The Inflation Tipping-Point
By Gold Money
The non-linearity of inflation psychology and the present danger of stagflation
Submitted by John Butler at GoldMoney Inc. The full report can be accessed here.
Introduction
Ever since the 2008-09 global financial crisis there has been a lively debate between those anticipating a prolonged deflation and those predicting a transition to inflation. In certain respects, both sides of the debate have been correct, if sometimes confusing monetary, credit and price inflation. Recent data indicate, however, that the terms of debate are now shifting decisively in favor of those expecting price inflation or, more precisely, stagflation. Not only is US core CPI trending higher; the dollar uptrend has given way to a downtrend, implying the end of low headline CPI. The result could be CPI above 4% by 2017. The psychological effect of 4%+ CPI, combined with timid action by the Federal Reserve on rates, could represent a ‘tipping-point’ in public inflation expectations. Once this occurs, there is a risk that economic behavior changes in unpredictable ways that can damage real potential economic growth. Investors should prepare accordingly.
The concept of a ‘tipping-point’ can apply to a wide range of phenomena.
One classic example is that of a crowded theatre slowly filling with smoke. At first, perhaps only one person notices the smoke and, comforted by the fact that others remain calm, remains seated, if slightly on edge. But then a handful of others also notice and become concerned. Finally, at some point, these folks stop watching the show and instead start watching each other. As the growing concern across the theatre becomes evident, someone finally makes for the exit, triggering a rush by others. Yet many of those rushing out might not have noticed any smoke. The critical point is reached not because more people notice the smoke; rather, more notice changes in others’ behavior and thus change their own.
The danger of inflation for economies and financial markets can also be understood in this way. As prices begin to creep higher, a few investors, businesses and households begin to notice. Rather than just going about their business as usual, they begin to watch the behavior of others more closely. Finally, a handful of economic agents suddenly change their behavior in a significant and highly visible way, triggering similar responses by others, who might not even have noticed that prices were rising.
What sorts of behavioral changes might those be? Perhaps investors begin to favor assets which protect against inflation. Perhaps businesses take out loans in order to finance stockpiles of inventories, in anticipation of higher prices. Perhaps consumers begin to do the same with durable household goods. By these very actions, investors, businesses and consumers all begin to reinforce a vicious inflationary circle, limiting the available market supply of broad ranges of goods and thereby driving up prices. Regardless, once the inflation tipping-point is reached, the rush to the exit–to protect against rising prices in some way–is damaging to economic efficiency, especially within the highly specialized global economy of today, implying …read more
Source: The Inflation Tipping-Point
