I cannot help but laugh at the latest nonsense out of ECB president Jean-Claude Trichet. Please consider Trichet: Need to prevent oil-fed inflation spiral.

Speaking at an event organized by the London School of Economics, Trichet said the recent surge in energy and commodity costs had driven the sharp increase in headline euro zone inflation over the last year.

“In those circumstances, the central bank must prevent increases in the prices of raw materials from being incorporated into the long-term inflation expectations which could trigger second round effects on wages and prices,” he said.

“Unemployment at 9.9 percent of the labor force remains much too high, and structural reforms are of the essence to make the euro area economy much more flexible and to elevate its growth potential,” he said.

Inflation Expectation Theory is Nonsense

There is not a damn thing the ECB or anyone else can do about peak oil. There is nothing the ECB can do about rapidly expanding credit in China. There is nothing the ECB can do about misguided QE policies in the US.

But most importantly, this entire notion of “inflation expectations” is nonsense. It’s time for a recap of Miracle of Survival and Falling Inflation Expectations.

Bear in mind what follows was written in response to misguided Fed worries about deflation (falling, not rising, inflation expectations). The same applies in either direction as I shall get to in a moment, but first consider this snip regarding falling inflation expectations.

Miracle of Survival and Falling Inflation Expectations

Series of Questions

  • If your refrigerator conks out, will you buy a new one or wait 6 months to take advantage of lower prices?
  • If the transmission on your car fails will you wait 6 months to get it fixed?
  • If your pantry is bare, will you wait 1 month to buy food even if you expect food prices to drop?
  • If you need a new winter coat, will you wait and if so, how long?

The answer to that last question is “Perhaps for a bit, but you will not wait 3 years even if you expect prices will be even lower 3 years from now.”

Miracle of Survival

Today I received an even better example from “Chris” who writes…

Hello Mish

The best argument in your “winter coat” deflation comparison is consumer electronics. Everyone knows that as soon as they buy something from the consumer electronics department the price next month will go down or the same product will be offered with more bells and whistles for the same price. Yet by some miracle Best Buy seems to survive!

Thus, the next time you hear the Fed or some parrot taking about the importance of inflation expectations and how people will hold off buying stuff if they expect prices to fall, please calmly ask them how the hell Best Buy stays in business, making a huge profit on hundreds of stores, selling merchandise that will undoubtedly be lower in price in a few months.

According to the incredibly silly “inflation expectations” model, Best Buy cannot possibly exist, so it must be a miracle that it not only exists, but thrives.

To show that inflation expectation is nonsense in both directions please consider the following questions.

Rising Inflation Expectations Questions

  • If your refrigerator is working, will you buy another one out of fear prices are going up?
  • If you have a nice winter coat will you buy another one out of fear of rising prices?
  • If your freezer and pantry are full, will you buy more food with nowhere to store it?
  • Other than your car, do you have a place to store oil?

Businesses may buy ahead of price increases, but no more than they have room to store raw materials. Consumers may stock their freezers but only at the expense of something else they will then not have money to buy.

The only time people get in a mad rush to dump currency is in periods of hyperinflation or when credit is expanding rapidly. Well credit is not expanding rapidly, consumers are deep in debt and deleveraging.

Given constant supply of money and credit, if consumers stock up on one thing it is a mathematical certainty they will have to cut back elsewhere.

Why Do Prices Rise?

Prices do not rise out of expectations; prices rise out of increased money supply and credit (or supply constraints such as peak oil). If prices rise as a result of supply shocks, even peak oil, prices have to fall somewhere else, if money supply and credit are constant.

Wage growth is anemic. Credit is anemic. Fears of an inflation spiral as a result of rising “inflation expectations” is nonsensical.

No Winning Solution For Trichet

I am not saying Trichet shouldn’t hike. I am saying his explanation is piss poor. Quite frankly he is trapped in a One Size Fits Germany Policy on interest rates. There are no solutions given the widely varying economic problems of Euro-Zone countries.

The ultimate irony in Trichet’s madness is he proclaims to be worried about inflation, yet promised “unlimited liquidity” at 1.5%. Are we to believe a hike from 1.25 to 1.5 percent will cure the inflation problem, so much so that the ECB can continue offering “unlimited liquidity”?

Apparently not, given Trichet wants to hike rates to contain the “inflation expectations” of his own “unlimited liquidity” policy.

Is that twisted or what?

Please see Confused Trichet Walks Tightrope on Liquidity, Rate Hikes, Greece; Reflections on Unexpected Things for more details.

Mike “Mish” Shedlock
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