A couple of years ago, when the financial crisis was kicking off, Bill Bonner, John Stepek and I had the first of many conversations about inflation and deflation. A few cups of tea in, we agreed that we expected to see a few years of deflation, then a nasty bout of inflation. That view hasn’t changed. The question is simply when deflation turns to inflation.
As far as the market is concerned, the turn is almost upon us. Press stories about inflation currently “swamp” those about deflation, as John Authers reports in the FT this week. And Australia’s shock rate rise, coupled with gold surging through its previous record high to hit $1,040 an ounce this week (finally!), both suggest we are on to the next stage of the crisis – the bit where you should buy any hard assets you can get your hands on, be they equities or houses.
But we’re not so sure. Why? Because there just isn’t any evidence of inflation anywhere yet. Core inflation is still falling in the US, Japan and most of Europe. Even in Australia, inflation is running at only 1.5% a year. It’s not much of a worry in Britain either: the retail price index is down 1.3% on last year, and the consumer price index up just 1.6%. Our banks still aren’t lending much; consumers are repaying debt; industrial production is falling fast; and unemployment will rise for a long time to come.
We’re seeing asset price inflation (with commodities, bonds and stocks all weirdly rising as one), but consumer price inflation is notable only for its absence. We suspect that will change, just not yet.
Finally, a quick word on house prices. A string of positive news has meant the bears are getting nervous again. They shouldn’t be. The market is moving on very low volumes. Supply is restricted by reluctant sellers and demand restricted by a still semi-shutdown mortgage market. In Edinburgh – where I am trying to buy a house – there’s very little on the market officially; what there is remains overpriced.
Occasionally, a bored cash buyer gives in and pays up (giving the impression of rising prices). But mostly we don’t. Why? Because we know the sellers will get desperate long before we do. Would-be buyers can rent indefinitely. Would-be sellers can only refuse to sell for as long as they can afford the mortgage. With unemployment rising, wages freezing and the age of the cheap tracker passing, they should soon start selling. Then prices should start falling again.