John Hussman: Real Inflation Is Several Years Off

Excerpt from the Hussman Funds' Weekly Market Comment (7/6/09):

Given current household leverage from mortgage and consumer debt, coupled with the inability to access mortgage equity withdrawals (that largely fed spending increases during the most recent economic expansion), my concern continues to be that unemployment will behave as a leading indicator rather than a lagging one. During typical economic downturns, there is always some feedback from employment losses to credit losses, but that effect has been more contained because debt burdens have not been nearly as high, and homeowners have not been saddled with negative home equity. The dynamic of this downturn is different, so investors should be slow to accept the employment is a lagging indicator argument under present conditions.

On the inflation front, I continue to believe that any persistent inflation pressure is most probably several years out. The primary inflation risk is not simply that the Treasury and Federal Reserve have dramatically expanded the volume of government liabilities. To the extent that these agencies have taken assets in commercial mortgage securities or preferred stock of banks these transactions could theoretically be reversed without leaving a persistent increase of government liabilities in their wake. The real problem is that avoiding inflation here requires that these transactions can be undone, and that will prove impossible if mortgage defaults do not actually stop. There is no reason to believe that they will, particularly given the enormous overhang of second-wave mortgage resets that will begin later this year. So the real problem is not just that we've issued more government liabilities, but that the assets that we've taken in return will turn out to be worth less than the liabilities we created. The difference, of course, will represent pure money creation, and that's what will feed inflationary pressures over time.

Very short-term, to the extent that we observe periodic upward pressures on interest rates, we will also tend to see a pickup in monetary velocity that may lead to month-to-month upward surprises in inflation. But again, the longer-term impact is most likely several years away. Unless we see a major abatement in foreclosures and mortgage losses, neither which I believe is likely here, I expect that the government liabilities we've created will ultimately represent monetization. That doesn't imply hyperinflation by any means, but it does suggest a near-doubling of the U.S. CPI over the coming decade, with most of the pressure coming several years from now.

Comments

[Larry House:]

I think you are absolutely right. With high unemployment, high unused capacity, current deflation, and zombie consumer that just does not spell inflation in the near term. It will have to be reckoned with some day, but not soon.

Jul 07 11:45 AM

[VennData:]

What will remove the problem of "reserve note" liabilities exceeding the assets created is when the Fed's able to issue their their own debt. In the mean time increasing the discount rate will bring money back (that's why those levels are so high now.)

Inflation just isn't a problem, except for salesmen whose business is to sell you inflation protection.

Jul 07 11:47 AM

[TurtleTrader72:]

Inflation rarely comes without wage increases and right now that is definately not happening. Despite the excessive printing of money by the government I don't see inflation being an issue anytime soon.

Jul 07 12:11 PM

[DataBoy:]

Um, is anybody noticing prices at the supermarket, even Walmart?

Inflation is here NOW.

Jul 07 12:51 PM

[user396040:]

I think this is right on the money. There has been a big increase in the percentage of mortgage debt which is directly or indirectly guaranteed by the federal government (Fannie, Freddie, Ginnie, FHA, etc.) - this reduces systemic risk of the failure of a major financial insitution but it may build in years of deficits as the government has to respond to demands that it honor these guarantees. I think inflation is a ways off but we could always get a big pop in oil prices due to geopolitical developments.

Jul 07 12:57 PM

[Living4Divi...:]

Hussman: transactions "could theoretically be reversed"

Theoretically, yes. Practically ?

Jul 07 02:25 PM

[Steve in Gr...:]

Social Security and Medicare are going cash flow negative either now or soon. Huge increases in Federal spending are coming via the stimuli (1, 2 and 3 and maybe more). Health care "reform" will further accelerate the cash flow drain. The States are bankrupt. All this spending cannot be financed with tax rate increases, because this will reduce the total collections, nor can it be financed much longer by Treasury note issuance, because we are reaching the limits there as well. Further money supply inflation will have to happen on top of what has already been done. Our Chinese creditors are getting sick of our debt and are looking for alternatives. The economy will pick up in the rest of the world in 2010, but not in the U.S. and all these USD will begin to chase non-U.S. real assets. The result will be accelerating USD price increases and economic stagnation in the U.S. during 2010. We've got the first half of the Misery Index (unemployment) in 2009. We'll get both halves (plus inflation) in 2010.

Jul 07 02:29 PM

[Pink Panther:]

There are two types of inflation:
1. the supply/demand driven one -> self correcting, "regular" inflation
2. the one caused by loss of confidence and a drop in the value of a currency; when everybody wants to bail out of a currency before it's too late -> self reinforcing, hyperinflationary type of inflation

I agree, that the former is out of question right now.
But watch out for type 2, I'd be very concerned in case the dollar hit record lows

Jul 07 04:11 PM

[John Galt:]

The deflation camp says that we have huge deflationary market forces and therefore we will have deflation. They focus on the deflationary forces.

The inflation camp says that we will have inflation because of our government's response. They focus on the response, and yes, printing obscene amounts of money is an inflationary thing to do.

So we have deflationists focus on the market forces, inflationists focusing on the response.

I believe that inflation is THE ACT of bidding up prices ( not just on 1-2 goods, but across the economy). Your old Econ 101 text book might call inflation " more money chasing fewer or the same amount of goods... Which results in higher prices and lower purchasing power.

but the key phrases here is "chasing". For more money to "chase" fewer goods you can't have people sitting on money, depositing it in the bank, paying down debt. We have a consumer drive economy and the consumer is dead. They aren't spending. Look at the money multiplier. Are banks lending money, is it flowing through our economy? Are people buying things and trading?

Yes the government printing more money, but it is NOT chasing goods and we have even government reported CPI negative. They under reported inflation just like they are under reporting deflation.

Falling home prices
Falling... flat at best wages
People getting new/temp jobs are paying much less
Oil is down from 147
Commodity prices are way off their highs
Prices on many consumer goods are falling

Does that sound like inflation to you? It sounds like a deflationary spiral to me. More money sitting in the bank will be spent at some point in the future. When banks start lending or people start spending then *that's* the catalyst but right now we are in a deflationary enviornment.

I'm in the deflationary camp and a lot of deflationists are bullish ( while inflationists are more bearish), but I am bearish.

Jul 07 04:54 PM

[DaveW:]

The 'inflation speculation trade' is here now, a me-too bubble about to burst...


On Jul 07 12:51 PM DataBoy wrote:

> Um, is anybody noticing prices at the supermarket, even Walmart?
>
>
> Inflation is here NOW.

Jul 07 06:43 PM

[Jimbo:]

John Hussman always gives us thoughtful essays. I would suggest that inflationary AND deflationary forces are at work at present. Wages, for those still employed, are flat or even declining. Real estate of all types is declining. But consumer prices for everyday living are increasing. Permit me one puzzling example: I have been buying ten quart packages of dry skim milk to hold down my fat consumption. It wasn't too long ago that a ten quart package cost $5.85. Then, the price went to something like $6.40. I switched to another store. That store stopped carrying powdered milk. The original store now charges $7.99 a package. But fresh milk at the original store is selling a gallon of milk for $2.89. The fresh milk is now cheaper than the dry milk. And I read that dairy farmers are culling herds because they cannot make a profit! The cost of many foodstuffs have gone up steadily. Given that wages are flat, or declining, It looks like the best descriptor for our situation is STAGFLATION.

Jul 08 02:37 PM