Tuesday, January 12, 2010

Asset inflation, here we come!

I see that central bankers really haven’t figured out this “bubble” thing. The deputy governor of the Bank of Canada recently stated that the Bank of Canada won't raise interest rates to cool housing:

“Some observers – those who see a housing bubble forming – have said that since low interest rates have stimulated housing market activity, the Bank should now raise interest rates to dampen that activity,” deputy governor Timothy Lane wrote in a speech delivered by an adviser on his behalf in Edmonton. “But that poses a problem.”


Those who fear a bubble worry that many people are taking advantage of cheap money to buy homes they wouldn't be able to afford once rates rise, leading ultimately to a crash in prices.

Mr. Lane said the bank understands the concern, but it uses its lending rate to keep inflation in check for the whole economy and the housing market is “only one of several factors” that influence inflation.


Instead, he said, the government could increase capital requirements for lending institutions, adjust loan-to-value ratios and change the terms and conditions required to obtain mandatory mortgage insurance.

[He]e said. “Ultimately, it is the Minister of Finance who is responsible for the sound stewardship of the financial system.”
Lane’s remarks are reminiscent of Ben Bernanke’s speech at the AEA in which he absolved the Fed’s role in the last bubble. This has prompted comments such this one, the Fed missed this bubble, will it see a new one?

Central bankers seem to stuck with the concept of inflation as it existed in the 1970’s, where a vicious feedback loop created a self-reinforcing cycle of inflation. In my previous post what kind of inflation? I believe that this next round of inflation is likely to show up as asset inflation, which primarily manifests itself in commodity prices.

What party?
If the role of central bankers is to take away the punch bowl just as the party gets going, the Bank of Canada has now abdicated that responsibility to the party's host (the government). By contrast, Bernanke's response has been "what party?"

Asset inflation, here we come!

1 comment:

Patrick said...

I think it might be worth distinguishing between "financial assets" and the inflation or deflation of their prices and the price inflation of commodities. Sure, Futures contracts on commodities are financial assets, but I mean to distinguish stocks, bonds, real estate, and currencies like the Euro from food, energy, metals and lets not forget the future king commodity - clean water.

I tend to agree with KaPoom Theory from iTulip.com, that we can see deflation in financial assets with inflation in commodities.