Pippa Malmgren: ‘biflation’ is coming, and it's going to hurt

Merryn Somerset Webb talks to economist and former US presidential adviser Pippa Malmgren about how the contest between powerful deflationary and inflationary forces will create real pain for the public.

If you missed any of Merryn's past interviews, you can seethem allhere.


Merryn: I'm here today with Pippa Malmgren, who is the author of this rather wonderful book, Signals, which we're going to talk about during this interview. Pippa is a former presidential advisor in the US and also the founder of DRPM consulting. So Pippa, the first thing I want to do is talk briefly about why you wrote this book.

Pippa: Well I've worked with the president of the United States, and found that his questions and the questions of people in such leadership positions are exactly the same as the questions your cousins ask, which is: will interest rates go up or down? Should I mortgage? Should I sell? When should I get paid for my skills? And I realised that, actually, economics is so daunting for most people, it's so heavily mathematical and technical. So step one was to write a book that just put it all in plain English.

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The second reason was because I watched so many people suffer from the last financial crisis, and I saw many signals that got me to sell my house and move my family into rental accommodation during 2007, and I thought, "Why doesn't everybody else do this?" and it's because they didn't see the signals, and that's partly because they all look at official data and not at just things around you, you can see with your own eye.

And I thought, "I need to write something to empower people to have a clearer understanding of what's happening in the world economy than just from data points".

Merryn: OK, that's so interesting. We're going to move on to the signals that you see around us at a moment in a minute, but can we just go back to 2007: what were the signals that you saw then that made you sell your house?

Pippa: Well I give a list in the book, but I'll give you some interesting ones: I accidentally ended up on the top floor of Bloomingdale's in New York, while running an errand. And it was Halloween time, and I saw hundreds of china sets in very gaudy Halloween colours.

And I thought, "Who is spending this much money on a china set for one event a year? And how big must houses be to be able to store an entire china set for only this event? And somebody must have a Christmas plate set as well, and who knows, an Easter Bunny plate set. And how much does it cost to heat a house that's big enough to store all that?"

And to me it was a signal that the Chinese were producing so much volume that the designers had to go further out the risk curve and produce narrower and narrower stuff to get the public to buy, and I thought, "We're definitely spending more than we're earning and at some point the music will stop". And that was a signal for me.

"We're at a moment in history when every major central bank is doing its level best to create inflation. And history tells us that usually at some point this succeeds."

Merryn: How interesting. Now, one of the things that you're seeing signals for at the moment is inflation. At the moment everybody, almost everybody

Pippa: Everybody.

Merryn: bar perhaps you and me, is worried about deflation much more than inflation. In fact, every interviewee I've had on this sofa over the last few weeks has discussed deflation and almost nothing but deflation. But this is not the signal that you're seeing?

Pippa: No, and I'm delighted to hear these odds, because with a trader hat on, when I hear the market is 99% in favour of only deflation, I'd like to take the opposite side of that trade, especially since we're at a moment in history when every major, central bank is doing its level best to create inflation. And history tells us: usually at some point this succeeds.

But more than that, if we look around the world, there are extraordinary examples of inflation unfolding right before our eyes. Only in recent weeks Belarus has found the shop shelves stripped bare because the inflation hit very quickly. Russia's about to hit about 17% inflation; Argentina's at 23%. The next thing is, OK, the Federal Reserve says, "That's not our problem".

That was another impetus for writing the book, because I remember the Jackson Hole meeting in 2013, where all the central bankers were gathered and the Federal reserve position was, "There are no spill overs, there are no consequences; certainly no adverse consequences of monetary policy". Every emerging market central banker in that audience made a sound that I thought was a signal, which was this sound: [slaps forehead]. It was a, "What? You really think that there's no carry trade? If you give away free money then it's not going to land up somewhere?"

And where did it land up? It landed up a lot in emerging markets; it landed in hard assets: property, stock markets went through the roof. And we have seen things like the price of proteins hitting all-time record highs, which for an emerging market is a very important event.

