The Inflation Debate Is Not Over Yet

John Mauldin |

inflation qe, quantitative easing inflation, central bank inflation, us dollar strength

A note has been circulating among economists, calling into question the wisdom of another group of economists who wrote an open letter to the Federal Reserve a few years ago suggesting that one of the risks of their quantitative easing program was increased inflation. Since we have not seen CPI inflation, this latter group is calling upon the former to admit they were wrong, that quantitative easing does not in fact cause inflation. To no one’s surprise, Paul Krugman has written rather nastily and arrogantly about the lack of CPI inflation.

Cliff Asness has responded with a thoughtful letter, with his usual tinge of humor, pointing out that there has been inflation, it just hasn’t been in the CPI. We’ve seen it in assets instead. That money did go someplace, and it has disrupted markets. So why is Cliff’s letter a candidate for Outside the Box, when the markets seem to be bouncing all over heck and gone?

Because, come the next crisis, there is going to be another move for yet another round of massive quantitative easing. And the justification will be that increases in the money supply clearly don’t have much to do with inflation.

I should note that while I did not agree with the original letter (I thought we were in an overall deflationary environment, and I wrote that the central banks of the world would be able to print more money than any of us could possibly imagine and still not trigger inflation – views came in for considerable pushback), my reasons for believing QE2 and QE3 were problematic dealt with other unintended consequences. And ultimately, as global debt gets restructured (which will take many years) inflation will become a problem. Did you notice how Greek debt spreads blew out yesterday? It’s not just about oil. And trust me, France is going to be the new Greece before we know it. The people who think they can control markets and direct investors like sheep are going to be in for a huge surprise, but the nightmare is going to be visited upon the participants in the market.

We then move to a few thoughts from Peter Boockvar, in a letter he writes to savers, noting that the same people who brought you quantitative easing are also responsible for the demise of any income that might possibly have come from saving.

I wish I had good advice for your savings, but I can’t advise buying stocks that have only been more expensive in 2000 on some key metrics right before you know what, and I can’t recommend buying any long term bond as the yields also stink relative to inflation. With the Fed now saying that the dollars in your pocket are now worth too much relative to money in people’s pockets overseas and thus joining the global FX war, maybe you should buy some gold, but I know that yields nothing either. You are the sacrificial lamb in this grand experiment conducted by the unelected officials working at some building named Eccles who seem to have little faith in the ability of the US economy to thrive on its own as it did for most of its 238 years of existence. Borrowers and debt are their only friends. To you responsible saver that worked hard your whole life, may you again rest in peace.

And then we finish with some thoughts from our friend Ben Hunt, who takes exception to being told how to think and believe and act by “those smart people with degrees” who only want to do what’s best for us. Not just in economics but with regard to ISIS and Ebola and everything else. After reading Ben’s essay I called him and said, “Me too!”

I am tired of being manipulated, placated, spin-lied to (if it’s not a word it should be), mutilated, spindled, and folded.

We have to keep our eyes open and entertain the possibility that central banks will “lose the narrative,” that is, their ability to control markets with simple statements. The BIS recently had this to say:

Guy Debelle, head of the BIS’s market committee, said investors have become far too complacent, wrongly believing that central banks can protect them, many staking bets that are bound to “blow up” [at] the first sign of stress.

Mr. Debelle said the markets may at any time start to question whether the global authorities have matters under control, or whether their pledge to hold down rates through forward guidance can be believed. “I find it somewhat surprising that the market is willing to accept the central banks at their word, and not think so much for themselves,” he said. [Source: Ambrose Evans-Pritchard, “BIS warns on 'violent' reversal of global markets”]

The 10-year US Treasury slipped below 2% earlier today, but has rebounded somewhat to 2.06% as I write. Oddly, the yen seems to be strengthening slightly as the stock markets once again fall out of bed. Oil continues to weaken. As noted above, Greeks spreads are blowing out. Super Mario needs to get on his bike and start peddling before that concern spreads to other nations almost as insolvent. France will soon be downgraded again. Don’t you just love October?

What an interesting time to hold a midterm election. Have a great week!

