THE MISTERY OF THE MISSING INFLATION

Nouriel Roubini


NEW YORK – Since the summer of 2016, the global economy has been in a period of moderate expansion, with the growth rate accelerating gradually. What has not picked up, at least in the advanced economies, is inflation. The question is why.


In the United States, Europe, Japan, and other developed economies, the recent growth acceleration has been driven by an increase in aggregate demand, a result of continued expansionary monetary and fiscal policies, as well as higher business and consumer confidence.
 
That confidence has been driven by a decline in financial and economic risk, together with the containment of geopolitical risks, which, as a result, have so far had little impact on economies and markets.
 
Because stronger demand means less slack in product and labor markets, the recent growth acceleration in the advanced economies would be expected to bring with it a pickup in inflation.
 
Yet core inflation has fallen in the US this year and remains stubbornly low in Europe and Japan. This creates a dilemma for major central banks – beginning with the US Federal Reserve and the European Central Bank – attempting to phase out unconventional monetary policies: they have secured higher growth, but are still not hitting their target of a 2% annual inflation rate.
 
One possible explanation for the mysterious combination of stronger growth and low inflation is that, in addition to stronger aggregate demand, developed economies have been experiencing positive supply shocks.
 
Such shocks may come in many forms. Globalization keeps cheap goods and services flowing from China and other emerging markets. Weaker unions and workers’ reduced bargaining power have flattened out the Phillips curve, with low structural unemployment producing little wage inflation. Oil and commodity prices are low or declining. And technological innovations, starting with a new Internet revolution, are reducing the costs of goods and services.
 
Standard economic theory suggests that the correct monetary-policy response to such positive supply shocks depends on their persistence. If a shock is temporary, central banks should not react to it; they should normalize monetary policy, because eventually the shock will wear off naturally and, with tighter product and labor markets, inflation will rise. If, however, the shock is permanent, central banks should ease monetary conditions; otherwise, they will never be able to reach their inflation target.
               
This is not news to central banks. The Fed has justified its decision to start , despite below-target core inflation, by arguing that the inflation-weakening supply-side shocks are temporary. Likewise, the ECB is preparing to taper its bond purchases in 2018, under the assumption that inflation will rise in due course.
 
If policymakers are incorrect in assuming that the positive supply shocks holding down inflation are temporary, policy normalization may be the wrong approach, and unconventional policies should be sustained for longer. But it may also mean the opposite: if the shocks are permanent or more persistent than expected, normalization must be pursued even more quickly, because we have already reached a “new normal” for inflation.
 
This is the view taken by the Bank for International Settlements, which argues that it is time to lower the inflation target from 2% to 0% – the rate that can now be expected, given permanent supply shocks. Trying to achieve 2% inflation in a context of such shocks, the BIS warns, would lead to excessively easy monetary policies, which would put upward pressure on prices of risk assets, and, ultimately, inflate dangerous bubbles. According to this logic, central banks should normalize policy sooner, and at a faster pace, to prevent another financial crisis.
 
Most advanced-country central banks don’t agree with the BIS. They believe that, should asset-price inflation emerge, it can be contained with macroprudential credit policies, rather than monetary policy.
 
Of course, advanced-country central banks hope such asset inflation won’t appear at all, because inflation is being suppressed by temporary supply shocks, and thus will increase as soon as product and labor markets tighten. But, faced with the possibility that today’s low inflation may be caused by permanent supply shocks, they are also unwilling to ease more now.
 
So, even though central banks aren’t willing to give up on their formal 2% inflation target, they are willing to prolong the timeline for achieving it, as they have already done time and again, effectively conceding that inflation may stay low for longer. Otherwise, they would need to sustain for much longer their unconventional monetary policies, including quantitative easing and negative policy rates – an approach with which most central banks (with the possible exception of the Bank of Japan) are not comfortable.
 
This central bank patience risks de-anchoring inflation expectations downward. But continuing for much longer with unconventional monetary policies also carries the risk of undesirable asset-price inflation, excessive credit growth, and bubbles. As long as uncertainty over the causes of low inflation remains, central banks will have to balance these competing risks.


