Desperately Seeking Inflation

Central banks around the world have formed a consensus that they could and should manage wages and prices to a steady 2% rate of inflation. The reason for doing this is to allow wages to adjust downward so that national competitiveness is improved and economic growth follows. History says that nominal wages are remarkably “sticky” so that companies cut payrolls by laying off employees rather than reducing wages. Obviously this is politically undesirable – and make no mistake, central banks are political creatures – so the idea is a steady, stealthy reduction in real wages.  In other words, a company that does not raise wages effectively reduces them. Japan has kicked off a major money-printing initiative, referred to as “Abenomics,” with the stated goal of raising inflation.  I am continually surprised that financial journalists think that the decline in real wages in Japan is an unintended consequence of “Abenomics.”

Tomorrow morning, the Eurozone CPI for May will be reported and is expected to show a y-o-y increase in the vicinity of 0.6%, down from a previous 0.8%. The ECB is expected to respond to this report with its own version of Abenomics, in a probably vain attempt to manage prices and drive down the Euro against the dollar.

China is resuming its own stimulus and the yuan has responded with a steady decline. Competitive devaluation is beginning to take hold as the expected ECB announcement will signal that three of the four largest economies are engaged in competitive devaluation, attempting to export deflation. Of course the Fed will be unable to resist the temptation to join the fray because the proposed recipient of the deflation is the US. Things are about to get interesting.

Of course, the truth is that there is nothing wrong wiht deflation. Mild deflation is the normal state of a healthy economy, as technology and capital investment improve productivity and reduce costs and prices. But if the economy were healthy, we wouldn’t need all these Fed interventions and no-one would pay $250K for a half-hour after dinner speech by a retired Fed chairman. And that would be sad, wouldn’t it, Mr Bernanke, Mr Greenspan, Ms. Yellen.



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