Inflation, Stealth Style

Running deficits and slashing interest rates has widened in the gap between the have-a-lots and have-a-littles on both sides of the border

October 27, 2014
by Michael Hlinka

From the October, 2014 print edition

There are two key economic indicators that people in positions of power—and by that I mean politicians and central bankers—look at very carefully, and those are unemployment and inflation. Since the so-called financial crisis (I say “so-called” because I believe that what it really signalled was serious structural problems) of 2008-09, unemployment on both sides of the 49th parallel has remained stubbornly high. The latest numbers from Canada suggest that it’s hovering around seven percent while in the US it stands around six percent. As I’ve noted on several occasions, I think that these numbers grossly understate the real unemployment rate:  I’d put it around 10 percent in Canada and 12 percent in the US.

I suppose that one could say, “Okay, Hlinka, I’d agree that we’re not seeing the labour markets spring back in the manner we would have hoped. But at least there aren’t inflationary pressures.”  That is seemingly a fair comment. In North America, we measure inflation with the consumer price index. It has held steadily around two percent in Canada over the past while, slightly below the longer term average of three percent. It’s been even lower in the US over the past three years, bouncing between 1.6 percent and 1.7 percent.

This has surprised many people. In addition to governments on both sides of the 49th parallel, running large deficits (the federal deficit in this country understates the true picture because of the province’s spending), both the Bank of Canada and Federal Reserve have pushed short-term interest rates down into uncharted territory. The target for the bank rate—which is the rate at which the major financial institutions can borrow from one another in the overnight market—is one percent, while the Fed Funds rate, the US equivalent, ranges between zero and one-quarter of one percent. For all intents and purposes, money is free, which means that there is a lot of it sloshing around in the system. Therefore, by the simple dynamics of supply and demand, you would think that there would be inflation, wouldn’t you? According to the CPI there isn’t; however there is something else going on right now in North America and I think of it as inflation, stealth style.

Years ago, economist Milton Friedman famously said that inflation was always a monetary phenomenon. What he meant was that it only results when there is a shortage of desired goods and services, relative to the money that is there to purchase them. Let’s say that a country produces 100lbs of peanut butter and 100lbs of jam, and each is equally valued.  There are $200 in the economy. Doesn’t it stand to reason that the price of both peanut butter and jam would be $1 a pound? Now let’s say that the money supply doubles, but the output remains the same. Isn’t it equally logical that the price of both products will double, along with the money supply? The answer is self-evident.

Okay. But what if after the money supply is doubled, people aren’t interested in buying any more peanut butter? They only want jam. It’s common sense that the price of peanut butter would remain where it was, while the price of jam would soar to $3 a pound. If this simple example makes sense, then we can transport it to today’s world and understand the inflation that is occurring in front of our eyes, that is not being captured by the consumer price index.

It’s asset inflation. Housing prices are at an all-time high in this country and what few Canadians realize is that the average price of US homes has surpassed the previous high water mark from 2007-08. Both the Dow Jones Industrial Average and Standard and Poor’s index have been hitting all-time highs virtually every month. While it’s true that commodity prices are well off their peaks, it is equally true that if you look at a slightly longer time horizon—here I’m thinking 10 years—many have appreciated sharply. Gold, for example, has increased at a compounded rate of 11.5 percent in the past decade. And for goodness sake, several months ago two paintings by Andy Warhol sold for $100 million!

What does all this mean? For one thing, it points out how badly those in charge have done in “fixing” the North American economy. By running deficits and slashing interest rates, they’ve been applying bandages when, if I may extend the triage metaphor, the bleeding has been internal all along. We’ve seen a widening in the gap between the have-a-lots and have-a-littles. The jump in housing prices, in particular, will lead to less social mobility than we’ve enjoyed before in this continent. So while the inflation of today isn’t as bad as the inflation of yester-years, it’s not to say it isn’t happening.

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.