So then the Fed says, "But you should have raised your own interest rates. You could have let your currency appreciate and you didn't do it, so not my problem, your problem", and their view is, "Wait a minute, I was already suffering so much pain from the financial crisis and now you ask me to endure even more? There are limits".

And so the simple question, I think, that we have to ask is first of all: does inflation fix deflation? And I have a lot of views on that. Second: is it really true we don't have any inflation anywhere? I'm not sure that's true, and even in industrialised economies, one of the most interesting signals we see is something I might call biflation' and shrinkflation'.

Merryn: OK, now shrinkflation we have discussed, and I've written about it a bit in the magazine, and in particular last week, or a few weeks ago, I wrote in the magazine about the Creme Egg Debacle', whereby there are fewer Crme Eggs in a multi pack now than there used to be, and worse than that there' less chocolate, and even worse than that the chocolate is of slightly lower quality, right?

Pippa: Indeed.

Merryn: Now, you could say that that was a symptom of a deflationary mind-set among consumers, ie: it's not possible to raise the price of anything, so if you want to improve your margin, you have no choice but to cut back on the cost of the product itself. But you don't see it like that; you see this as a sign of inflation.

Pippa: Well, I think it's very much like what we saw in the 1970s, which is a pre-cursor to a price hike, is that a manufacturer will make the packaging the same size but put less inside, and we've surely seen that in many, many different ways. The Cadbury Creme Egg story was the most recent, people were outraged.

Merryn: I was outraged!

Pippa: And in that particular incident, they did lower the price by 20 pence, but what matters is the price per unit went up because they reduced it from six eggs to five. Another version of it is we're at all time record high price for beef in the US. So steaks on your plate at a restaurant are getting smaller, and if you look at it you are paying more per ounce.

Now, have we had actual price hikes? I would argue yes: Hershey's raised their price of Hershey's kisses by 8% just a couple of months ago. So price hikes are beginning to happen. The question is...

Merryn: Can I just go back slightly: these price hikes you think are a direct result of QE? And the money from QE spilling over into other economies and driving up prices there, and those price raises are now feeding back into the US economy and the UK economy.

"You can talk to bankers, investment bankers and policy makers and they'll say, "There's no inflation". Then you go to their homes and the only thing they can discuss over dinner is the rising cost of living."

Pippa: I agree with Sir John Hicks, the Nobel Prize winner from 1974, who wrote a great book on causality in economics, and he basically said it's almost impossible to tie these things together.

But I don't think it's coincidental that every sovereign wealth fund and pension fund that I'm dealing with is desperately trying to buy agricultural farmland, particularly in the industrialised world. And when the price of that goes up, which it has, then the cost of producing on that land goes up as well, and that begins to affect agricultural prices, and I think it has.

One of the strange things is the margin compression. So, yes you have record all-time high prices for the land, but the costs are also rising, so the profit margins are weak, and that's why I don't think we're going to have hyperinflation. I think what's happening is we've got a contest now between deflationary forces that are genuine and powerful, but inflationary impulses that are real too. And you put the two together and you create real pain for the general public.

Merryn: OK. So Pippa tell me more about this idea of biflation'.

Pippa: So it's an interesting phenomenon where it feels to people, even in the US, the UK and outside of Europe, like everything that's mandatory is going up in price, and everything that's discretionary is going down. So your Apple iPad, that may be falling in price, but the cost of your rent, your fare on the subway, your school fees, your college books, healthcare; all the things you have to have, those prices are definitely rising.

And so a central bank says, "Well, one offsets the other", but I have a real question about this: the Chinese have recently announced Foxconn our biggest employer in China that they're building their first production facility in Pennsylvania, ie: it's starting to be less expensive to produce in America than in China. Do we really think that these prices will keep falling?

