by Daniel Putnam | October 1, 2012 12:35 pm
Ever since the Federal Reserve announced its latest, open-ended version of quantitative easing, it seems as though everyone with an Internet connection has weighed in on the next problem we’re all supposed to worry about: runaway inflation. While it’s true that continued money-printing is likely to lead to broad-based inflation at some point — rising prices are a “monetary phenomenon” after all — there’s nothing to suggest that the issue should be a concern in the immediate future.
Here’s why: Neither of the usual precursors — tight employment markets and elevated capacity utilization — is in place.
Looking first at the jobs market, the fact that unemployment is high is hardly news. However, the pressure on Americans’ pocketbooks runs much deeper than the headline unemployment rate. Investor’s Business Daily reports that household incomes fell 1.1% in August, 5.7% since June 2009 and 8% since the start of the Obama presidency. In addition, human-resources consulting firm Mercer reports that companies expect to increase employees’ base pay by 2.9% in 2013, not much more than the 2.7% registered in 2011 and 2012.
This indicates that the classic model of rising inflation — too much money chasing too few goods — just isn’t happening right now.
Capacity utilization, meanwhile, is well off of its post-crisis lows, but at 78.2 it’s still below the long-term average of 80.8 (dating back to 1967). While there’s plenty of debate about the relationship between capacity utilization and inflation, it’s tough to see economic growth being strong enough to cause significant uptake of the excess capacity that continues to exist.
It’s also noteworthy that the Treasury yield curve has flattened since the Fed’s announcement — the opposite of what would be expected if the smart money were starting to place its bets on sharply rising inflation. What’s more, the breakeven inflation rate implied in the difference between the nominal 10-year Treasury and the 10-year TIPS fell to 2.42 percentage points at the end of last week after being as high as 2.73 in mid-September.
These aren’t the only considerations for investors weighing potential inflation threats, however. The real argument against inflation as an immediate threat is that while this round of QE is more aggressive than any thus far, the fourth anniversary of QE1’s inception is coming up on Nov. 25. In this interval, there also have been varying degrees of monetary stimulus from Japan, the U.K. and the European Central Bank.
If this much money has been hurled at the financial system over a four-year period without any significant impact on price levels, why is the latest round of QE going to be the stimulus that makes the difference?
This isn’t a call to run out and starting shorting iShares Barclays TIPS Bond Fund (NYSE:TIP), SPDR Gold Trust (NYSE:GLD) or any other asset class seen as being an inflation hedge. Instead, it’s a broader warning not to get carried away with the discussions of the inflation threat. This is truly a case where investors need to see the proverbial whites of inflation’s eyes before concluding that “QE-Infinity” is a recipe for disaster.
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