices and house prices.
  • The increased money supply is not feeding through to the real economy – the suggestion here is that, although money supply is being increased significantly, it is not feeding through to the real economy because banks are not lending out and because people and companies are saving more. It could also be down to the fact that banks, companies and the government are deleveraging (paying off debts and reducing their size) in order to become more stable in the wake of the crisis. For these reasons, the money created has stayed within the financial system rather than leaking to the wider economy and hitting inflation – at least not yet.
  • Still too early to fully judge the impact of the ECB’s policies – this seems to be linked to the argument above but the paper suggests that the low interest rates and other non-standard measures which the ECB has undertaken (such as unlimited long term loans) are yet to have their full impact. The suggestion seems to be that, as the economy recovers, the true impact of the policies will become clear.
  • So, what will happen? The paper concludes that these policies are likely to have some impact and that inflation will show up at some point.
Although this is clearly just the view of one paper, the tone and line of argument here is quite telling.

Clearly, there is still concern that inflation will show up and even that it may already have and be going unnoticed. This fits with recent concerns raised by the Bundesbank that low interest rates and loose monetary policy can pump up financial bubbles and set the scene for the next crisis.

This debate is here to stay in Germany and Europe. As the ECB considers further long term lending operations (LTROs), how to deal with actions of other central banks and the large divergence in growth between Germany and some struggling countries, it could come to the fore once again. 

9 comments:

Anonymous said...

There's no inflation because we are in a liquidity trap. The faculty at ECon German Universities should have explained that if they were actually good at understanding that.
Unfortunately this ordoliberalism mantra has blurred the intelligence of pseudo-wised men.

With half the eurozone in austerror and the other mercantalizing it as much as it can, there will be no inflation until 2016.

Who wants to bet with me?

Joe L

jon livesey3612 adydan said...

The reasons that inflation remains part of the German psyche is that it wasn't just a phenomenon of the 20s. Serious inflation began far earlier. In 1914 the German Mark was 20 to the Pound Sterling, and by 1918 it was already at 200.

The reason is that the Imperial German Government funded the Great War by money printing. They increased the money supply by a factor of ten, from 2.7bn Marks in 1914 to 27bn Marks in 1918, and not surprisingly, a tenfold increase in the money supply got them a tenfold, or 1000%, inflation in just four years.

Visitors to Berlin in late 1918, after the Armistice, noted that Germans had already lost faith in the Mark, and were exchanging their cash for anything real - stocks, shares, gold, silver, real estate and foreign currencies.

This process was pro-cyclical. The more that Germans dumped the Mark, the lower it fell. By 1921 it had fallen to 700 to the Pound, and the process accelerated into 1923, which was the blow-off phase.

Since then, hyper-inflation has had a many myths attached to it. That it was a phenomenon of 1923 - in fact it was a ten year process. That it was "caused" by reparations - in fact it started five years before reparations were agreed. That it "just happened" when in fact it was a direct consequence of money printing. Banknotes don't print themselves.

So Germans are wise to be concerned about inflation, just not right now. Inflation is nowhere in sight today, but we could run into situations leading to high inflation in the EU in the future. A good example would be a huge Bank bailout funded by newly printed cash, or a deep energy crisis funded in the same way.

Jesper said...

Bank of England has printed more money. What has happened in the UK?

Wages up or down?
Asset prices, property prices, up or down?

If wages aren't rising in tandem with cost of living, does it become easier to pay back borrowing?

If wages does rise in tandem with cost of living, how does that affect 'competitiveness'?

Rik said...

@Jon
Talking a lot of times with Germans on this also not the not economically schooled ones.
My idea why Weimar still plays is because of the fact that in the German psyche it is linked to the great wars, especially WW2. The rest of the world might see WW2 as a 1939 or 1940 or 1941 to 1945 thing. Germans simply include the prelude to it. Basically that is the economic crisis and the rise of Hitler and Co.

Therefor hard to see how you can uncouple that. From the other side as well still with every occasion you have people bringing the War into the discussion (look at the EU thing and Germany's leading role in that). You bring up the War you bring up inflation.

Germany itself is further basically as there will be only very few people left who voted Hitler in. But in politics still the fact that Germany started 2 worldwars and especially in WW2 did a lot of very weird stuff still plays an important role.
And they all have been looking thoroughly at the causes basically from 1946 just to be able to avoid making the same mistakes.

