The father of inflation warns for... inflation

Gastopinie door Frank

Mr Alan Greenspan, the father of inflation, wrote an interesting article in the Financial Times titled:Inflation – the real threat to sustained recovery. Amazing indeed. The man who layed the groundwork for the biggest credit bubble and asset inflation bubble in the history of this planet is warning us that inflation might threaten a possible recover. This smells like a need for closer examination and some remarks...

"The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged."

Excuse me Mr Greenspan, but raising debt supported by a capital buffer made up by equity value does not seem like an improvement to me when the problem was too much debt that imploded the equity value in the first place. Furthermore, diminishing fear of insolvency doesn't mean diminishing insolvency. You are either insolvent or not insolvent. And beyond that Mr Greenspan, corporate equity value is not the same as corporate value. Corporate equity value is the perception of the corporate value by the market. I'm always careful with perceptions especially when everybody seems to make the wrongs ones in our past bubbles.

Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy."

Dear Alan, this paragraph merely suggests that higher stock markets would bring us back to the good old days of 2007 of asset inflation, inflated book values, leverage, easy lending practices, securitisation and spending beyond our means. But wasn't too much asset inflation, unreal book value, too much leverage, too easy money, too much lousy securitisation and too much spending the cause of this mess? What you want is to go back to the situation that caused this mess. How can that possibly prevent deflation when it caused it? Please explain to me what you mean by stepping up lending and reducing leverage simultaniously.

"Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it."

Pardon me Mr Greenspan, but next to euphoria and fear I would also place easy credit or in other words: leverage. Furthermore, if present stock prices are a forecast for future business activity, then why are you warning for inflation?

"For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3½-year lag) with annual changes in money supply per unit of capacity."

Mr Alan, what makes you think that the FED or government can possibly do anything about our current problems? Where is your humility? Central banks all over the planet have been working overtime like never before, printing like mad and yet almost everything around them is deflating at warp speed. The FED has had every forecast and prediction wrong for the past 18 months. What can you possibly say or do to convince us that you guys can solve the problem when you are the ones who created it? You should have warned us for inflation in 2003, not now Mr Greenspan. Futhermore, central banks should realize and admit that they've lost control over the problem. It is only when the market is going to realize that, that the real severeness of this crisis is going to surface.

"Inflation is a special concern over the next decade given the pending avalanche of government debt about to be unloaded on world financial markets. The need to finance very large fiscal deficits during the coming years could lead to political pressure on central banks to print money to buy much of the newly issued debt. Current debt issuance projections, if realised, will surely place America precariously close to that notional borrowing ceiling. Fears of an eventual significant pick-up in inflation may soon begin to be factored into longer-term US government bond yields, or interest rates. Should real long-term interest rates become chronically elevated, share prices, if history is any guide, will remain suppressed."

Sometime in the future inflation may be a problem. However, I think that this "sometime" is far away. Central banks are printing huge amounts of money. The problem is that this money does not get into the market. Central banks are not sending money to people or businesses. They are giving it to banks. And banks are not lending. They can't because they are insolvent and don't find any creditworthy borrowers who still want to expand their debt. Because of that, there is no multiplier effect through fractional reserve lending. Futhermore, the amounts of money that central banks print pale to the gigantic amount of debt floating around in the financial system. Debt that can not possibly be paid back. Central banks created the biggest credit and inflation bubble in the history of the planet. That bubble is deflating now.The big credit pyramid is slowly imploding.Deflation is not the problem, it's the cure for the problem.