At the end of the year weâre still in a muddle

[raghu <mraghu01@xxxxxxxxx>]

Hi all,
There are interesting year-end articles at ft.com and also at Morgan
Stanley's "global economic forum":

http://www.morganstanley.com/GEFdata/digests/20051216-fri.html
http://news.ft.com/cms/s/98ab01a4-6e30-11da-9544-0000779e2340.html

The FT article mentions an ingenious piece of rationalization for the
inflation scenario by J.P. Morgan's George Cooper. His argument appears to
be a classical example of circular reasoning: "the inflation is low
because there are factors keeping it low" (in Cooper's case "low outside
temperature").

--raghu.


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A more likely explanation for the recent trends in financial markets, in
my view, is that there is a lot of money sloshing around the system. This
money is finding its way into lots of homes, which explains why bond
yields are low and equity and commodity prices are high.

The immediate inflationary pressures do not look that great. Headline
rates are now edging down again, as the $10 a barrel drop in the oil price
is working its way through the system. Core inflation rates did not appear
to be showing any evidence of âsecond orderâ effects; in other words, high
oil prices are not being passed on. The latest US numbers indicate that
unit labour costs are under control; there was actually a 1 per cent fall
in the third quarter.

However, one can make a perfectly respectable argument that the money
sloshing around the system is already causing inflation (in asset prices)
and will eventually lead to a more general rise in the price level.
Indeed, some argue that the official consumer price indices understate the
inflationary level.

One can bolster this argument by pointing to the high levels of debt in
the US and the UK. Eventually, this debt will cause a problem and the
temptation will be for central banks and governments to inflate their way
out of it.

But a quite ingenious counter-argument comes from George Cooper of JP
Morgan. He likens the economy to a central heating system, with the money
supply acting as the boiler, the inflation rate as the temperature and the
central bank acting as the thermostat.

Cooper argues that if the boiler is running at full blast but the
temperature inside the house is still low, that indicates the outside
temperature is very low. In other words, for rapid money supply growth to
be producing only low inflation levels indicates plenty of deflationary
pressures.
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