Inflation Threatens To Blow

Rob Mackrill - Fri 09 May, 2008

The IMF adds its voice to concerns about inflation as oil hits $124.

Well we’ve been worrying about it for some time.

Now it seems the International Monetary Fund is too...‘flation.

Said IMF deputy MD John Lipsky yesterday:

“...inflation concerns have resurfaced after years of quiescence.”

Quiescence...mmm, there’s a word. What’s its opposite...inquiescent...non-quiescent...uncooperative...bloody-minded...obstreperous...out of control..? Whatever it is, ‘flation was under the heel for a good long time. Now it’s not. It’s slithering out in all directions and “concerns have resurfaced”.

And they’ve resurfaced at a time when the economic growth engine is spluttering, so giving rise to the worst of both world’s for central bankers – stagflation.

But the really interesting part of the IMFs admission – in our humble opinion at any rate - was the view they expressed on rampant commodity prices. The basic resources stoking factory gate and consumer price inflation indices around the world. The FT reports:

“In an indication the commodities boom may not be the bubble imagined, Mr. Lipsky said the forces pushing prices up ‘appear to be fundamental in nature’ – and these were being amplified by lower US interest rates and the dollar’s decline.”

This is a view shared by our colleague natural resource guru, Garry White, editor of Smart Commodities. Personally, I suspect there’s a little more to it than just the fundies. The fundamentals are compelling of course (there’s only so much we can plunder from the earth’s crust plus the BRIC sprint to riches etc.) but it’s the nature of markets to go to extremes and there are no shortage of momentum investors to help them get there. I lean to the Soros idea of commodities as a “growing bubble”. As the anonymous wise man once said (allegedly): ‘This too shall pass’. Something someday will burst it and then entranced speculators will snap out of the mind set prices only go one way. An attitude that endured for years, until recently, in the UK housing market. (An update on house prices below.)

The fundamentals will continue we don’t doubt but the hot money will migrate to the next investment fashion. Then perhaps we will see a price that more closely resembles physical demand.

Lehmans said recently there was $20-30 of “hot money” speculation in the oil price. Another, F William Engdahl thinks it could be more, as much as 60% of today’s price may be pure speculation. Citigroup sees oil going all the way back to $40 in two years time and yet here we are today at another oil price high topping $124.

Why are people speculating on oil? Well, because they can for one. The innovation of exchange-traded funds makes investment in oil and a whole range of commodities little of us knew about five years ago accessible and tradable on a daily basis. Then there’s the lure of the inflation hedge. In times of inflation real assets offer a buttress against the insidious impoverishment brought about by rising prices. Gold, silver and other precious metals are noted beneficiaries also. And there’s been the no small matter of a falling dollar as the market adjusted to a hyperactive Fed that, amongst other actions, has cut interest rates seven times since last September.

The threat of unhinged inflation rests on good part on how long commodity prices continue to rise. It’s a threat that probably gives ECB bank chief Jean-Claude Trichet sleepless nights. Following the ECB decision to keep rates on hold once again at 4% he said t he Eurozone was “experiencing a rather protracted period of high annual rates of inflation”. It was “imperative” that the households and companies did not think inflation rates were normal and raise prices and wages accordingly.

And there lies the danger. Once people start to realise they’re getting poorer and starting to slip behind the Jones’s, dissatisfaction sets in which turns to anger which become pay demands. Then the lid to Pandora’s Box is truly blown open and those of us around at the time start to remember the bad old days of the ‘70s.

*** The FT house price survey, yet another but one I have a liking for as it uses Land Registry data, reports prices fell 0.2% in April. The second month of consecutive falls but, unlike other market reads, the annualised growth rate remains positive at 4.1%, albeit down from 5.2% in March.

Within their analysis, a notable, but not wholly unpredictable, divergence in the national picture is revealed. In the first quarter of this year prices in the North, Yorkshire, the Midlands, Wales and the South-West have been falling. Prices in Greater London, the South-East and East Anglia for the most part have been rising. Annual house price inflation in Greater London still registers a near 11% rise in the year to March, albeit down from a whopping 18.6% rise the year previously.

The brutal recession in transactions we’ve talked about before is reflected in the number of house purchase loans approved in March - just 64,000 against 115,000 a year ago. This house price correction is “being amplified by a contracting mortgage market,” says researcher Dr Peter Williams. Quite.

And the mortgage market will take time to heal. Two years reckons Iain Cornish, chairman of the Building Society’s Association. An organisation representing lenders which appear overall to have had a good credit crunch. If that proves accurate, the “contracted mortgage market” will be a thorn in the side of the housing market for some time yet.

*** A reader writes on the subject of sending children to private schools in other countries, something I mentioned yesterday, where the fees can be cheaper:

“Saw a comment about sending children to be educated in cheap fee paying schools in South Africa. Really good idea, I think (you seemed sceptical), outdoor, healthy existence, old-fashioned values etc etc. 

“Just been to Cape Town where my old South African school friend is sending his children to school in India... about £2,000 a year, I think he said, for one of India's finest and most exclusive public schools. The only problem is that the Indian kids work rather too hard ... maybe a good thing. His two daughters (who are half Indian, he's white South African) love it, especially as they are not as exam driven as the Indian kids.

“The future? (I think my brother pays approaching £30k a year for Marlborough).”

So for aspirant parents on tight budgets, it could be time to check out the developing world’s finest educational establishments.

And for the record, I’m not so sceptical. In fact, I’m considering something similar for my own ankle biters...in Canada.

Regards

Rob Mackrill
The Daily Reckoning