How the Feuding Kellogg Brothers Fought their Cereal Wars

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More than a century ago, Kellogg’s created the first breakfast cereal, the corn flake, in Battle Creek, Mich. Today, the name Kellogg’s evokes corn flakes as well as Pringles potato chips, Pop tarts, Eggo and other snack items. But the brand’s status as an American icon glosses over the family drama between brothers John and Will Kellogg, whose ideas gave birth to the business.

The book, The Kelloggs: The Battling Brothers of Battle Creek, chronicles this conflict. It is written by Howard Markel, a professor and the director of the Center for the History of Medicine at the University of Michigan. He recently joined the Knowledge@Wharton show, which airs on SiriusXM channel 111, to talk about the bitterness that tinged the brothers’ relationship.

The following is an edited transcript of the conversation.

Knowledge@Wharton: Normally, I would wonder why a professor of medicine would be interested in this story. But John Kellogg was actually a very well-known physician.

Howard Markel: Yes, he was one of the most famous physicians of his time. He was a best-selling author. He edited a magazine that was read by millions around the world. And he ran the Battle Creek Sanitarium, which was a world-famous medical spa, grand hotel and up-to-date medical center that thousands of people flocked to every year.

Knowledge@Wharton: His success in medicine was important when he and his brother decided to get into food production.

Markel: One of the doctor’s great interests was in the digestive tract. He saw a great many patients with upset stomachs, ulcers — what was then called dyspepsia and what Walt Whitman called “the great American stomach ache.” And little wonder, if you look at what Americans ate in the late 19th century — a lot of animal fat, heavy, greasy fried foods, creamed vegetables, pickles, spicy condiments and so on. No wonder everyone had a stomach ache.

These very worried people came to the doctor for digestive advice. Cereal was really a by-product of his whole philosophy of health.

The doctor prescribed what we would call today wellness. He called it biologic living. Some of it was based on his religion, Seventh-day Adventism. The idea was to eat a whole-grain and vegetable diet, exercise and the like. But he developed cereal — first wheat flakes, then corn flakes — as an easily digestible meal.

Knowledge@Wharton: His brother Will sees this as a potential marketing idea?

Markel: Absolutely. The doctor was the showboat, the brilliant doctor that people wanted to see. But Will ran that sanitarium. He was the chief of staff without title for nearly 25 years. He was a great businessman. He was also right there experimenting with the doctor because it took thousands of tries to get the right formula for corn flakes. He saw right away that there are a lot more of healthy people who just want to have a healthy, nutritious breakfast than sick people who want an easily digestible one. It was his brilliant, eureka-like moment that led to him leaving the doctor’s employ and creating what was called the Battle Creek Toasted Corn Flake Company. We know it today as Kellogg’s.

Knowledge@Wharton: The relationship between the brothers is part of the story, and the fact that they did not see eye to eye.

Markel: The doctor was eight years older than Will, and he humiliated and browbeat his brother for their entire lives. When they were kids, it was physical [attacks as well as] taunting and such, but even when they worked together, the doctor treated him like a lackey. He paid him very poorly. He humiliated him in front of the guests. The doctor was so busy, he would ride his bike across the campus. Will would run, and huff and puff while he took notes, so the doctor wouldn’t miss a stitch on his great ideas. They didn’t have a great relationship.

When Will left the company and started being successful, the doctor started making his own cereal, and that took away from Will’s brand. He actually sued the doctor, and the doctor countersued. The lawsuit went all the way to the state supreme court over the issue of who had the right to use the name Kellogg on a box of cereal. The doctor thought, “I’m the world-famous doctor. I’m the digestive guru. It’s me.” And Will said, “Hey, wait a minute. I spent millions of dollars advertising Kellogg’s Corn Flakes. They think of me.” And guess what?  Will won.
Knowledge@Wharton: How successful was Will?

Markel: He was successful beyond his wildest dreams. He said to some of his early investors, “I sort of feel it in my bones.” This was his great creation, corn flakes. Within a few years, they were just shipping out carload after carload of cornflakes on the trains to the hinterlands.

In 1906, you have to imagine how difficult it was for a mother to make breakfast, frying up bacon and making eggs. You had wood-burning stoves, so you had to stoke the fire. After 1906, you could just pour breakfast out of a box. Even Dad could make breakfast. It was just utterly incredible. It was one of the great modern inventions of the early 20th century.