Your really thinking through the implications of a stronger dollar analyst,

John Mauldin, Editor
Outside the Box


The Inflation Imputation

By Cliff Asness, AQR Capital Management LLC

In 2010, I co-signed an open letter warning that the Fed’s experiment with an unprecedented level of loose monetary policy – in amount, and in unorthodox method – created a risk of serious inflation. Sporadically journalists and others have noted that this risk has not come to pass, particularly in consumer prices. Recently there has been an article surveying each of us as to why; seeming to relish in, when provided, our various rationales, presumably as they sounded like excuses. It seems none of the responses provided what the authors clearly wanted, a blanket admission of error. I did not comment for that article, continuing my life long attempt not to help reporters who’ve already made up their mind to make fun of me – I help them enough through my everyday actions, they don’t need more!

More articles of similar bent keep showing up. The authors seem to find it amusing that four years of CPI data wouldn’t get people to change their economic views, while ignoring that 80 years of overwhelming evidence has not dissuaded Keynesians from the belief that this time, if they could only run everything, not just most things, they’d really get it right.

Focusing my attention, as was predestined, Paul Krugman lived up to his lifelong motto of “stay classy” with a piece on the subject entitled Knaves, Fools, and Quantitative Easing. Some lesser lights of the Keynesian firmament have also jumped in (collectivists, of course, excel at sharing a meme). Responding to Krugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like many unpleasant tasks, it’s necessary. I will, at least partially, make that error here, while mostly trying to deal with the original issue separate from Paul’s screeds (though one wonders if CPI inflation had risen in the last four years if Paul would be admitting his entire economic framework was wrong – ok, one doesn’t really wonder – and those things never happen to Paul anyway, just ask him).

Let me say up front that this essay will satisfy nobody. Those looking for a blanket admission of error will get part of what they want; a small part. Those hoping I hold the line denying any misstep will also be disappointed. I believe truth, as is often the case in similar situations, lies in the middle of these and I prefer truth, as I see it, to any reader walking away sated.

We indeed warned about the risks of inflation in 2010 and the CPI has been, to put it mildly, benign since then. First, to give the baying crowd just a bit of what it wants (I will take some of it back soon), our bad (I say “our” but obviously I speak only for myself). When you warn of a risk and it doesn’t come to pass I do think you owe the world this admission, even if you later explain what it means to warn of a risk not a certainty, and offer good reasons why despite reasonable worry this particular risk didn’t come to pass. I, and many other signatories, live in the world of economic or political prognostication, in my case money management, where if you get a bit more than half your calls right you are doing quite well, more than a bit more than half, you’re doing fabulously. I’ll put our collective record up against Krugman’s (and the Krug-Tone back-up dancers) any day of the week and twice on days he publishes.

Let’s start with the big one. We did not make a prediction, something we certainly know how to do and have collectively done many times. We warned of a risk. That’s a very specific choice people like the open letter writers, and Paul, have to make all the time, and he knows this, but that doesn’t deter him. Rather, Paul engages in the old debating trick of mentioning this argument himself and dismissing it. This technique worked for Eminem at the end of Eight Mile. But let’s not be fooled by chicanery (silly Paul, you are no Rabbit). If I had wanted to make a prediction, I would have made one. I didn’t, nor did my fellow signatories. Frankly, if there are any economists, aside from those never-uncertain-but-usually-wrong like Paul, who did not think such unprecedented Fed action represented at least a heightened risk, I think it was malpractice on their part. An honest Paul Krugman (we will use this term again below but this is something called a “counter-factual”) would have agreed with our letter but qualified that while heightened, he still didn’t think this risk would come to fruition and that he thought it was a risk worth running. Still, I will give the critics half credit here, accept half blame, and issue a demi mea culpa. By writing the letter we clearly thought this risk was higher than others did, and wished to stress it, and it has not (as most commonly measured) as of now come to bear. Our, and my, (half) bad. I hope that makes the critics (half) happy and they can stop copying each other’s articles over and over again.

