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Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!

Wednesday, November 19, 2014

Inflation Potential

Inflation pressure gauges I use are currently rather subdued. Put simply, the global economic
expansion underway has not cut far enough into excess capacity to sustain the normal cyclical
acceleration of inflation that comes with a recovery / growth period. Recent expansion of
global capacity has continued at a moderate pace and demand growth of 4% needed to reduce
excesses has not been sustained. In the US, for example, the economy has expanded for over
five years, but the operating rate is still below 80% as companies have been adding capacity
since late 2010, with the current yr/yr growth 2.1%.

I have a long term inflation model which compares money M2 growth against real economic
growth potential. This model is based on 10 year averages and currently pegs inflation potential
at 4% per annum. The US experienced peak cycle - to - date 12 month inflation of 4% for just
a brief period in 2011.

The strong cycle of monetary liquidity growth experienced over the past year should have
resulted in the beginnings of a cycle of accelerating inflation this year. One future gauge
of pricing pressure has been moving up in 2014, but the move has been exceedingly modest.
My primary inflation pressure gauge, which gives heavy weights to commodities prices
and factory operating rates, did pick up sharply this year, but has settled down in recent
months. $CRB Commodity Comp. Weekly

Note the top panel of the chart which shows yr/yr momentum of the CRB. When it rises to
10% or above and can sustain that level for a period of a few months, US CPI inflation
accelerates. As you can see yr/yr price action for the CRB  has spent a fair amount of time
in negative territory in recent years.

In the Nov. 10 post, I discussed why the economy has the available capital in terms of
resources to grow for several more years. History does strongly suggest there will be some
upside pressure on the inflation rate ahead unless capacity growth is fast enough relative
to output gains to keep operating rates from rising too sharply.

Over the very long run, US inflation has averaged around 3%. Conditions now do not
support a rise of inflation to the long term average.

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