Markets are hoping the Fed has got the message

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Fed Chair Janet Yellen finished up last week, and the Federal Reserve voted unanimously Wednesday to keep its key interest rate unchanged at 1.25 to 1.5%, while they proudly announced that Inflation is still below the Fed’s 2% target.  That was a farewell gift to Yellen, so she can leave with her legacy intact.

With Yellen’s retirement, the theory is that interest rates in the USA will be open to rising in the future, possibly as soon as the next Fed meeting in March.  Then came the horrible news on Friday that unemployment was again sharply down, and wages were rising by a minuscule factor.

Canadian boob Mark Carney helped things along by announcing that the Bank of England would have to raise their interest rates “faster then previously guessed”.  Every single one of Carney’s previous guesses in his role has been nonsense, obviously, but for some reason people keep believing him. The Bank of England’s interest rate sits at 0.50%, a rate it hasn’t breached since 2009.  The BoE’s inflation target is also – miraculously – 2%.

The idea that that would make interest rises a near certainty sent the financial market system into action.

It was officially called a “correction” last night, when the drop of the Dow Jones and the S&P500 tipped over 10%.

The market has played smaller versions of this little melodrama out over the past years, temporarily throwing market scares in to get central banks to retreat from their interest rate increase promises.  This is their biggest tantrum yet since the GFC, so this time they must be really worried about it.

They’re hoping the Fed and the other central banks get the message and retreat from the idea. Yellen retracted her rate hike schedule right at the point of the 2016 lows – financials bottomed out on the same day.  Politicians will be desperate that they do. And that’s a problem for you – if you live in the Western economies.

Political and central bank decisions on interest rates that are based around nonsense inflation numbers are eroding the wealth of the vast majority of its citizens who don’t comprehend it. Almost none of the public have a grasp of what has been happening to their money this century – a process that is making almost all of the Western world poorer.  And its a process that is almost certain to accelerate.

Governments need inflation – but have to hide it

Western governments – all with aging populations – are completely incapable of funding the pension and medical needs of the hundreds of millions of people set to retire in the next few decades. That’s without the periodic, politically-driven spending binges they go on.  National debts are now so high that most can’t afford the interest payments without printing money, let alone pay back the loans. The only way they can repay what they owe is by creating money – some version of borrowing via selling bonds, which is currently dressed up as “Quantitative Easing”.  If the money they owe is worth less in the future, it’s easier to keep up with interest payments, and try to pay back.  The problem with that is, its your money that’s worth less.

Quantitative easing boosts asset prices – but “assets” (like property and shares) are unevenly distributed across the population.  The wealthiest and older households become even wealthier, while QE-induced house price inflation and rent increases disadvantage non-homeowners and the young.  If politicians announced tax changes to enrich the wealthiest of society and redistribute wealth away from young to old there would be riots in the streets. But disguising the measures as “monetary policy” means the young, furiously attempting to vote for Bernie Sanders or Jeremy Corbyn, don’t notice. That keeps the protests minimised to “my student loan went up” or general Trump/Tory themes.

Now, obviously, the problem for governments is that when they invent money, it causes inflation.  And the trick is how they get away with it.

Real inflation today is far higher than what governments report.  I’m sure you shrug it off when you hear the number, but if you thought about it, there is no part of you that believes that prices have risen between 0% and 2% a year for the past decade.

With very few exceptions (like say, consumer electronics), the price of nearly all of the things you actually need in your life – food, transport, property, medical care, insurance, education – is going up by substantially more a year than the mythical CPI or RPI inflation numbers proudly published by governments.  If the pre-1990s methods of measuring inflation were currently being used, inflation would be happily advertised as more like 10%.

The modified inflation calculations use mechanisms like “substitution”, “geometric weighting” and “hedonic adjustment” to reduce the rate of increase in the cost of a “basket” of purchases:

  • Substitution is when statisticians replace something in the “basket” that is going up in cost a great deal with something that isn’t. That’s an incredibly handy tool.
  • Geometric weighting is when a cost item is made to be a smaller percentage of the “basket”.  For example, the healthcare sector represents just over 17% of the US economy, but it makes up only 6% of the US inflation calculation.
  • Hedonic adjustment is the best one: its when an item is reduced in price for the purposes of the inflation calculation because they claim that you’re getting more for your money and you are therefore effectively paying less. This trick is used to adjust the price of nearly half of all the products that go into the inflation calculation.

Those three methods of cheating the numbers leave out another famous trick: “Shrinkflation”.  This is where a company gives you less of a product for the same price. Companies are dealing with severe input-cost inflation just like you are, and one of the easiest ways for them to keep their profit margins static is to give you less for the same money and hope that you won’t notice. Chocolate companies have become famous for it.

The inflation numbers are a myth, but they’re used by governments to defend keeping interest rates on their bonds low, keep genuine inflation high, and to make their debt less expensive in real terms.  And they’re all doing it: Europe, Australia, New Zealand, the USA, Great Britain.

Any politician that upsets that apple cart by saying “we’re cutting services, government wages and pensions” as opposed to “we’re maintaining our quantitative easing program” wouldn’t last a week.

But again – this is your money that’s worth less every year.

Genuine inflation is going to continue to rise

This isn’t some temporary cyclical blip: it going to continue.  And the majority of people have no idea of the scale of the problem.

Globalisation has meant that billions of people elsewhere in the world have finally been able to compete for the Earth’s inherently limited resources – oil, fresh water, agricultural products, timber, metals, etc.  For centuries, markets for all of these things were completely dominated by people from developed countries. What we today call developed countries were the first to industrialise, and they used their technological and military superiority to build empires to dominate the acquisition of those resources.

Initially, developing countries were only able to catch up with the West in the relatively unskilled agricultural sector, as well as some extractive primary sectors like mining (capital often gave Western entities ownership of the profits form those industries anyway).  Increasingly, those countries moved into more lucrative manufacturing sectors too: think post-war Japan, the Four Asian Tiger economies of Hong Kong, Taiwan, South Korea and Singapore after that, and recently Brazil, India, Vietnam and Turkey.  Further technological advancements in telecommunications and travel mean that a tidal wave of people are now competing with Westerners for highly paid jobs in white-collar sectors: IT, engineering, and business services such as finance and consultancy.

Countries that previously didn’t have a middle class at all now have one that numbers in the tens, even hundreds of millions.

So now, people in the developing world are increasingly able to compete for jobs and capital with those in the West.  That will mean the demand and “value” of Western labour will continue to go down, and the cost of resources is going to continue to go up. Genuine inflation, not the bullshit numbers you’re fed, relative to wage increases, is going to remain rampant.

“OK, whatever – do you have a point in all this?”

Yeah, I’ve got a few:

  • Inflation figures are bullshit, so if you didn’t get a pay rise of 7-10% or more last year, you’re poorer than you were.  And every year that happens, you’re going to continue to get poorer.
  • Inflation figures are bullshit because they’re used as the premise for government money-printing levels – which they need to maintain, to manage their debt levels.
  • This 10% market tantrum (which started in a week when 5 of the 6 biggest US market cap companies reported stellar, double-digit profit rises) is a message to the Fed and other central banks not to get off course.  They have no motivation not to heed it.
  • If you want to do better out of this system than the rest of the population, you need to own productive assets: businesses, shares, rental and commercial property and commodities.  You’re not going to keep up with actual inflation relying on your job to pay you more than 7-10% or hoping your government pension will ever allow you to survive.

I hope that didn’t depress you too much.

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