Inflation not purely a monetary phenomenon

I'm puzzled. Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon," yet when I apply this to the UK it doesn't work.

I looked at the Bank of England's figures for M4 from end 1963 to end 2007, and by my calculation the monetary base has increased by a factor of about 240; yet prices have increased only 15 times in the same period. (*)

Currently (and time permitting) I'm also working through David Hackett Fischer's "The Great Wave". In his concluding chapter, he lists seven different causal explanations of inflation, and none of them quite fits the observed facts, not even monetarism. For example, in the sixteenth century, European prices began to rise some time before the imports of gold and silver from the New World could have made a difference.

His idea is that inflation-waves are "autogenous" (don't academics love this kind of label?), by which he means that people make decisions based on current circumstances and their personal predictions for the future, and that helps shape the next set of circumstances. It's like watching a football game unfold, each player adjusting his movements according to his perception of the others.

Fischer thinks that one important factor in the price-wave of the Middle Ages was a trend towards marrying earlier and having more children, which put pressure on natural resources at the same time as altering the ratio of working adults to dependant children. Perhaps this has modern echoes in the growing longevity and reducing mortality rate in the developing world, plus the increasing numbers of dependant elderly in most places.

At any rate, inflation in the West is likely to become less susceptible to control by adjusting the interest rate. What will the Monetary Policy Committee do then?

Perhaps it might help if we established some control over the actual amounts pumped into the economy by the banks (and other creditors). I can dimly remember the news in the 60s, about limits on how much you could borrow to buy fridges, washing machines etc - apparently a minimum deposit was a requirement of the Hire Purchase Act 1964.

However (it seems), Japanese manufacturers found ways to get round this and offer (in effect) 100% loans, and then came the pandemic of credit cards, starting with "your flexible friend" Access (1972). Telegram Sam the drug dealer is always friendly, at first.
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(*) Unless, of course, the discrepancy is accounted for by (a) the need for the monetary base to expand each year to cover interest on loans already made, and (b) much extra money being locked-up in real estate - an awful lot of building and rebuilding took place as the postwar economy recovered.

Investment, inflation and market collapses

We have had no fewer than three major financial institutions (outside the US) call for an utter collapse of the equity markets in the last two weeks.

... says Karl Denninger. Seems like the pros are sitting around waiting for someone else to panic first. Then it'll be time to get in, right?

I recently looked at what happened to shares when a period of inflation begins. You might think that since inflation will also balloon the underlying tangible assets of companies, shares would do okay. But here's the results:

If you're an active investor, you may start thinking about opportunities. Look at the red zones. Draw a line from a deep points to a high one, and feel the greed; but draw lines from a temporary rally to another low, and feel the disappointment. You do need to get your timing right.

But inflation heavily penalises the passive investor, too. His boat settles onto the harbour mud; while the unlucky speculator dives headfirst off the retaining wall, deep into the goo. Inflation raises the risks for all.

Crime and punishment

Henry Wallis: "The Stone Breaker" (1857)

(I've brightened Wallis' painting above, but the foreground in the original is very dark, making a contrast with the gleaming, unreachable beauty of the twilit sky and its reflection on the lake.)

In a country with proper justice, nobody would dare intimidate a witness.

In such a country, wrongdoers are afraid of the law. They'd know that such a crime would certainly be prosecuted and that they'd end up doing at least 15 years breaking rocks.

... says Peter Hitchens in today's Sunday Grumbler.

"Pitee renneth sone in gentil herte," said Chaucer, sometimes ironically. The worthy compassion shown to unfortunates by the Victorians has, gone too far, some argue.

But there are now different reasons to pity. Prisons do not punish the wrongdoer in the old-fashioned ways, but the incarcerated man is no longer protected against bullying, beating, buggery and theft. In how many movies do we hear the police threaten a criminal with what his fellows will do to him in prison? Judge Mental does not put on his black cap and say, "You will be taken from here to a place of detention where you will have your arm forced up your back and..."

Then there's life outside, for the neglected underclass. "Theodore Dalrymple", a doctor who has dealt with many prisoners in Birmingham (UK), used to note in the Spectator magazine that prisoners' health improved considerably in prison, because of no (or reduced) access to drugs. Read the good doctor here on how the liberal approach to mind-altering substances is pretty much a sentence of death (prolonged and degrading). Here's an extract on alcohol:

I once worked as a doctor on a British government aid project to Africa. We were building a road through remote African bush. The contract stipulated that the construction company could import, free of all taxes, alcoholic drinks from the United Kingdom...

