Inflation and deflation, lower interest rates, and the prices of assets

It’s hard to bid up consumer prices when taxes and debt obligations eat up much of a person’s paycheck

I had a question for you regarding inflation/deflation as it relates with the decreasing interest rates. If I understand you correctly, you’re saying that when rates fall, it’s deflationary. However, you’re also bullish on housing (for higher rents and higher asset prices to continue with weak rates). I’ve also seen a continuing uptick in food prices. Minimum wage keeps rising although it seems like there is pressure on real wage growth in Canada – maybe there’s growth in the US employment market. Is your yardstick for inflation commodities (ie gold & oil) and real non-governmental manipulated wages (ie wages set by the market and not by government?) or how would you define it particularly in light of rising house, rent & food prices.

N – Canada

The higher taxes, the lower real GDP growth

Relation between the tax revenue to GDP ratio and the real GDP growth rate (average rate in years 2013-2018, according to List of countries by real GDP growth rate, data mainly from the World Bank). European Union. Source: Wikipedia
This chart displays the same relationship as above, but includes nations outside the EU. The US (27.1%), Australia (27.8%) and Canada (31.7%) have lower tax revenue to GDP ratios than all the larger EU nations. Source: Wikipedia
Household debt is gobbling up more of people’s income. Lower interest rates help to mask the payment burden, but the total debt households are accumulating continues to grow

This person asks some very reasonable questions and I hope to clarify them.

When I speak of price inflation, I speak strictly of consumer prices as reflected in the government data. Of course, these numbers tell only a small part of the picture, and that is done by design. For most of my discussions, I stick to the published government data as these data points are what largely determines central bank monetary policy.

Certain items will always reflect the true rate of monetary inflation

With this said, there are many necessities and “fixed” items (e.g. healthcare, housing, education, debt payments, and taxes) whose cost burdens continue to escalate higher than the general rate of inflation, and their amounts have been taking up a larger percentage of a person’s income over time. This helps to keep the published inflation numbers lower, as people have less available to spend on consumable and durable goods.

Certain items like house prices and rents reflect true monetary inflation and cannot be imported

There is one primary reason why the costs of these items rise higher than other prices; these items cannot be imported and their prices cannot be arbitraged between nations, like consumables, which can be produced and sourced from low cost countries. This is the primary reason why the governments of high cost nations promote free trade at the expense of the average worker; it helps to maintain the illusion of low inflation. This is why government tends to intervene in sectors like housing and healthcare. These are the areas of the economy that are highly susceptible to the damage that government spending largesse causes. In other words, the price increases of housing, education, and healthcare more accurately reflect the rate of monetary inflation (not general inflation) over time.

This is why we are seeing a surge in social program spending; it is being done out of necessity. As long as this monetary system is in existence, the governments will have to keep covering up their profligate ways, which were made possible by their central banking enablers.

So, rents cannot be arbitraged between nations nor different regions in a country. I may buy clothes that were produced in Vietnam, but I cannot pay the same rent as someone living in Hanoi. You may live in Toronto, but you will not pay the rent of someone living in Medicine Hat. Thus, I am bullish on rents.

As long as the central banks stand ready to buy all that is needed to keep rates moving lower over time, so governments can spend without a thought of national bankruptcy, I will be bullish long-term on housing, rents, stocks, and bonds. The costs of these items cannot be transferred from overseas. The key point that underpins this whole dynamic is the ability of the nation-state to remain in business without any debt repudiations. The central banks have made this certain and they will make sure that all sovereign debt will remain and be serviced. This is the deflationary drag I discuss. If any type of default looks imminent, all bets are off and the loss of confidence will cause bond yields and inflation to rise. That would put an end to this monetary experiment.

The prices of commodities can be sourced from all over the world. I just wrote an article discussing my thoughts on where I think commodity prices are moving. Although I believe the longer trend is definitely higher, this does not mean I want to establish a large bullish macro-position on commodities in general. The U.S. used to be the largest producer of many commodities, and if it remained that way, commodity prices would be much higher. But many developing nations are growing in importance as commodity producers, and as long as interest rates remain low, the supply side of the equation will continue to produce more than normal, as their costs of capital is less.

The only commodity I currently recommend is gold. It will always be the first to move when uncertainty reigns. If Fed Chair novices like Jerome Powell make mistakes, which I see as probable, gold will reflect this. Mr. Powell seems to be a simple-minded monetary scientist and he does not engender my confidence. I had more conviction in Ben Bernanke’s abilities. It is just difficult for me to imagine a world of higher spiraling commodity prices when so much of the world’s income is spent on housing, taxes, and debt payments.