Fake Inflation Expectations Meet Good and Bad Inflation

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/fake-inflation-expectations-meet-good-and-bad-inflation?post=119521&uid=4798

You have to ask yourselves if inflation expectation increases amount to fake news. Here is a recent FRED chart of inflation expectations:

5-Year Forward Inflation Expectation Rate 

We know that this inflation expectation increase has failed in the past. It failed in 2013/14 with the bond tantrum. It failed in early 2016. It failed in 2012, and in 2011, and in 2010, and in December, 2007. That was a big, big fail. This is the most failed economic indicator ever devised! But people continue to push it as if it is truth. Maybe eventually it will be true, kind of like those who predict recessions every year will get it right now and then.

Here is the longer chart showing just how this indicator is always bullish, with results that are, well, just the opposite:

5-Year Forward Inflation Expectation Rate, Longer Timeframe

So, how do we treat the fake news of inflation expectation surveys? The Fed tells us how itself: 

Kliesen found that households routinely overestimated inflation and also assumed higher expected inflation than financial markets did for the entire period studied. The mean of the survey-based measure was 49 basis points higher than the market-based measure and more than 100 basis points higher than the actual rate of inflation.
Kliesen also showed the root mean squared error (a commonly used statistic to gauge the accuracy of forecasts) for each measure of inflation expectations. He found that the market-based measure was 34 percent more accurate than the survey-based measure.
He wrote, “When using measures of inflation expectations to forecast future inflation, policymakers and forecasters should focus on market-based measures of inflation expectations. They are much more accurate than survey-based measures.”
Just ignore the surveys, according to the Fed. They are not indicators that contain any real meaning. Are the surveys themselves fake news? Well, most likely they are not But they can be used by people who have an agenda, a trade that they want to profit from. That is when inflation expectations could be used as fake news. 

Good and Bad Inflation

Lance Roberts hits the nail on the head when he reports there is good inflation, based upon growth in pricing for imports and exports, growth in disposable income, growth in wages at home. 

But that is not the inflation we are getting. We are getting health inflation, and Obamacare is just one example, that works like high gas prices, like a tax on consumers. Taxing labor is inflation destined to bring the economy down. It is a bad inflation. 

High rents are a tax and rents have been increasing in many closed access cities where there is prosperity, but not enough housing. Workers are punished by rents and high house prices. This is also bad inflation. So we are experiencing bad inflation, which will negatively impact effective demand because of the stress of market spillover. It does little good to get massive raises if they are all buried by massive rent and health increases. 

Bond tantrums also create inflation expectations that rarely pan out. So, if inflation is mostly the bad kind of inflation, it is a fake expectation. It acts as a drag on the economy.

One form of fake inflation is the extra cost to produce, which could end up being passed to consumers both here and abroad. It isn't the kind of wage inflation that is driven by foreign and domestic consumers highly desiring our products, which is a competitive prosperity. It is wage inflation that could be driven by inefficiency. 

The inefficiency could come from Donald Trump forcing companies to produce too much of their product creation in the USA for sale in the USA, in order to lower imports. That seems to be a Trump goal. Wages are high here, and not competitive compared to world averages.

Trump could easily increase product inflations that are bad, and if the markets are hoping for this sort of inflation, a tax on consumers, the markets should be careful for what they wish for. Why would nations who are on the Trump end of higher tariffs jump to buy more American products?

And as we see from the polls, there are many Americans who are distressed about a Trump presidency, wanting to make him a one term president. Will they change their spending habits accordingly?

Keep in mind that real inflation shows a raise in all product prices with wage increases following. It is a monetary phenomenon. Raising some prices through protectionism is not inflation, it is a tax on people who cannot hope for large wage increases. That sort of economics can only end badly. 

Since that limited product inflation would not be real inflation, national debt would not be washed away by a decline in dollar value of the debt that would come with an overall inflation.

Another form of inflation that is bad is runaway inflation. It is an inflation that threatens both the bond market, the collateral for derivatives, and threatens the fabric of society. While the inflation of the 1970's in the US could not be compared to the hyperinflation of post WW1 Germany, it was beginning to get out of hand, rising to 14 percent yearly in 1980. The Fed was influenced by Nixon at that time and a temporary prosperity born out of a massive monetary inflation did not last.

But in these days, stopping runaway inflation will be much more difficult. Structured finance has made it almost certain that banks and counterparties will be at risk and a credit crisis could result. If Trump wants a 1970's like inflation, we will pay for it most likely in a way far worse than in the '70's, when Volcker raised rates to 20 percent to stop the inflation.

Good inflation would be when demand goes up and then inflation follows due to pricing power. But Trump may want to kindle bad inflation that makes pricing power a function of a monetary mistake, and make it look like prosperity. If that is the case, he would put the cart before the horse, and America would ultimately suffer from the sugar high that resulted. Trust me, I remember prices in the '70's being changed in stores multiple times per week. We can only hope that Donald Trump does not want a return to bad inflation that becomes difficult for the Fed to control. 


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