And there's a bit question about a very technical issue called hedonics, which is about quality adjustments, and the thing is, OK yes there are great quality adjustments on an Apple iPad, so you pay the same price but you get much more computing power, but three quarters of us don't know how to use it.

Merryn: And also we don't have the option to pay the lower price.

Pippa: And they don't give you the option to pay the lower price. So I think what's fascinating is you can talk to bankers, investment bankers, policy makers and they'll say, "There's no inflation". And then you go to their homes for a dinner party and the only thing they can discuss over dinner is the rising cost of living.

Merryn: And where does the falling oil price fit into this?

Pippa: I think in a number of ways. One of them is: I think the Saudis registered very strongly, that a major contributing factor to the Arab Spring was the sudden increase in the price of bread. It was a jump in the wheat price. At the time there was a drought in Australia and in Russia that contributed to that, but the point is they're very vulnerable to rising food prices.

They realised that if they didn't do something about the oil price, their main geopolitical opponents were being empowered to start producing more. So Iran, Russia, and the United States. And I think they made a very deliberate decision to basically filling out the budget of Russia, Iran; and to postpone and delay production in the United States, and I think that's happening as US fracking entities start to go bust. That's a supply destruction phenomenon. That tells me over time there'll be upward pressure again on the price, because it's no longer so viable to invest in that space.

"You can't just make enough', or the right amount' of inflation. Once you unleash it, it goes, and you can't control that outcome."

Merryn: OK, well that takes us back to the question as to whether inflation can cure deflation. Now I'm guessing that you're going to tell us that there's a natural deficiency of demand perhaps with the demographic situation etc, so we can't cure that deflationary problem by creating inflation?

Pippa: I'm with Paul Volcker: he's kind of like the Bruce Willis of the world economy, right? He's saved us from this the last time, and his view is, you can't just make enough, or the right amount of inflation. Once you unleash it, it goes, and you can't control that outcome. So the question is: does it really offset or, as Christine Lagarde said, "If you unleash the genie of inflation to offset the ogre of deflation", maybe what happens is you get a tussle between both sides, and higher volatility.

I would argue that is what we're already seeing, and heaven knows the level of volatility in different markets we've seen has been off the charts, record breaking.

I think the only thing that fixes both of them, is innovation. And that's why it's so important that we focus on building the economy of tomorrow and generating more GDP and having a real conversation about what we need to do to create the environment in which that can occur, given it's going to be more difficult if you have both deflationary and inflationary impulses bearing down on every entrepreneur.

Merryn: No, with both of those- we'll come back to innovation in a minute, because I know you have some interesting things to say there, but before that: this conflict between inflationary and deflationary impulses, you are very worried about social unrest and rising militarism in quite a lot of the world, right?

Pippa: Indeed. So let me try and explain it as I understood it from the Russian and Chinese officials that I talked to in the course of writing the book. Their view is, "Look, how does the US and the industrialised world get out of their debt problem? They're going to default" and there are different ways you can default, you can say, "We'll just never pay you back", the Argentine style. You can say, "I'll pay you back a little later, a little less", the Greek style haircut. You can default on your own citizens and call that austerity.

But all three of those are politically unattractive. The best way, the way you always choose, is inflation. That's how you paid for the American Revolution, the Civil War and Vietnam. So it's like what Goldfinger said to James Bond: "Once is happenstance, twice is coincidence, three times is enemy action".

So both the Russians and the Chinese say, "Look, we're your biggest creditors. Not only are you defaulting on us, so we're going to take a hit at some point, but you are creating the conditions for price instability in the world, through this quantitative easing approach that you have". And sure enough, when quantitative easing was going up, your oil price went through the roof the minute that they announced it's over; all commodity prices started to collapse. So they're objecting to that volatility, and they believe that the effort will succeed.