Knowledge@Wharton: It wasn’t only the effort that went into making a traditional breakfast, but what was being consumed went against the healthy philosophy that John had.

Markel: You were eating a lot of cured, salted meats or potatoes fried in the congealed fat from last night’s meal. It wasn’t what we would call a healthy breakfast by any stretch, and this was — it was sold that way. It was sold directly to mothers and their children. Will came up with the first [idea of putting a] toy in the box. It was a coloring book. That came out in 1909. He found that the coloring book took up a lot of space in the box, and it was a lot cheaper than adding the extra corn flakes. It was just a brilliant idea all around.

Knowledge@Wharton: When did they start to develop the other types of cereals that ultimately made this company famous?

Markel: Right away, Will developed not only Corn Flakes, but a few years later Rice Krispies.

He learned how to pop rice the way we now know it as “snap, crackle and pop.” He actually stole the recipe for shredded wheat and came up with Kellogg’s Shredded Wheat. That was a different lawsuit, by the way. Of course, the doctor came up with all these [recipes for] bran cereals that Will stole. It was very easy to steal a cereal recipe, even if it was patented. All you had to do is change one tiny little step. So Will sold All-Bran and Bran Crumbles and things like that. The other cereals that we know Kellogg’s for — Frosted Flakes, Sugar Pops and Sugar Smacks — those all came to be after Will retired and after he died.

Knowledge@Wharton: Battle Creek was important to the cereal industry for quite some time.

You note that there were dozens of cereal companies there at one period of time?

Markel: At one point in the early 1900s, there were over 100 different companies. A lot of them were fly-by-night companies or were successful only for a few years. And unless you’re a historian like me, you would never know the names of these cereals. One my favorites was called Maple Flakes. Even in the early 1900s, they had maple syrup-impregnated flakes. There was C.W. Post.

Charlie Post was a patient at the doctor’s Battle Creek Sanitarium. He couldn’t pay his room and board, so he worked it off by working in the kitchen and stole some of their most famous recipes.

Knowledge@Wharton: How did the rest of the Kellogg family react to this battle between John and Will?

Markel: It was very toxic. The other family members, particularly their sisters and brothers, didn’t know which way to turn. These were both very powerful men, and they did not want to curry their disfavor in any way.

John Harvey [Kellogg] and his wife, Ella, had 42 adopted children. They never had their own children. In fact, many people believe they never even consummated their marriage. Will had three children — two boys and a girl. While he was quiet about his complaints about his brother, they knew very well about this battle, and it did not have a good effect.

Will, of course, had an inferiority complex the size of Rhode Island. Despite his great success, he was the Bill Gates of processed food. I use that name not just because of his success as an industrialist, but also because of his success as a philanthropist. The W.K. Kellogg Foundation is about a $9 billion foundation and does remarkable work to this day. But he had a great inferiority complex and was never terribly happy. He was very domineering. When he died, his grandson wrote, “Nobody really shed a tear.” To me, this was one of the saddest stories ever to come out of Battle Creek.

Knowledge@Wharton: It wasn’t a surprise that John would want to get into the business after Will had early success. When Will won the court case, he was allowed to have a small notification on the cereal boxes?

Markel: Yes, the settlement was almost like a commentary from the Talmud. You could put it in tiny little writing on the back flap, on the bottom of the box. The doctor still invented many health foods beyond flaked cereal. He was one of the early users of psyllium. We know it now as Metamucil. He was one of the early developers of soy milk, probiotics and acidophilus. Bran cereals were a big deal for him because it wasn’t just digestive health per se. He was a big fan of regularity and wanted not only himself but his patients to have four to five bowel movements a day, just like the gorillas he studied in the zoos that ate a high-bran diet.

Knowledge@Wharton: What was the relationship of the brothers after the court case?

Markel: It was never good to begin with. They rarely spoke to one another. Their last face-to-face meeting was a terrible argument, and John died only a few months later. It’s really quite sad. John did try to make amends, but Will would have none of it. They both went to their graves very sad about how acidic this relationship became.

Knowledge@Wharton: What happened to the sanitarium after Will left to start the cereal company?

