Friday, May 12, 2017

A Whiff of Inflation

Yesterday's PPI number -- 0.5 percent -- was mildly shocking to the markets.  A six percent annualized inflation rate would change things considerably.  No one, of course, is expecting PPI number to be anything other than an aberration.  But, what if it isn't?

In one important way higher inflation could be therapeutic.  Inflation lowers the "real" value of debt and, ultimately, inflation may be the only mechanism to reduce the absurd sovereign debt levels in the western economies.  Inflation euthanizes sovereign debt in a way exactly equivalent to taxing the principal value of the debt.  It just looks different and often goes unnoticed.  The public won't agree to taxes to lower the value of debt, but they may well not notice that inflation is eating up the value of the debt.

The true economic problem with inflation arises to the extent that it is "unexpected."  Future commitments make assumptions about future economic values, including the "expected" future inflation levels and interest rates.  If these latter two variables prove to be widely different than earlier expectations, there could be real economic dislocation.  Expected and constant inflation poses few problems since contracts can be adjusted to reflect such inflation, but unexpected inflation can be disastrous because it makes so many past decisions look foolish in retrospect.  Resources get consumed in a wasteful manner, if expectations are too far off the mark.

So, keep an eye on inflation indicators.  They could be game changers.

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