"The time has come," the Walrus said,"To talk of many things...And why the sea is boiling hotAnd whether pigs have wings."
- Alice Through The Looking Glass
The remaining issue to be addressed, in our review of the Walrus's list of questions and "things," is the vexed problem of why the sea is boiling hot. Only recently, many people were petrified by the threat of the sea freezing over; credit markets froze in the wake of the collapse of Lehman Brothers, and leading financial institutions were quasi-nationalized. There was also an imminent danger of the sea simply evaporating as liquidity dried up and no one was prepared to lend to anyone else.
But the threats and fears of last winter have melted in the summer sun. Now the clear and present danger - at least such is the new consensus around the world - is that the sea is already, or will soon be, boiling hot. This is the inevitable result, so we are told, of the inflation that will be visited upon the global economy because of the massive infusion of money undertaken by central banks. The money supply has rocketed upward, and this, according to elementary economic theory taught in every beginner's course in macroeconomics, must lead to INFLATION.
However, given the reckless disregard on the part of governments, especially Uncle Sam, for what everyone knows to be true, the threat is not merely that of inflation - the sea warming up - but of HYPERINFLATION, when the sea will become boiling hot.
This horrendous possibility clearly demands our fullest attention, so let's see what's going on. A good place to start - for rational people - is with the latest facts regarding inflation. Is there any evidence of higher inflation beginning to show through? Here is a roundup of recent inflation data in the leading developed and developing economies, taken from JP Morgan's "Global Data Watch" of August 14 and relating to the rate of change in consumer prices in the second quarter of 2009, compared to the same period in 2008:
In the US, prices were down by 0.9 percent, i.e. negative inflation. In Canada the change was zero, i.e. no inflation. In Japan prices were down by 1%, and in China they were down by 1.5%. In the euro-zone as a whole, prices were up by - wait for it - 0.2%, which was also the change in Germany, although in France they were down by the same margin.
There were, however, countries with more substantial rates of inflation: notably the UK (2.1%), Norway (3.1%) and Australia (1.5%), among the developed economies; and India (7.5%), Russia (12.2%) and Brazil (5.2%), among the emerging countries. But the global picture shows negative inflation of minus 0.3% for the developed world and positive, but still below average, inflation of 3.8% for the developing world in the second quarter of 2009.
Clearly, any heating up is a very recent phenomenon; or perhaps the inflationary boilers are only going to be felt in the future. Where would we look for signs of future inflation? First and foremost, in the bond market, because investors expecting inflation will sell bonds to avoid seeing their value eroded by inflation. But government bonds continue to trade at yield levels that are quite low by historic standards, and corporate bonds have been recovering strongly for months.
Maybe the prices of commodities augur inflation? Actually, prices of grains have plunged recently and are at their lowest levels in a couple of years. Even gold, the ultimate safe haven for inflation-threatened investors, has traded below $1,000 an ounce since February and shows no signs of soaring to multi-thousand prices levels, as it would if the sea really was near boiling point.
In short, the examination of empirical evidence yields no evidence of current inflation or indications that the financial markets actually believe it to be looming. What, then, of the theoretical underpinnings of the pro-inflation arguments: that a massive increase in the money supply must, as inevitably as night follows day, lead to an upsurge in inflation? Is it not written in all the textbooks?
Since this is not the place to even summarize theoretical arguments, let's just say this: There are serious economists with very cogent explanations of why it is NOT inevitable in the current economic environment and, indeed, why it will NOT happen. Some believe inflation can be avoided, and some, more extreme, believe that the real threat remains that of deflation, and that it will be hard to avoid that.
For the man in the street or, better, on the beach, the best reality check is to keep dipping your foot in the water: if it doesn't get scalded, the sea can't be boiling hot.