To monetarists wedded to Milton Friedman's
mantra that inflation is always and everywhere a monetary phenomenon,
the bloated balance sheets of the Federal Reserve and other major
central banks are so much dry tinder ready to catch fire."The Fed
says long-term inflation projections are stable, but when I look at
things I see money growth has gone way up, the dollar has depreciated
even against weak currencies like the euro and now productivity growth
has slowed. Those are not comfortable signs," said Allan Meltzer, a
professor of political economy at Carnegie Mellon University in
Pittsburgh, Pennsylvania.Only the sort of outcry from Main Street
that prompted US President Jimmy Carter to appoint Paul Volcker as Fed
chairman in 1979 with a mandate to crush inflation could prevent prices
from spiraling higher, he said."That message has to come from the
public. We won't get it from the bond vigilantes and not from the Fed
and not from this administration," said Meltzer, author of A History of
the Federal Reserve.Yet the solid consensus is that inflationary
worries are misplaced given the dim outlook for growth that prompted the
Fed this week to say it intended to keep short-term interest rates
close to zero until 2013."When it comes to most of the developed
world, there are no domestically generated inflationary pressures," said
Richard Cookson, global chief investment officer at Citi Private Bank
in London.Cookson says many countries find themselves in the
position Japan has been in for the past two decades: As the private
sector pays down unsustainably high debt, consumers and businesses are
loath to borrow and spend.Under such circumstances, the mechanism
whereby newly created central bank reserves are multiplied into loans
and bank deposits breaks down. Moreover, cash is flowing through the
economy much more slowly than usual, removing another potential
generator of inflation.At some point, the money multiplier will
function normally once more, but not any time soon, Cookson said. "The
problem is that it could take many years because balance sheets are so
ravaged," he said.With yields on conventional US, German and British
bonds languishing at historic lows, markets seem to share the view that
economic recovery will be gradual."I think the Fed correctly came
to the realization that it is going to be a long slow slog, and long
slow slogs generally don't generate a lot of inflation," said Michael
Feroli, an economist with J.P. Morgan in New York and a former Fed
staffer.Harm Bandholz, chief US economist at UniCredit Research in
New York, said the Fed's easing, taken in isolation, could be viewed as
adding to price pressures. "But general inflationary pressure is not
high in this type of environment of continued slow growth and
deleveraging," he said.A weak US labor market is Exhibit A in making the low-growth, low-inflation case.So
many Americans have given up the search for a job that only 58 percent
of the working-age population was employed in July, a 28-year low.Moreover,
those in work saw their inflation-adjusted hourly compensation drop 1.2
percent in the second quarter from a year earlier, confirming the trend
of real wage stagnation that has marked the US economy since the 1970s.Economists
at Standard Chartered Bank said they expected the jobless rate, now at
9.2 percent, would still be at 8.5 percent at the end of 2012. "This
means weak wage growth and low inflation pressure," they said in a
report.True, the spread between 10-year nominal and inflation-linked
US Treasury yields, a key indicator of inflation expectations, is much
higher than in early 2009 when fear of deflation was raging at the
height of the global financial crisis.And gold, a classic hedge
against inflation, scaled a record high this week and is up 24 percent
so far this year. But John Higgins, senior market economist at Capital
Economics, a London consultancy, said inflation expectations were likely
to recede as commodities lose altitude."What might trigger that is further signs of economic weakness and signs that inflation itself is subsiding," Higgins said.Oil
has fallen about $20 a barrel since April and copper, another
super-sensitive barometer of global economic demand, fell to an
eight-month low this week.The retreat in key commodities partly reflects slowing growth in China brought on by steady monetary tightening.This
in turn has fanned expectations that China's own stubbornly high
inflation, which touched 6.5 percent in the year to July, is close to
cresting. Indeed, economists at J.P. Morgan reckon inflation across
emerging markets has probably peaked.But that does not mean
policymakers in developing countries can lower their inflation guard.
Talk of currency wars has not gone away. Beijing for one has voiced
anger that the Fed, with its latest easing, could once again export
inflation by fueling capital inflows and cheapening the dollar."The
recent correction in global commodity prices could help to ease some of
the inflationary pressure in the short run, but in the medium run loose
monetary policy in the West may heighten imported inflation concerns,"
Jianguang Shen, chief China economist at Mizuho Securities in Hong Kong,
said in a note.
