It seems rather ludicrous to be worrying about inflation when the economies of the western world (and many of those in the wider global community) are on the verge of recession. But the seeds of inflation are a long time germinating and once started are terribly difficult to control. So it is not surprising that the commodity markets this week have reacted to the longer term threat of inflation with a renewed interest in the price of metals, so readily seen as a hedge against inflation during much of this decade. How long the current mini-rally will last remains to be seen but speculator fears over inflation are probably well founded assuming one is looking forward into the next decade. The Bank of England announced last week that it was becoming the first central bank to implement a policy of quantitative easing ” essentially printing money and pumping it into the economy by buying private and government debt, bonds and other financial instruments.
The size of the intervention by the Bank has caught investors by surprise. The Bank has announced £150bn ($200bn+) is available yet the entire corporate bond and commercial paper market in the UK is worth only £57.5bn ($80bn), and total gilt-edged (equivalent to US Treasuries) government debt eligible for the Bank’s auctions totals just £250bn ($350bn) according to the Telegraph newspaper this week. This isn’t tinkering around the edges. Not surprisingly, the UK gilt market jumped this week by the biggest amount in 17 years on the news.
The objective, to reduce the cost of borrowing, still stubbornly high even though the Bank base rate is at 0.5%, is to increase the amount of money in circulation promoting growth and trade. Laudable objectives and if the Bank can pull it off without sowing the seeds of inflation further down the line it will be applauded. However, they are charting unknown waters. Previous extreme examples such as the Weimer Republic in Germany and Mugabe’s Zimbabwe led to hyper inflation. The markets can perhaps be excused then for fearing even a modest return to inflation in a couple of years, whether that warrants buying commodities today is highly doubtful but speculators are by their very nature an optimistic lot and moved as much by sentiment as fundamentals. Interestingly, gold traditionally a strong commodity hedge perked up last week but has since fallen back, playing it’s more recent roll as safe haven rather than inflation hedge. Although Ben Bernanke has talked about adopting quantitative easing in the USA no decision has formally been taken yet. The UK was probably prompted into moving now because recent nominal GDP growth in the UK has fallen to 0.5% the lowest in 50 years and way below the sustainable nominal GDP of 5% year over year according to Citigroup. The last time the UK experienced such repeated declines in nominal GDP was in the 1930’s.
For those interested in a concise definition of the various stimulus methods open to the central banks, the Telegraph newspaper has listed them out in a recent article which should be entitled Stimulus Options for Dummy’s ” let’s hope our central bakers aren’t the dummies. Our future rather depends on them getting this right.