Of course, the necessity to go to work somewhat limited the workers’ consumption of alcohol. Nevertheless, drunkenness among them far outstripped anything I have ever seen, before or since. I discovered that, when alcohol is effectively free of charge, a fifth of British construction workers will regularly go to bed so drunk that they are incontinent both of urine and feces. I remember one man who very rarely got as far as his bed at night: he fell asleep in the lavatory, where he was usually found the next morning. Half the men shook in the mornings and resorted to the hair of the dog to steady their hands before they drove their bulldozers and other heavy machines (which they frequently wrecked, at enormous expense to the British taxpayer); hangovers were universal. The men were either drunk or hung over for months on end.

Our soft-handedness on crime and drugs, is really an extreme hard-heartedness.

The economy is like a rainforest

The news always speaks of "the economy" as though it was one homogeneous whole. In fact, it's a host of micro-economies, financial equivalents of ecological niches.

In the rainforest, there are places that are light or dark, hot or cool, high or low, wet or dry. In the economy, there are savers, borrowers, amateur and professional investors, crooks, marks, young bold, cautious old, workers, shirkers and berserkers.

So centralised economic policy is enormously difficult. An intervention that helps one part, may hurt another, and further action is implied. It's like the tablets for hypertension that give you gout, which means you need tablets for the gout, which are likely to harm the lining of your stomach. Some might say, throw the lot away and have a glass of sherry before bedtime.

Or, in rainforest terms, let each species find its niche and organise its own survival strategies.

But I don't think this is an argument for complete liberal laissez-faire. To extend the analogy, maybe it's better to prevent harm than to seek to do good; the forest guardians need to control the rubber and banana companies, the clear-cutting loggers and polluting miners.

Dow Jones - worse bubble than the FTSE?

Just out of interest, I thought I'd do the same trend-spotting exercise for the Dow Jones as I did yesterday for the FTSE, i.e. extrapolating the highs and lows in the late 80s and early 90s.

The results are very different. October 2007 saw the Dow's highest-ever peak, and today, after falling over 2,000 points from that point, it still stands about where it was in the tech bubble of December 2000 (see yellow line).

And my hi-lo wedge (red lines) suggest that the Dow has been seriously above trend for most of the last 11 years. Of course, you can draw lines however you like, but I'm trying to do approximately the same as for the FTSE and the implication is that the Dow "ought" to be between 7,000 - 10,000, centring around the 8,500 mark. This chimes with what Robert McHugh predicted last year (9,000). (If you draw the "high" line to connect the '87 and '94 peaks, the hi-lo lines converge towards 7,000!)

I wonder what's keeping it up?

Stockmarket crash - a golden opportunity

I thought I was a bear: Wolfie says there's near-panic, City Unslicker talks about the FTSE losing a couple of thousand points, now Richard Lander on CityWire reports a prediction of the FTSE as low as 3,000 and another 60% to come off the S&P 500.

We could be approaching a once-in-a-generation Templeton opportunity, a financial fire-and-forget that could richly reward those who save very hard right now. Give the rifle another pull-through, hitch up your belt, and wait...

The FTSE - semi-wild guesses about fair value

I suggested on Wednesday that the market may already have lost much of its bubble, considered in real terms, and here below is my simple attempt at chartism.

What I've done is to draw two purple lines, one connecting the lows in the mid-80s/early 90s, and the other the highs in the same period. I've chosen that time-frame because it's before the silliness of the late 90s, and it does also include a period when the UK economy was in the doldrums.

Using these parameters, the late 90s and early 00s were well above trend, whereas last year's highs only just peeped above the upper line and the current value is hovering a little above the centre of the hi-lo wedge.

The implications are that the next low, if it comes soon, shouldn't be worse than around 4,500, and by 2010 (when I'm guessing the tide will turn) the bracket would be in the 4,700 - 7,000 bracket, with a midpoint of c. 5,850.

Taking the market at close yesterday and extrapolating to that 5,850 midpoint, would imply a future return (ignoring dividends) over the next 16 months, of c. 2.5% p.a. - not nearly as good as cash, especially in an ISA. On the same assumptions, to achieve an ex-dividend return of 6% p.a. would require entry into the market at c. 5,400.

On this tentative line of reasoning, we should be looking for a re-entry opportunity somewhere in the 4,500 - 5,400 level, say 5,000. Shall we wait for the next shoe to drop?