An Inflation Indicator To Watch, Part 3

Central Bank omnipotence. I recommend being wary of economists claiming to have everything figured out, whether they claim to have tamed the business cycle or, our topic here, inflation. The economy isn’t an animal or a motor vehicle or any of the other analogies that suggest a designated expert can control it, and the inflation outcomes of the last three decades weren’t engineered in an economics lab somewhere deep in the Eccles Building. On the contrary, it might be perfectly normal for inflation to trend toward low single digits—without central bank intervention—when a large trade deficit diverts purchasing power overseas, foreigners fail to inject that purchasing power cleanly back into America’s circular flow, and commercial banks refrain from rampant money creation. (Okay, banks have sometimes acted stupidly, but not by enough to offset trade-related deflationary forces, as shown in the last chart above.)

In other words, the Fed was probably more lucky than skillful, and it certainly wasn’t omnipotent.

Finally, inflation surfs the same waves stocks and bonds surf, but on the opposite phase (with exceptions, of course, such as TIPS), suggesting the circular-flow indicator can also help investors create their own luck. In future commentaries, I’ll make recommendations for applying it to economic and capital market forecasting. In particular, look for research supporting our bond outlook, which should give you another reason to swim away from the mainstream. Who knows? Adjusting your stroke for the circular-flow indicator might make a late but lucrative New Year’s resolution.

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