Of course being able to call out risks, not just make firm predictions, is quite important. If you believe the risk of an earthquake is 10 times normal, but 10 times normal is still not a high probability, it’s rational to warn of this risk, even if the chance such devastation occurs is still low and you’ll look foolish to some when it, in all likelihood, doesn’t happen. If you can’t point out risks you are left with either silence as an option, or overly and falsely self-confident forecasts. Perhaps the latter may work for former economists turned partisan pundits but the rest of us will have to live with the ex ante and ex post ambiguity of discussing risks. It’s a real subtlety but I think there is truth somewhere in between the current attack meme of “you predicted inflation risk and were wrong and are now hiding behind the word ‘risk’“ and “we only said it was a risk so we cannot be wrong.” I think when you boldly forecast a risk you are saying more than “this might happen but either way I can’t be blamed” and something less than “this will happen and I stake my reputation on it.” We should all be mature enough to know the difference, but apparently that ship has sailed...

Not surprisingly, the above stress on risk jibes with my personal view of monetary policy, one that might not be shared by all my co-signatories. I tend to think it matters less than most think, and matters less often than most think. I tend to view it, for finance fans, in a “Modigliani Miller” (MM) framework, where most corporate financing transactions are paper-for-paper, mattering little. But, in the MM framework bankruptcy costs do matter. Therefore most corporate capital structure decisions are irrelevant, except to the extent they increase the chance of serious financial distress, in which everyone but the lawyers lose (in many models this risk must be balanced against the tax advantages of debt).

From this perspective, slight adjustments to the target Fed funds rate based on exquisitely sensitive perceptions of the probability of economic overheating or slowdown probably make little difference (and don’t even start me on the dots), but deflation or excessive inflation are important to avoid as their damage can be great. They are the bankruptcy costs of monetary policy. Thus, I think sounding the alarm, not making a prediction, that experimental and aggressive monetary policy raised one of these risks was appropriate. But, still, I think most people engaged on the topic spend a lot of time talking about monetary policy in the same way dogs spend a lot of time talking, yes in their secret dog language, about the cars they chase. The cars aren’t affected and generally don’t care.

Now, if you thought the above was an excuse on par with, continuing my canine fixation, “the dog ate my inflation,” and not the demi mea culpa I intended, you’re really going to hate the full blown non-conciliatory excuses about to come.

Economically, I think what everyone of any political or economic stripe missed, certainly including myself, was how little money would circulate, how little would be lent and then spent. In econo-geek, how low the money multiplier would be. Money kept by banks at low but positive interest rates at the Fed clearly isn’t doing much of anything, creating inflation as we feared, or helping the economy as they hoped. To the extent inflation worriers like us were wrong, so were those predicting great economic benefits. The Fed clearly wanted this money lent by banks and spent by companies on investment and by people on consumption. They didn’t get that, and we didn’t get the inflation we feared. This is not to say that low interest rates, real and nominal, and high prices for risky assets (and the supposed “wealth effect” that comes with them) were not Fed goals. They clearly were. But it seems these intermediate goals have not had their desired effect on the real economy.

Quantitative easing (QE) and other inventive forms of loose monetary policy have simply been less than hoped or feared. Some may declare Fed policy a great success as we’re not in a depression, but they can’t show any counter-factual, and given that this money has largely sat dormant, albeit presumably lowering risk premia (raising asset prices), it’s likely we’d have a similar record-weak recovery with or without it. How this is a victory for one side of the debate or another is beyond me, but obviously clear to Paul and his back-up singers. Of course, it’s also clear to Paul that the 2009 stimulus package saved us from this same second Great Depression (but more stimulus would of course have been much better). Yep, and if we traded good cash for just one more “clunker” we’d be growing at 5% per annum by now with a normal labor participation rate.

By-the-way, ignored in the critics’ review of the original letter was the line, “In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program...” On this I’m unapologetic. We were right, we’re still right, and thanks to people like Paul we’ve moved in the wrong direction. But that’s a fight for another day.

