Some folks are debating whether central banks’ inflation targeting makes any sense.
Part of that debate centers around the extent to which the financial crisis and structural deflationary forces (think: technology) have effectively relegated traditional models to the dustbin of history.
If that’s the case, then central banks are chasing the dragon – minting trillions and trillions in fresh printing press money in pursuit of a goal that ultimately isn’t attainable.
In the meantime, all of that liquidity ends up inflating bubbles in financial assets. Bubbles which, when they pop, will ironically plunge the world back into the deflationary doldrums and presumably send central bankers back to the printing presses to do the same thing all over again.
There’s all kinds of evidence to support that assessment. There are bubbles in financial assets everywhere you look and yet the inflation measures that (mis)guide central bank policy remain stubbornly depressed. Any slight uptick in headline CPI prints is scrutinized in a fruitless (and increasingly desperate) effort to discern a trend while everyone ignores meteoric moves in everything from tech stocks to cryptocurrencies to real estate.
That’s the backdrop for a decent piece from Bloomberg’s Cameron Crise called “Asset Price Inflation Is Right On Target.” More below…
One of the most important things you can do when managing a portfolio is to focus on the things you can control while mitigating the impact of things you cannot. Mistaking the two can often lead to disastrous results. The same holds true for policymakers, and markets are offering a timely reminder of the danger of tilting at windmills.
- Three developments grabbed my attention over the last few days: the pullback in technology stocks, the parabolic rise in crypto- currencies, and the economists’ letter calling for the Fed to raise its inflation target.
- Despite the horrible price action in technology shares recently, let’s put things in perspective: FANG stocks are still up well more than 20% on the year. That’s an awful lot. At the same time, the price of many crypto- currencies has gone parabolic in a way that we haven’t seen since tech stocks in the late 1990s. There’s even the same “new paradigm” driving the price action. If that’s not a speculative bubble, I don’t know what is.
- Meanwhile, economists think that if only the Fed targets higher inflation, the economy will respond. Is Jeff Bezos really going to say, “OK, I’ll give up a bit of market share because the Fed says they’ll tolerate higher inflation?” Somehow I think not.
- In fact, there is overwhelming evidence that the Fed has no control over the price of durable goods, which comprise 11% of the personal consumption basket. The durables deflator as fallen monotonously since the mid-1990s. Stripping out durable goods puts the “PCE deflator for things the Fed can control” about 0.3% higher.
- But back to tech stocks and crypto-currencies. The transmission mechanism for Fed policy generally comes through asset prices. I constructed a “PCE asset price” index that reflects the asset allocation of U.S. households in housing, equities, and fixed income since 1990. Quelle surprise! Asset inflation is back to pre-crisis levels.
- The late 1990s saw a period of low core inflation and rampant asset price inflation that ended with a spectacular speculative bubble. While I wouldn’t necessarily tar today’s equity market with the same brush, crypto-currency price action is eerily familiar.
- In fairness, the size of that market remains pretty minuscule in macroeconomic terms. Yet to my mind it’s a canary in the coal mine, a warning of the dangers of a monetary focus on inflation that central banks cannot really control while ignoring price rises in things that they can. At least one member of the ECB seems willing to consider this viewpoint; the Fed would do well to think on it as well.