Markel: For a while, it did not run nearly as well. But then it got back on its feet and ran rather well until the Great Depression. By that time, Dr. Kellogg was near retirement and those who took over over-extended themselves by building a 15-story patient tower and [added] a lot of luxurious amenities. The Depression struck and they couldn’t pay their mortgage. The sanitarium went into receivership, and the physical plant of the Battle Creek Sanitarium was sold to the federal government in 1943. It became a rehab hospital for vets who were injured. It was called the Percy Jones Hospital. Sen. Bob Dole recuperated there. It’s still there in Battle Creek, but it’s a federal center filled with bureaucrats rather than ailing patients.

Knowledge@Wharton: How is John viewed now in medical history?

Markel: His ideas about preventive medicine and diet, nutrition — even though he wasn’t always right with the science — history has proven him correct. He took a couple of bad turns along the way that are problematic. He believed in eugenics, like a lot of white Anglo-Saxon Protestant men and women in the United States of that era. He actively funded it and participated in many conferences and the like. He also was a very chaste man and was very opposed to sex outside the marriage and even masturbation, so a lot of people made fun of him.

But you have to remember, sexuality at the turn of the last century was looked upon very differently and spoken about very differently than today.

Knowledge@Wharton: How long did his cereal company last?

Markel: The Battle Creek Food Company, which sold 60 different products, lasted until his death in 1943. The whole estate was put into his foundation, which was called the Foundation for Race Betterment. It was a eugenics foundation, which sputtered along and was actually raided by the people who were the trustees and [the funds were] misused. All the money was squandered by the early 1960s.

Knowledge@Wharton: What would have played out if these two gentlemen were running the company today?

Markel: John Harvey sold out his interests in what became Kellogg’s right off the bat. He may still have sniped and bothered Will, but Will became very good at lawsuits and winning. He became quite the billionaire.

I think one of the things Will might have been upset with was the amount of sugar and snack food-ization of the processed food industry. He was always [adamant] about [good] nutrition, convenience and [paying] a good price for a good meal. He might have a few problems with sugar Frosted Flakes and the like.


Gold And The Coming Collapse: Are We Close To A Major Monetary Event?

by: Hubert Moolman



It really should be clear that a major international banking crisis is inevitable and likely to occur fairly soon. Due to the extreme debt levels, many banks are close to that point of failure.
 
An event like a stock market crash is likely to push many banks to that point of failure, since the pressure it would create (on cash resources), would expose their inability to fulfill their obligations.
 
Cash (not bank credits/digits) is still the means by which banks have to settle liabilities and obligations (especially amongst each other). If a bank goes down, it will be due to the lack of cash (not bank credits/digits). It is for this reason that there is a campaign to ban cash (for the general public) or limit the use of it.
 
The banks are in competition for the available cash resources, and they do not want you to be an obstacle. This is similar to what happened during the Great Depression (1933) when gold was confiscated. Then, banks proved their solvency with gold; therefore, the general public was prevented from competing for the limited amount of gold resources.
 
It is for this reason that I believe it is very unlikely that gold would be confiscated during this crisis.
 
Today, it is cash that is the cornerstone of the banking system (especially the US dollar), since it is cash that is promised, not gold.
 
However, gold is still relevant when it comes to warning us of the imminent collapse, and of course, providing some protection against potential financial loss as a result of it.
 
Previously, I have shown how the gold price relative to the US currency in circulation is possibly warning of a major monetary event. It now appears that we could be either at, or very close to, such a possible event.
 
Below is a chart (from macrotrends.com) that shows the ratio of the gold price to the St. Louis Adjusted Monetary Base back to 1918. That is the gold price in US dollars divided by the St. Louis Adjusted Monetary Base in billions of US dollars. So, for example, currently, the ratio is at 0.34 [$1,346 (current gold price)/ $3,942 (which represents 3,942 billions of US dollars)].
 
 
On the chart, I have indicated the three red points (a) where the Dow/Gold ratio peaked. These all came after a period of credit extension, which effectively put downward pressure on the gold price. Points 2 (green) were placed just to show the similarities of the three patterns.
 
After the peak in the Dow/Gold ratio and point 2, the Gold/Monetary Base chart made a bottom at point 3 (green) on each pattern. It is at these points that the monetary base could not expand relatively faster than the gold price increased. Today, this could mean the point at which the game is up for those who are short gold.
 
