In a speech at the New York Economics club on Wednesday, Fed Chairwoman Janet Yellen gave a speech on monetary policy that signaled her easy money bias is alive and well. After six years of zero percent interest rates and with trillions sloshing around the financial system, Mrs. Yellen handicaps the chances of too high inflation as significantly below the chances of persistently low inflation.
Mrs. Yellen’s comments echoed the comments of another economist that is ostensibly in the know, Christine Lagarde, the managing director of the International Monetary Fund (IMF). At the IMF’s spring meetings, Lagarde raised concerns about an extended period of low inflation in advanced economies.
My initial reaction to this was, inflation is too low? How can that be? What goods and services prices is the government measuring? My cost of living isn’t rising too slowly. How about yours?
The single largest expense for most Americans is the cost of a home. Home prices are up 13% over the last year. What about transportation and food—some of life’s other necessities. The Bureau of Labor Statistics reports that used car prices are basically flat over the last year. But numbers from private sector firms show that prices are up 3.3%. Food price inflation is subdued in the CPI, but if you are planning a Memorial Day barbeque this year, your grilling meats are going to run you about 5% more than they did last year. That doesn’t seem like too low inflation.
My second reaction to Yellen and Lagarde’s concerns about too low inflation was, be wary of economists bearing forecasts. When economists doubling as policymakers start ringing alarm bells about an economic issue, the time to worry has usually passed.
Talk of too low inflation is starting just as capacity utilization (a leading indicator of inflation) and loan growth (another leading indicator of inflation) are beginning to perk up.
In March, capacity utilization hit 79.2%–its highest level since the recovery began. The long-term historical average is about 80. When utilization rates rise above 80 inflationary pressures start to rear their ugly head. The same is true of bank loans. The Fed can flood the system with liquidity without causing measured inflation to rise, but when banks start turning that excess liquidity into loans, money growth rises and so does inflation. Business credit is now growing in excess of 12% per annum.
The takeaway for investors: As Ben “The-Sub-Prime-Crisis-is-Contained” Bernanke taught us, crafting an investment strategy on the forecasts of prominent economists can be a costly endeavor. Inflation remains a threat that you should prepare for.
Jeremy Jones, CFA
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