Weimar and inflation is simply part of their WW2 experience. And unlike some people also here seem to think they donot want to repeat that again (and basically at any cost).

A lot of things in this crisis can be explained that way.
Their fear of inflation, why they dropped the no bail out effectively, but also why it is very unlikely that they will be the ones that pull the plug out of the Euro.
If they want that it will be likely the Finns, Hols or Austrians that do it. Or it will be done very indirectly just making the conditions unacceptable for the South.
But also the fact that in Germany inflation is a public issue, while anywhere else it is an issue basically dealt with by specialists.

Anyway in a nutshell. It is a very 'hard sell' to tell Germans high inflation is needed. As said that comes close to asking them to repeat the WW2 experience (what they did to others as well as how they themselves suffered).
It is also a public political issue and not a political elite or economic specialist one. Which simply gives a totally different set of rules.

Rik said...

@Jon2
You can see from the other commentor on this post (in all fairness that is basically how most of the AngloSaxon financial and economic world ticks) that they simply donot have a clue.
Simply as missing the point that the inflation or not is a risk assessment issue at this stage. In which Germans have simply another risk assesment seen their history.
And there is very little hard empirical proof on the issue.
Plus from the AngloSaxon side simply missing the fact that the only thing that has played out in this game (if the South would act if no hard incentive) the AngloSaxons simply made the wrong call and the Germans the right one. Look at Italy, Greece and Spain at the moment, they all need a good kick in the backside to make them move.
Inflation itself simply hasnot played out yet. We are still in the process of it and the outcome is not yet insight. First of all the economies are still not properly running. Second and likely more important the consequences of especially QE have not played out yet (simply a lot of uncertainty in those bubbles) and third the process to be successful has to be reversed somewhere. Even the present debtlevels could lateron constitute a problem not even to mention when they will rise even ffurther.

Basically it is MxV. With a low V keeping inflation low. But if V picks up what is the intention problems are likely to start.
With the main way that Cbs can keep the thing under control (MxV)being decreasing M to make that happen.
Simply meaning selling the QE bonds in a pace that make that happen. Raising rates. Normal rule is what comes up must go down.
Simply a huge risk in that. Looks like either the yield or the inflation goes out off control when the economy would really pick up.

Have a look at some Koo stuff he wrote a 1/2 year ago (by far not an exact indication) or so on MxV.
And some stuff Davies wrote on inflation 1-2 years ago FT which indicate that inflation takes some time (usually 2 years) to hit in.

Rik said...

Nearly all discussions on inflation are missing a lot of points.
Just some of my thoughts.

1. Usually CPI or something very similar is used.
Basically it works decently in most standard cases. And you need something quantifiable.
However inflation on a more social level is different for all people.
Just to take the German example.
First of all even when they would only care about CPI they care about German CPI not EZ one.
EZs can legally be the one, in real life simply things donot work that way.
Another German issue is housing costs. These are several times higher than CPI. Houseprices going throught the roof in some areas and rents picking up recently as well. Most Germans (people in fact) will simply see/feel that as inflation whatever official definitions say.

2. Inflation is basically what you can do with your present money earlier or later on the timeladder.
Which brings asset prices in general up.

3. As a consequence of the above weighted how people think what inflation is is almost certainly much higher than the CPI the officialdom comes up with.
And especially German politicians better keep that well in mind.

4. The way inflation also the CPI kind is looked at has to be watched as well.
For starters very likely now the average expectancy is lower but the sigma has risen considerably in the process of crisiscan kicking.
What I mean is that there are very likely more people now (weighted) that think inflation will run out of control than there were pre-crisis.
A different distribution can give other results.

5. It is as said about expectancy. Which is based for a big part on current and history. And simply as said under eg 4. expectancy might differ now much more than it usually does.
Furthermore expectancies can change very fast (look at Southern yields).
Second the probem that most a lot of (potential) bears have is that at some stage financial government holes will be stuffed with freshly printed money. Simply not all think it will run out of hand directly, but will lateron.
For the EZ when a call has to be made high inflation or break it up.
And it is clear we are not there yet.
And as extra that is a one moment political event not an economic process. So likely things will hit in in a few days (as people start to price it in). If that effect would be large it is probably impossible to stop. You could get 10-20-30 or even more of the total stuff on the market in say a week. Plus a combination problem of bonds and currency (possibly equity tanking as well). While in the build up and normal economic processes you are talking about may be 0.1 % in that timeframe (of which the CB buys say half). 20% or so with no other buyers is in another universe.
In other words risk is probably higher than before while inflation especially the CPI kind is lower.

