January 8, 2008

ALL THE TALK IN THE WORLD CAN'T CREATE INFLATION WHERE NONE EXISTS:

Weighing In on Inflation (CAROLINE BAUM, January 8, 2008, NY Sun)

With the tremors from the residential real estate market working their way first through the financial system and then into other areas of the economy, the Fed's "inflation problem" won't exist for very long. Something's gotta give.

"Japan is a perfect example of what asset price deflation can do for you," Mr. Kasriel said.

For the last decade, consumer prices in Japan have fallen at an average rate of 0.2%. Rock-bottom interest rates — the Bank of Japan's benchmark rate has been below 1% for 12 years — have done nothing to alleviate the modest deflation, or decline in the price level.

Hard to believe, but Japan's double asset bubble — in real estate and stock prices — burst in 1989. And it still can't dig out from under.

The slowdown in economic growth and inflation isn't necessarily contemporaneous. Inflation is a lagging indicator, generally peaking after the economy enters recession, according to Mr. Kasriel.

A fire can't burn without tinder; inflation can't smolder when the Fed is creating the raw material at a snail's pace. The monetary base, which consists of bank reserves and currency, is growing at an anemic 1.1% rate. In inflation-adjusted terms, the base is contracting.

All the talk about the Fed's inflation problem doesn't seem to have registered with the market where expectations are weighed. The spread between nominal and inflation-indexed bonds, a proxy for expected inflation, has been falling.

The yield on the 10-year inflation-indexed Treasury fell to 1.54% last week. A year ago, the yield was 2.4%.

This is a real yield. The holder is compensated separately for inflation.

Posted by Orrin Judd at January 8, 2008 7:53 AM
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