It appears that we are just past point 3 on the current pattern, so it would be very unwise to be short gold.
 
In 1933, after point 3 was in, the gold confiscation order was passed (point b). This came about due to the pressure to fulfill gold obligations. This was confirmed later by Roosevelt when he justified Gold Reserve Act 1934 by saying that, "Since there was not enough gold to pay all holders of gold obligations, ... the federal government should expropriate and keep all of the gold". Remember, today, this could mean cash as it relates to the banking system.
 
Again in 1971, after the relevant point 3, due to being unable to cover all the foreign holdings of US dollars with the related amount of gold, the US suspended (really ended) the convertibility of the US dollar into gold, on 13 August 1971 (point b). Today, this means a devaluation of the US dollar.
 
Now, we are possibly at point b (or very close to it), where a major monetary event could happen.
 
Whatever happens, gold and silver are likely to spike much higher over the coming months.


Malaysia as a Means to Different Ends

By Phillip Orchard

 

Malaysian Prime Minister Najib Razak is visiting the White House this week. Over the past two years, Najib has been embroiled in a massive corruption scandal that is threatening the continued rule of his United Malays National Organization party, or UMNO, which has governed Malaysia since independence in 1957. U.S. anti-corruption investigators have added fuel to the fire, mapping out the alleged conspiracy and freezing assets of the prime minister’s associates. Throughout this time, however, heavy Chinese investment has been helping bail out the beleaguered government, rapidly expanding China’s footprint in key sectors of both Malaysia’s economy and that of the broader region. Meanwhile, Chinese-Malaysian military ties have been gradually strengthening.
Given Malaysia’s importance as a U.S. security partner and a gateway to maritime trade routes that connect Asia and Europe, the issue illustrates how politics sometimes affects geopolitics. It also demonstrates China’s penchant for gaining the favor of its neighbors by easing the pressure it had applied on them. But it does not indicate a substantive shift in Malaysia’s strategy, nor in the balance of power in East Asia.
 
Strategic Value
Malaysia’s strategic value stems from its position at one of the world’s busiest sea lanes. The gap between peninsular Malaysia and Malaysian Borneo is the southern gateway to the South China Sea and a thoroughfare for seaborne trade bound for the Malacca Strait, the length of which peninsular Malaysia runs.
 

Some 80 percent of China’s oil imports pass through these waters; roughly half of Chinese exports do as well. Denial of this passage would be a threat Beijing could not abide. Nor would its leaders tolerate a tighter coordination among the Association of Southeast Asian Nations’ littoral states that would deter China’s southern expansion into the South China Sea.
But Beijing also sees opportunities in Malaysia. It is a partner in China’s One Belt, One Road initiative, a series of projects meant partly to bypass chokepoints such as the Malacca Strait by opening up alternate routes in the Indian Ocean. Malaysia represents, moreover, a way for China to undermine the influence of the United States – the only naval power capable of shutting down Chinese trade.
For its part, the U.S. sees Malaysia as one of many potential partners that can help stabilize the region. Washington relies heavily on Singapore to support its security interests in the region, but it cooperates with Malaysia on regional security efforts such as counterpiracy. Malaysia even allows the U.S. to launch surveillance flights from its territory and receives occasional port calls from the U.S. Navy. So long as the U.S.-Singapore partnership remains robust, the U.S. will refrain from pushing for a formal alliance with Malaysia or, say, permanent basing access. The main U.S. strategic goal with Malaysia is to prevent the country from drifting too far into China’s orbit — especially if Chinese military assets there could threaten U.S. assets in Singapore and the Philippines. The country’s inclusion in the doomed Trans-Pacific Partnership trade pact was in large part a strategic decision in support of this aim, intended to help the country avoid Chinese economic coercion.
 