6. The QE LTRO stuff has to be reversed (as will the excess debt accumulation btw). That is yield but also inflation wise the risky event. Look at the taper discussion.
Pumping money in a depressed economy with a liquidity issue is much less risky. What comes out of that medium term probably and reversing it is much more risky.

7. Another point is that it is imho beyond moronic to push inflation up on one side. What a lot of economist want now for the EZ.
While at the same time half of the EZ has to deflate to become competitive again.
These things simply donot go together. Kicking yourself in the private parts because you need exercise kind of stuff.
Strictly they are not the same. However wagesdecreases are a hard sell the less people can do with their lower wages the more difficult the process gets. Wages are a huge part (probably by far the most important medium and longer term) for prices. And the other around as well. Look at low income countries pricelevel is nearly always much lower. Increase min wages there and pricelevel goes up as well. Wages and prices (and so upward pressure on wages and inflation are simply highly correlated). Combining these policies is therefor simply moronic square.


John King said...

This is a world debt destruction deflation that has only been slowed due to Central Bank meddling in the markets. Debt created assets become slow to clear. The side game is that food, housing & stock markets are "beneficiaries" of the excess cash in the systems. The answer to the "wo bleibt" question is that it will arrive when least expected but when faith in the banks finally fails.

John King said...

This is a world debt destruction deflation that has only been slowed due to Central Bank meddling in the markets. Debt created assets become slow to clear. The side game is that food, housing & stock markets are "beneficiaries" of the excess cash in the systems. The answer to the "wo bleibt" question is that it will arrive when least expected but when faith in the banks finally fails.

Rik said...

@John
Agree that this is deleveraging and as such basically deflationary (especially on asset prices).
It is mitigated by CBs via QE type measures. Putting liquidity in the system that however partly moves to other stuff than where the overborrowing was before. A process we now see in action.
However that is just part of the story/question.

Of that deleveraging in general an important part is the debt/overborrowing by governments isue. A thing that basically still gets worse than it already is and with no proper answer in sight in many countries.
Basically that question can be solved in 2 ways:
-sound money way (focus on pricestability):
-print yourself out of the mess as government (focus on debt reduction).
Simply nearly everywhere that choice still has to be made. As said at this moment things looks stabilised but at the same time sovereign debtlevels seem still on the rise. With as well in alot of countries no credible policies in place how to get real grip on the situation. What we see is unrealistic high prognosis; 'now it is not a problem so in the future it also will not be' thinking; permanent support by others in the EZ etc.
Basically hoping the problem solves itself in some miraculous way.

At the end of the day this issue will still have to play and the outcome is unsure. And will also depend on how markets see things as this is where the pressure to make decisions will largely come from. Partly pressure will come as well from the electorate but that will most likely take more time. Merkets can change in a few days, electorates, because they go via elections, take much longer.

As said this question is till open.
seen from there it was also pretty unrealistic to expect high inflation in the early stages of this crisis. CBs were to focus on pricestability at first. Politicians were to scare away from bold decisions. Can kicking was/is/will be always the by far most likely option as long as that is an alternative.
Add recession and deleveraging in the basics inflation was simply unrealistic in the early stages of this crisis.
However as said in the end game it is a realistic option. Somewhere in this process countries at least a lot of them will have to make unpleasant choices. Inflate yourself out or austere yourself out with can kicking not longer an option).

Growing looks simply not realisitc. It is basically continuing policies that have caused the present crisis At the end they were even pre-crisis not sustainable. And are evenless so now in a more difficult climate (lower structural growth overall). Only function there is simply avoiding that the bottom falls out of the system. But the choice will be inflation or austerity.

And of course inflation will also mean austerity for most at a personal level. It is more austerity as the methodology I mean. Drop in standards of living is more or less guaranteed hatever happens. Especially seen the fact that on a worldscale labourcosts in the West simply looks too high compared to the new competition.

It was also pretty clear imho that the QE money would move to the elite. It is 'given' to financial investors. Probably the least effective group if you want to kick start an economy.
And from there ending up further down was not very likely. It was much more likely to go the way as all financial investments from that group. Short term yield seeking and all over the world.
Real investments were very likely to be marginal. Investments were also to be mainly short term. And a lot would be dropped abroad.