There is growing hope in some quarters that economic
recovery is at last under way in the USA. Is this just an election-inspired
pick-up in sentiment, now rapidly vanishing, or do we take it more seriously;
and if it really is recovery, what are the inflationary consequences?
Some observers point to house prices, which show signs
of having turned the corner. The latest Case-Shiller
data shows that house prices rose 8.5% between April and August; and
single-family housing starts are up by 43% compared with last year. Rental
yields, which have stimulated residential investment, are attractive compared
with other alternatives, and average house prices down 30% from 2006 highs
are a further incentive for buyers. And this is the key: housing is
attractive as an asset on the basis that financial alternatives, bonds and
equities, are demonstrably more expensive. Residential property is simply
better than other alternatives.
Financial alternatives, such as government bonds and
equities, have performed well over the last three years on the back of cheap
money, which has flooded the markets courtesy of Mr
Bernanke. Lucky investors are bound to question how much further these
markets can run, now that we face the
fiscal cliff and other uncertainties: hence why it might make sense to
move money from Wall Street to Main Street. As well as residential property,
high levels of personal and private sector debt suggest there will be other
distressed assets available. Could this even extend to a pick-up in mergers
What we are considering is essentially a money-flow
question: how, why and when money parked in non-productive financial assets
will migrate into the economy. This is already happening through unfunded
government expenditure, which is distributed through the welfare system.
However, the private sector is also under increasing pressure to do
something, reflected in the fall in excess reserves held at the Fed by some
$200bn over the last year. When this figure fails to increase in line with
QE3's monthly injection, raw money is simply piling up on Wall Street, adding
to pressure for it to be deployed into the real economy. And money going into
the economy, to the extent it is not neutralised by
the deflator, is simply recorded as growth in GDP.
Therefore, we will see statistical economic growth.
This does not mean that we are about to see economic progress, which is an
entirely different thing. Instead, we have a recipe for stagflation, loosely
defined as a pick-up in prices without an accompanying increase in economic
activity. This happened memorably in the 1970s, leading to a serious
inflation problem by the end of that decade.
This time, there is a far larger overhang of cash
circulating unproductively in Wall Street, ready to be spooked by a future
trend of rising interest rates, which is inevitable from a zero base. The
resulting stagflation will only be the precursor of higher inflation, and
possibly even hyperinflation if not somehow nipped in the bud. Therefore, the
inflationary consequences of what is mistakenly touted as signs of economic
growth will probably be more serious than commonly thought, with the
potential to be upon us more rapidly than anyone currently believes possible.