Let us now praise visionaries of such subversive might that they crushed orthodoxy in their wake. Whether Copernicus defying the papal hierarchy with apostate theories about the heavens; Mongol horsemen who revolutionized war by introducing the saddle stirrup; or the fourteenth-century bright bulb who figured out – albeit a bit late in the game – that it was not felines but rats who carried the fleas that caused The Black Death; we owe a debt to the renegades who embraced radically more productive ways of engaging the world.
A similar transcendence is unfolding in, of all places, the Federal Reserve Bank. While not equal in magnitude of opposable thumbs on the evolutionary scale, we at Anfield regard it as an innovation of monetary policy that is as bold as it is overdue – all the more so because we have been promoting it for years.
The Underlying Inflation Gauge was pioneered by the Fed’s New York Office and introduced last May at a time when established measures of inflation were reporting anemic rates despite near-full employment, hardy consumer spending and sky-high confidence indices. It derived, according to the Fed, “from a large data set that extends beyond variables and displays great forecast accuracy than various measures of core inflation.” Crucially, the UIG includes in its metric universe the price of assets like stocks and bonds, precious metals, commodities and REITs, which are absent in consumer-price biased registers and are thus blind to the tight correlation between asset-price and economic growth cycles.
The contrast between the expansive UIG and its parochial counterparts was made graphically clear last month when its index rose to 3.0% in October on a year-on-year basis, the highest inflation rate since August 2006 and 100 basis points above the Consumer Price Index. Most importantly, it smashed through the Fed’s target rate of 2.0%, vindication for its recent series of interest-rates hikes. Robust inflation, it seemed, was hiding in plain sight.
The cyclical implications of the UIG’s big-net methodology are obvious. Take gold prices. If inflationary pressures are more compelling then broadly assumed, then gold – along with the dollar – should naturally reprise their roles as a hedge against rising prices. But there are also profound monetary considerations. Last month, Bloomberg columnist Joseph G. Carson addressed a decade of quantitative easing in a manner that, before the advent of the UIG, would have been heresy. If the specter of tepid inflation was nothing more than a simple, if gargantuan rounding error, according to Carson,“monetary stimulus in recent years was not needed and the path to normalizing official rates is too slow and the intended level is too low.”
Analyst John Rubino of DollarCollapse.com took it a step further, blogging that “the really frustrating part of this story is that had central banks viewed stocks, bonds and real estate as part of the ‘cost of living’ all along, the past three decades’ booms and busts might have been avoided because monetary policy would have tightened several years earlier, moderating each cycles’ volatility.”
As if on cue, Case Shiller data published last week revealed that home prices reached their highest peak since mid-2014 due to a shortage of housing stock and low borrowing costs despite rising interest rates. At the same time, Zero Hedge pointed out that the last time the UIG crossed the 3.0% threshold, recession and bear markets followed.
As it happens, Anfield has been warning of such hazards for years. Since the dawn of financial deregulation – begun during the Carter administration which removed controls on interest rates and repealed the federal law prohibiting usury – the global economy has fissured into two asymmetrical halves: the terrestrial one of trading goods and services and the digital lacuna that is the global financial system. According to Deutsche Bank the universe of financial assets – from stocks and bonds to public debt and bank loans – adds up to some $294 trillion or 378 percent of the world’s gross domestic product. The effects of which are magnified by all-but immeasurably turnover velocity. And it is estimated to be growing some five times faster.
For a central bank to ignore such Malthusian growth as inflation fodder is to mistake felines for rats as the primary mover of the plague. We applaud the New York Fed for spurning convention by adding wealth creation to its data sets. At the same time we are sympathetic with Martin Feldstein’s admonition, recently penned in the Wall Street Journal’s opinion column, that the combination of overpriced real estate and equities “has left the financial sector fragile and has put the entire economy at risk.”
Asset bubbles respect only rising borrowing costs that squeeze the margins on leveraged trades. But intra-cycle bubbles are subject to the pin-prick of capricious investor risk sentiment. Because the financial and real economies move at such different speeds, however, it is difficult to check the former without seriously damaging the latter. As it navigates the squalls ahead, let’s hope the Fed will employ the same clarity of thought that inspired a sensible way of measuring inflation.