Bank of England governor Mervyn King will be penning his second “Dear Gordon” letter this morning.
The annual rate of inflation, as measured by the consumer price index (CPI), came in at 3.3%. It’s the BoE’s job to keep it at no more than 1% above or below a central 2% target.
Its failure to do so won’t have come as much surprise to Mr King. He’ll have had his quill sharpened and his ink well refilled at the ready for quite some time now. The Governor has already told us all that he expects CPI could hit an annual rate of as much as 3.7% this year. So I suspect the tone of his letter may be more “I told you so” than “whoops, I did it again”.
If it’s any consolation for Mr King and his colleagues on the Monetary Policy Committee, they’re far from being the only ones missing their targets…
Why inflation will get worse before it gets better
Inflation is taking hold around the world. As the Lex column in the FT pointed out the other day, “the vast majority of countries that have inflation targets are way above them”. Canada is the only one of the major economies that is within its target.
So what to do? Well, one option is to just dump the target. You may well ask what the point is on having one in the first place, but that’s exactly what Turkey’s done. The country has simply caved in and pretty much doubled its inflation target to 7.5% for 2009, from 4%. Its target for 2010 will be 6.5%, and for 2011, 5.5%. Annual inflation for May came in at 10.7%, so the Turkish central bank still has a fair bit of work to do.
This, by the way, is how you can really tell that a country is still an emerging economy. They haven’t figured out how to lie properly yet. It’s like seeing a five-year-old with his mouth smeared in chocolate denying that he ate the last piece of cake. “Inflation? Here? Nah – look, it’s bang in line with the target. No, I didn’t change it while your back was turned. It’s always been like that.”
When you’re a mature economy you don’t do those sorts of things. No, what you do is find spurious ways to adjust the underlying numbers. You acknowledge that headline inflation looks bad, but ‘core’ inflation, which excludes food, energy and all those other things that are going up in price, looks OK.
But what do you do when even that stops working? The grim reality is that central banks (ie governments, whatever they say about independence) don’t want interest rates to rise. That spells recession as far as they’re concerned. Recession means pain, and voters hate pain.
So while they might try talking tough, they’re more than likely to stay behind the curve on inflation. Already some Federal Reserve officials are back-pedalling after Ben Bernanke’s comments on inflation saw the markets pricing in three to four hikes in the key US interest rate before the end of the year.
And while Mervyn King certainly seems to have his heart in the right place when it comes to inflation-fighting, there’s no way the Treasury will let him hike rates in the face of a recession. Not without a fight at least. We may yet see pressure to change inflation targets, Turkey-style, before the year is out.
So what does all this mean for your investments? The US and Britain are definitely facing recession, probably combined with inflation, followed quite possibly by a period of deflation. At various points in that cycle, different investments will look good – but with so much uncertainty over timing, it’s not easy to call which ones.
Why now is the time to invest in Japan
But why worry about the US and Britain alone when we have the whole wonderful world to invest in? And when you look at it that way, there’s an obvious market to buy just now.
Japan is possibly the only major economy in the world where the return of inflation is a good thing. You can read more about it in the latest issue of MoneyWeek (if you’re not already a subscriber, you can get your first three issues free by clicking here), but after years of falling prices, the threat of higher costs is just what the Japanese need to get them back out into the shops and spending again.
We’re not the only ones who like Japan just now. I was flicking through US financial paper Barron’s yesterday. One of the contributors to their mid-year roundtable was Dr Marc Faber of The Gloom, Boom and Doom Report, someone who’s always worth listening to. So I was pleased to see that Japan was among his top picks for just now too.
The case for Japan is not just about inflation. As Dr Faber points out, “pension funds and foreign investors are starting to have more power over Japanese management”, citing the recent ousting of wig maker Aderans Holdings’ management by activist US hedge fund Steel Partners. Dividends are also on the rise.
He’s also keen on gold, another good hedge against inflation. “The price could go down to $780 to $800 an ounce. If you have no exposure to gold, start buying it here.” You can find out how to do so on the MoneyWeek website: Investing in gold
source-Money Morning