Why there is a fine line between genius and insanity when it comes to rising prices.
Few of us will remember what it was like when you had to take a wheelbarrow of cash to the local bakery to buy a loaf of bread. In the days of the Weimar Republic, hyperinflation was so well entrenched it brought about huge changes to society, and we all know what happened next. Cleary, no one is saying that a mere 2.1% year on year increase in CPI will lead the UK down the same path. After all, we have bigger fish to fry (pun intended). Question remains though, what to make of all this talk of inflation?
The last time we were here was in 1996 when interest rates were on the rise amid fears of increasing consumer prices. Alan Greenspan famously termed the phrase “irrational exuberance” when referring to the burgeoning bubble in the stock market. He was right of course, but not before the markets doubled and lest we forget the Dow Jones was at 6400 at the time. The funny thing is of course that at a level of 33000 today, we are again talking of new paradigms, but that is another discussion.
Higher interest rates are the obvious sword of Damocles. It would kill everything. Imagine all the variable rate mortgages, the highly leveraged technology companies or the government trying to roll trillions in bonds at rates that could be three or four times as high. Obviously, this is not a drug problem, but a dosage issue. We need (some) inflation to grow out of this debt, but not so fast that we can’t afford to finance it at the same time.
The perfect rate of inflation is around 2%, and engineering our way out of the huge monetary and fiscal stimulus we have pumped into the economy can be a very tricky thing. Which is why many (including the Fed) are terming the current state of affairs: transient inflation. The idea is that we jolted the patient back to life, but once we have a pulse, we wean ourselves off all the drugs (read: cheap and unlimited credit) that we have come to rely on.
Japan has been trying to do this for about four decades now. With debt levels of more than 250% of GDP, you have to wonder how our current experiment is going to turn out. Not so long ago, we were actually afraid of deflation, and dismiss that at your leisure, but fact is the Nikkei is still some 25% below the highs achieved in 1987. Alas, the choice seems to be that we will either need to find new ways to transport huge amounts of cash for our daily shopping or the zombie apocalypse whereby companies cannot die, but they won’t be growing either. Great, is that why everyone is buying the markets?
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