In a field without a broad set of counter-factuals we all stick too much to our priors and ideologies, and perhaps I’m doing that now. But at least I see it, and that’s always step one. Paul is stuck on step zero (if he ever gets up to “making amends” I will be around but given his history he might never get to me). But, if you’d like to advance past step zero, Paul, we’re still waiting on why Keynesianism failed to fix the Great Depression (no doubt not quite enough stimulus; just one more Hoover Dam would have done it, or, as they called it back then, “Dams for Clunkers”), strongly predicted a deep post-WWII depression, didn’t predict stagflation, and generally was on a the downward spiral to the intellectual dustbin until the great recession resuscitated it, not as a workable intellectual doctrine, but as an excuse for politicians to spend on their constituents and causes.

Also remember, much like when the Germans bombed Pearl Harbor, nothing is over yet. The Fed has not undone its extraordinary loose monetary policy and is just now stopping its direct QE purchases. When monetary policy is back to historic norms, and economic growth is once again strong, a normal number of people are seeking and getting jobs, and inflation has not reared its head, I think we can close the books on this one, still recognizing that forecasting a risk and having it fail to come to bear is not a cardinal sin. But which one of those things has happened yet? Paul, and others, should by now know the folly of declaring victory too early.

At the risk of enraging a whole different group (I promise I’m not denying anything I’m just making an analogy, and one I know is very far from dead on) I’m amazed that a Paul Krugman can look at 15+ years of the earth not warming and feel his beliefs need no modification or explanation, but 4 years of the CPI not inflating is reason not simply to declare victory, but to decry those who disagree with him as “Knaves and Fools.” In fact, rather than also anger Mr. Gore and Steyer, I hope they find this paragraph supportive as I’m saying these debates are rarely settled in either direction in short time frames. Now, if I were cheekier (cheek is not denial!) I’d ask if perhaps our letter was right and the inflation we predicted is in fact occurring in the depths of the ocean? Or, maybe we should ex post relabel our letter a warning of the risk of “extreme price action” including of course the extreme stability we have experienced in CPI these last few years.

Now, while not pointing to the actual ocean it is fascinating where inflation has shown up. Don’t limit your view of inflation to the CPI. No, this isn’t a screed where I claim to have invented my own consumption basket showing inflation is rising at 25% per annum – though some of those screeds are interesting. It’s the far simpler observation that we have indeed observed tremendous inflation in asset prices since this experiment began (of course this was part of the Fed’s intent – but it was meant to stoke real activity not an end unto itself!). Stocks, the spreads on high yield bonds, real estate, you name it. Inflation is hard enough to forecast, but where it lands is even harder. If one counts asset inflation it seems we’ve indeed had tremendous inflation. While admittedly difficult to prove, as is any of this if we’re being honest as economics rarely offers proofs, you’d be hard pressed to find many economists or Wall Street professionals who don’t see current extremely high asset prices, and low forward looking returns to investors, as at least a partial consequence of the cocktail of QE, loose monetary policy, and financial repression. I understand Paul and others wanting to avoid this as not only does it show that they have no right to crow on inflation, but that the policies they advocate, and we decried, have had little effect on the economy but instead have, at least partially intentionally, exacerbated the inequality Paul spends the other half of his columns excoriating (while of course living himself off the global median income in protest and solidarity).

By-the-way, again the critics somehow manage to skip another prescient forecast in this same short open letter. We explicitly worried that the Fed’s policies “will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.” That’s econo-geek for “will drive financial market prices up and prospective returns down, and create financial instability when the Fed tries to stop.” Again, while this would perhaps not surprise the Fed, which actively desired low interest rates and a “wealth effect,” it seems that a fair reading shows that this much maligned letter wasn’t as wrong as the critics say, and was very right in ways the critics ignore.

Moving on, please recall that many, not all, supporters of QE and very loose monetary policy in general, did so exactly because they thought it would create some inflation, and they thought (and many still think) that’s what the economy needs. We, we the letter signers, are responsible for our own forecasts, but you might forgive us a bit for taking the other side at their word!

