Where were you when inflation was in bloom?
Wed Jun 25, 2008 7:39am EDT Email | Print | Share | Reprints | Single Page| Recommend (0) [-] Text [+]
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By Jeremy Gaunt - Analysis
LONDON (Reuters) - Alex Patelis, a 37-year old economist at Merrill Lynch, suggested to a group of financial journalists recently that it would be hard for them to write about inflation because they had never really experienced it.
That was not entirely true -- a couple of those present remembered paying those double-digit 1970s price rises -- but the point was taken.
For many people in the finance industry, from journalists to economists, traders and analysts, inflation is a textbook concept -- and that could have serious implications for how accurately markets are able to price financial assets.
It is, after all, more than 30 years since U.S. President Gerald Ford was sporting WIN (Whip Inflation Now) badges and only a little less than that since Paul Volker was leading a Federal Reserve crackdown on the U.S. money supply.
The other major threat currently facing global economies and financial markets is a recession. This, again, is not one for the younger whippersnappers. An analyst or trader would need to be 40 or more to have worked through the last prolonged U.S. recession, assuming he or she started work aged around 22.
The actual average age for people in the finance industry is hard to come by, especially given new sensitivities among human resources departments and recruiters about age discrimination.
But a simple glance around Wall Street, London's Canary Wharf or Frankfurt suggests the large majority of bank and investment professionals would find inflation and -- to a lesser extent -- recession unfamiliar phenomena.
"I'd be surprised if the average age was over 40," said Andrew Clare, professor of asset management at Cass Business School in London.
He said his own financial markets students, generally in their mid-20s, were taken aback to learn of eras when wages chased prices in double-digit leaps and interest rates soared after them.
LISTEN TO WHAT THE MAN SAID
Beyond the opportunity for older industry types to assert their superior experience, the bigger issue is whether this age deficit is having any impact on asset prices as inflationary pressures rise.
Despite policymakers from the Fed to the European Central Bank to the Bank of England warning about coming inflation, for example, expectations in the markets remain relatively low.
U.S. Treasury Inflation-Protected Securities, or TIPS, are currently suggesting market expectations of inflation at less than 2.5 percent. Euro zone equivalents are roughly the same.
This would seem pretty low given a record oil price that has nearly doubled in the past 12 months, gold up more than 35 percent and food commodities such as corn soaring 78 percent.
The yield on cash bonds -- 4.6 percent for 10-year euro zone government paper and 4.2 percent for U.S. Treasuries -- are also lower than a coming inflationary threat might suggest.
Cass Business School's Clare reckons there could be a couple of reasons for this, one of which is the age of market players.
"They are A) too young to have any inflation experience or B) they have put faith in monetary policy regimes that have proliferated since the early 90s," he said.
Central banks in general are committed to fighting inflation and some such as the European Central Bank have a target, in this case 2 percent or slightly less.
The Fed, however, has raised some eyebrows by cutting its main interest rate to just 2.0 percent in a move critics say is favoring the need for growth over the inflation danger.
KNOCK ON WOOD
While not having experience in something does not, of course, rule out the ability to handle it, there is evidence that it can affect financial decision making.
James Montier, a behavioral finance specialist and strategist at Societe Generale, says people stick with what they know.
"One of the huge problems we encounter is that people are always overweight their experience relative to historical data," he said.
In this way, he said, bond investors did not buy in for a long time to the idea of disinflation in the late 1980s and early 1990s, the eventual trigger for a long rally.
Part of a famously bearish investment team, Montier now says investors may be too comfortable about the impact of the subprime mortgage crisis and its fallout.
"No one has really experienced the bursting of the credit bubble. That makes it difficult for people to work out what it is going to be like," he said.
Veterans of financial markets, meanwhile, could be forgiven for looking at the current inflation levels and wondering what it is all about.
Mike Lenhoff, the chief strategist at wealth manager Brewin Dolphin, began his finance industry career in the mid-1970s. "It is just not that serious at the moment," he said.
But Lenhoff also knows -- as younger market players, perhaps do not -- that things can change quickly.
"If history is anything to go by, everybody has underestimated how far a trend can go," he said.
(Editing by Ruth Pitchford)