Monday, January 7, 2013

The future of inflation

Despite the clear deflationary implication of Congress’ latest tax hike, many on Wall Street are actually worried about inflation. 

“It’s Not Too Early to Worry about the End of Fed Easing” proclaimed one recent news headline.  The article was written in response to the release of the minutes from the U.S. Federal Reserve’s latest meeting which were released last Thursday.  The minutes revealed that Jeffrey Lacker, Richmond Fed Bank President,  is concerned that the Fed’s bond-buying stimulus plan will eventually stoke inflation. 

“It is unlikely that the Federal Reserve can push real growth rates materially higher than they otherwise would be, on a sustained basis," said Lacker.  “I see an increased risk...that inflation pressures emerge and are not thwarted in a timely way.”  The minutes showed several members of the Federal Open Market Committee foresaw a chance that asset purchases would need to be slowed or halted altogether before the end of 2013. 

Just like that, Wall Street has a new worry going forward, viz. the end of quantitative easing (QE).  This is in marked contrast to Wall Street’s worry of just a few weeks ago that the Fed was going overboard with QE.  Investors are now apparently torn between the fear of inflation and the worry that the Fed’s efforts at re-inflating the financial market will end too soon. 

A straight forward reading of the long-term Kress cycles tell us that inflation won’t be a major concern until after 2014.  The dominant long-term components of the 120-year cycle, the 40-year and 60-year cycles, will both bottom around October 2014.  The increasing descent of these cycles into late 2014 is expected to create significant deflationary pressures on the economies of developed nations, particularly the U.S.

This is one of the main reasons why the Fed’s intensive efforts at re-stimulating the economy through QE have been relatively ineffective.  As the following graph vividly shows, each successive QE has resulted in a less vigorous increase in equity prices, to say nothing of economic output. 

Inflation is also being kept at bay through the deflationary policies of the U.S. Congress (payroll taxes, Obamacare taxes, etc.) as well as the austerity policies of other major governments around the globe.  The year 2013 will ultimately tell the tale of whether the Kress deflationary scenario comes to pass.  My best guess is that we’ll start seeing an erosion in retail sales by the second quarter with increasing deterioration in each subsequent quarter.  By the end of the year corporate profits will be in decline, then the real trouble begins entering the fateful final year of the 120-year cycle – 2014.  

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