The Scandal
Malaysia’s role in the emerging competition between China and the U.S. in Southeast Asia puts the country’s domestic issues in a new light. The scandal revolves around a state investment fund known as 1MDB. Najib, who also serves as finance minister, launched and oversaw the fund, which fell deep into debt when oil prices famously dropped. Najib is accused of diverting nearly $1 billion into personal accounts and using some of the funds to secure election in the 2013 general election. (He claims the money found in his accounts was a gift from an unnamed donor in the Middle East.) A U.S. Department of Justice report released last year bolstered the claims, sounding the alarm among foreign investors and the Malaysian business community. Similar investigations launched in finance centers like Switzerland, London and Singapore haven’t helped matters.
The issue threatens not only Najib’s tenure, but also the relative political stability Malaysia has experienced during UMNO’s uninterrupted rule since independence. General elections will be called no later than the middle of 2018. Najib’s ruling Barisan Nasional coalition narrowly held onto power after losing the popular vote in 2013, and the opposition subsequently fractured. But a new opposition alliance has formed around Najib’s mentor, former longtime Prime Minister Mahathir Mohamad, and Mahathir’s erstwhile rival, Anwar Ibrahim, and threatens to chip into UMNO’s ethnic Malay base.
Protesters listen to speeches during the Bersih 4.0 rally on Aug. 30, 2015, in Kuala Lumpur, Malaysia. CHARLES PERTWEE/Getty Images
Thus, over the past year, the government has moved quickly to try to put the 1MDB issue to rest, and Chinese firms have evidently been keen to help. Several troubled assets owned by 1MDB were sold off to Chinese firms, eventually allowing Najib to declare the state investment fund debt-free. A flood of Chinese investment came pouring into other areas such as a rail line, industrial parks and a $100 billion real estate development. Tens of billions of dollars of Chinese backing for a trio of major port and pipeline projects could ostensibly weaken Singapore’s pre-eminent hold over regional energy flows. Through August, China-Malaysia trade was up 15 percent over the same period a year earlier.
Malaysia, meanwhile, has been mostly quiet about Chinese assertiveness in the South China Sea. And military cooperation between Malaysia and China has gradually been increasing. In November, during a visit to Beijing shortly after the U.S. Department of Justice report broke, Najib signed a deal to jointly build four littoral mission ships. Last month, Malaysian media reported that, in exchange for another lucrative rail contract, China had offered to station 12 units of the AR3 multiple launch rocket system in Johor, less than 25 miles (40 kilometers) from the U.S. military assets stationed at Singapore’s Changi Naval Base.
Najib has shrugged off the opposition’s claims that he’s selling out Malaysian sovereignty to the Chinese for political gain. But the underlying question remains: Can China’s accumulation of soft power in Malaysia be cashed in for hard power?
 
Largesse
Malaysia’s strategic interests must be factored into any attempt to answer this question. Like those of many of its Southeast Asian neighbors, Malaysia’s disjointed geography and somewhat arbitrary post-colonial borders lend themselves to deep ethnic fractures and regional disparities. As a result, the government in Kuala Lumpur tends to be too preoccupied with domestic issues to overextend itself in foreign affairs. Nearly 400 miles of water separate its two halves. Two of the most valuable pieces of British Malaya — Singapore and Brunei — are fully independent states. During periodic bouts of central government weakness, other semi-autonomous regions on Malaysia’s periphery routinely, if half-heartedly, threaten to secede as a means to reclaim lost power and reassert control over their resources.
To an extent, this environment plays into China’s favor. Chinese investment deepens the well of patronage the central government needs to keep the country together, maintain the political stability that foreign investors prefer, and build out the infrastructure networks needed to diversify its economy away from oil and natural gas. (Energy’s share of government revenues has dropped from around 41 percent to 22 percent since the collapse of oil prices.)
But in the long term, Malaysia cannot build its strategy around Chinese largesse. Doing so would assume that Chinese aid and investment can continue in perpetuity. Already, Beijing’s crackdowns on reckless outbound investment is reportedly threatening certain big ticket projects in Malaysia. It would also leave the government vulnerable to Beijing’s bidding. Moreover, UMNO’s ethnic Malay majority is deeply suspicious of Malaysia’s own politically and economically powerful ethnic Chinese population, making Chinese investment a potential political liability as much as an asset. Absent a lasting political accommodation, China has an interest in at least keeping regional states off balance. Given its potential for internal fracturing, Malaysia cannot allow that to happen.
What gives China an opportunity now – the inherent fractiousness of Malaysia – is what has also made Kuala Lumpur wary of close partnerships with outside powers and of participating in zero-sum competitions.