Macro insider: the hard truth about inflation

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Mark Carney told us everything we need to know.

When he becomes the new Governor of the Bank of England, inflation will be encouraged. That’s why he said the BoE should drop inflation targeting and instead go to a nominal GDP target. He could have said a ‘real’ GDP target but he very deliberately did not. So, like Japan, the US and, if only the Germans would get out of the way, the eurozone, all are stoking the fire of inflation as fast as they can.

The obvious question is: will it work? Many say no. But the fact is that governments are usually very good at creating inflation. Japan stands as a lonely example of failure. It does seem slightly absurd to go to such great lengths, and yet argue, ‘don’t worry, it won’t actually work’.

Why won’t it work? Central bankers say: ‘There is no velocity of money’. Yet, we see signs everywhere that lending is recovering. Small and regional banks, especially in the US, are extending credit again. Large companies like Rolls Royce are increasingly lending to their suppliers. Internet-based crowd sourcing mechanisms are channelling debt and equity to smaller firms.

EM wage-price spiral

People say: ‘There is no danger because wages cannot rise.’ Yet wages are rising remarkably rapidly in the one part of the world that defines the global cost base: the emerging markets. South African miners just received 22% wage hikes and they still demand more. Chinese workers are getting 70% pay hikes per year if they have skills and 30% plus if they don’t. In the Middle East pay rises have become part of the social contract. If they are not delivered, revolution is threatened. Emerging markets are experiencing a good, old-fashioned, wage-price spiral.

As wages rise, the cost of extracting gold, platinum, diamonds, food and energy all go up too. Higher costs mean narrower margins. All that leads to capacity closures.

Food and energy costs alone take up more than half of an emerging market worker’s income. The higher these prices go the more such workers will demand wage gains to keep up. But, the wage gains lead to higher costs and therefore reduced production, which, in turn, leads to higher prices. The workers know that gold, platinum, diamonds, thermal coal, soy, wheat and even hay are selling at high or record prices.

So, surely they deserve a larger piece of the action? But the wage gains they demand render many facilities simply unprofitable. That’s why Anglo American will shutter substantial operations in South Africa and Australia’s mining industry will follow suit eventually.

Going for gold

China has long been accumulating gold in sizable public and private purchases. Given their view that the US will default (on them) through inflation, this hedge makes sense. More recently, the Bundesbank has requested that their gold holdings, some 3,396 tons, according to, be shipped back to Germany from the NY Fed and from France.

That’s going to take a few 747s and dedicated trains. It indicates some level of concern about safety in countries that have clearly spent far more than they can possibly pay back. The fact that the one trillion dollar coin is even being discussed is further evidence of the rising concern about the inability to pay and the need for some hard asset that can retain real value in a world where everyone inflates and tries to devalue.

The problem with all that glitters as an inflation hedge is that governments are going to try very hard to confiscate these assets from you. Gold is easy. Laws can be easily passed that simply make it illegal to transact in gold or precious metals outside of the government’s formally approved exchange. Never forget that inflation is a form of expropriation. Taking these assets from you is as simple as taking candy from a baby. Diamonds are tricky from a valuation point of view but a metal detector can’t pick them up.

Don’t make the mistake that John Paulson and others have done. Mining stocks and mined assets are not the same thing: miners are getting hammered by higher costs, in spite of higher prices. They are the canary in the (thermal) coal mine. They presage the inflation pressures and higher commodity prices that are yet to come.

Dr. Pippa Malmgren is is the president and founder of Principalis Asset Management.

This article originally appeared in the February 2012 edition of Citywire Global.