Bottom line, the half mea culpa above was not a throw away. When you go out of your way to warn of a risk and after a suitable period that risk has not come to bear, at least where everyone, including you, expected it, you should admit some error, and I do. But there is a still a big difference between pointing out a risk and making a forecast (hence the half admission!). A big reason this risk hasn’t come to fruition is, while not as dangerous so far as we thought, it appears QE was only mostly useless. To the extent even that is only mostly true, where effects did show up, it actually caused rather a lot of inflation, but inflation that went straight into the pockets of those who needed it least and whom Paul wouldn’t swerve his car to avoid. That is, it inflated financial assets, benefited the rich, and enhanced inequality.

So, to those who’ve been waiting for one of us to say it, you can have half the mea culpa you clearly want, but mostly Paul is wrong, and twisting the facts, and doing so as rudely and crassly as possible, yet again. The rest of the JV team of Keynesians who have also jumped on board are doing the same thing, just with more class and less entertainment value than the master.

Now for a real prediction: Paul will continue to be mostly wrong, mostly dishonest about it, incredibly rude, and in a crass class by himself (admittedly I attempt these heights sometimes but sadly fall far short). That is a prediction I’m willing to make over any horizon, offering considerable odds, and with no sneaky forecasts of merely “heightened risks.” Any takers?

Cliff Asness is Founding and Managing Principal of AQR Capital Management, LLC

Dear Saver, May You RIP

By Peter Boockvar, The Lindsey Group LLC

Dear Saver,

To the forgotten and misunderstood soul, may you rest in peace. There just seems that nothing can save you now. You were bloody and battered after the stock market bubble crashed in 2001 and 2002. Afterward, you stuck with stocks but also decided to play it safe in real estate. That was ok for a few years but your stock portfolio fell again by 50% and while you have a great new kitchen and wood paneled library, the value of your house is now worth much less than your mortgage. I know, renting can be so much easier! But some guy named Greenspan said something about a wealth effect.

Finally you said enough is enough. You wanted a safe, conservative place for your savings where living off fixed income of mostly CD’s and bonds was possible. Maybe you’d buy an occasional stock again but maybe not. You called your local branch banker and were told that for the privilege of being a Platinum Honors client that you would be able to secure a better rate on a money market savings account. Nice! You were told that you’d be able to get .10%, more than triple the standard rate of .03% that the average person gets! Disgusted, you went online and saw this great add on the Bank of America website, it said “With a Featured CD I can earn a fixed rate on my nest egg.” Sounds enticing until you scrolled down the page and saw it paid .08% for a fixed 12 month term. It had to be a typo but unfortunately it was not.

Questioning now how you can ever retire on your savings after working hard for the past 40 years, you decided to find out who can possibly be responsible for these pathetic yields when you know your cost of living is rising well above the 1.5-2% that these statisticians at the government keep telling you. You ask what an hedonic adjustment is? Don’t worry about it because the purchasing power of your money relative to inflation has been declining day after day for at least 6 years now. This is madness you say. I agree.

You started to read the papers and watched the news and learned that the men and women that work at the Federal Reserve, mostly economists who call themselves central bankers, sit around a large table and decide what the right interest rate should be. Ok you say, they are smart, they have models created by people that likely did really well on their SAT’s, they know what they’re doing and this can’t last. Well, I’m sorry to say to you, we’re 6 years into zero interest rates and these people have no intention of ever saving your savings. You’re screwed and even though they say it’s in your best interest because zero rates and money printing will help the economy, don’t believe them anymore because the strategy has failed. After all, If these policies actually worked, I wouldn’t be writing this letter to you.

I wish I had good advice for your savings but I can’t advise buying stocks that have only been more expensive in 2000 on some key metrics right before you know what and I can’t recommend buying any long term bond as the yields also stink relative to inflation. With the Fed now saying that the dollars in your pocket are now worth too much relative to money in people’s pockets overseas and thus joining the global FX war maybe you should buy some gold but I know that yields nothing either. You are the sacrificial lamb in this grand experiment conducted by the unelected officials working at some building named Eccles who seem to have little faith in the ability of the US economy to thrive on its own as it did for most of its 238 years of existence. Borrowers and debt are their only friends. To you responsible saver that worked hard your whole life, may you again rest in peace.

Sincerely yours,

Peter Boockvar
Managing Director
Chief Market Analyst
The Lindsey Group LLC


DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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