And if that's the case they have to protect their own citizens from the consequences, and so both are now reaching for assets food and energy in particular way more aggressively than before. So the Chinese say, "The South China Sea where we have 10% of the world's fish-supply, new natural gas field finds I think that's ours now. Based on what you guys are doing. We don't want to have an argument about that."

The Russians are saying, "Ah, Ukraine, fourth largest food producer in the world, I think the value of that has gone up, and I think, given a choice we'd rather hang onto that." And the Arctic, as another example, where Russia's been much more aggressive, because they think there's 30% of the world's oil supply and 15% of natural gas. And we're back to fish: the price of fish in Russia's up like 60% since the sanctions were announced. That gives them impetus to say, "Fine, then we reach".

And this is partly what brings geopolitics back onto the stage, having been moved off the stage for a long period of time.

"Russia and China are reaching for assets food and energy in particular way more aggressively than before."

Merryn: OK, and how does that affect- let's look at investment: how does that affect the way that our readers should be constructing their portfolios over the next decade, say?

Pippa: Well, I think they should think about a number of things. For example: pensions. If the Russians and the Chinese are not going to finance the excess spending the Americans engage in, which they are clearly not doing, who's going to buy the bonds? The regulators tell the pensions, "You should only do safe things with the assets". Asterisk: the definition of safe is only our sovereign debt'. And this is the way that you move the losses to the savers. It's a very slow and surreptitious process. Every CIO of a pension fund can say, hand on heart, "I did the safe, conservative thing", but when you're at, not only record low bond yields, but negative bond yields in some cases, where do we think these prices are going to go in the next ten years, when again, every central bank is trying to raise the inflation rate? I would say that loss will happen at some point. So that's a big implication for pension holders and bond holders. So that would be one example.

I think we have to really think hard now about the social unrest issues that arise from price instability in global markets. We've seen protests, even in Singapore, mainly over higher food prices there, and higher rent. It's hard to protest in Singapore because then there's a dossier this big on you in the government's offices. But we've seen it in Hong Kong, we're seeing it in Latin America, we've seen it in South Africa, the Arab Spring. If these pressures of deflation and inflation are going to bear down more forcefully, we have to expect that we will see more protests; so then emerging markets are not so attractive. Let's add to that that the debt in emerging markets is all denomin not all, but a bit chunk is denominated in US dollars. Right now we have a rising US dollar, they are devaluing in their markets, so suddenly the debt burden has gone through the roof; and let's not forget devaluation is inflationary.

So their inflation rate is going to jump up; their ability to pay is going down; their revenue from commodities is collapsing

Merryn: And we have social unrest.

Pippa: And we have social unrest, this is not a pretty picture. So one of the things I talk about in the book is the movement of the manufacturing base from emerging markets to two principal locations: the Midwest of the United States and the Midlands here in the UK. And I think, as an investor, we should be looking at these areas very closely, because there's a lot of innovation going on.

Merryn: OK, that's exciting. Back to innovation: you published your book in a new and innovative way, right?

Pippa: Yes. Well I can't say that the answer is calculated risk taking by individuals worldwide, and then not engage in calculated risk taking. I can't start that innovation and then not use the most innovative platform. So I talk a lot in the book about crowd funding as a new mechanism of delivering capital into businesses, which I think is working very well.

So I launched it on Indiegogo, as a crowd-funded proposition, and it was amazing: we raised nearly 50% in about ten days. Every book publisher said, "You will never sell that many books in five weeks given you're a first time author", and in fact it's happening very rapidly, which just proves the point, I hope, that tomorrow's economy is being built today and in unconventional ways, and we are obliged to really study this and understand the mechanisms.

Merryn: OK, so if readers want to buy this book: Indiegogo.

Pippa: Go to indiegogo.com, and then you look up Signals' and by the way, to be clear, old economy people will want to buy a book, but I'm going to bring you into the new economy and tell you you're going to contribute to a perk. It means exactly the same thing.

Merryn: So there's no button they can press to buy a book. They'll press a button to get a perk

Pippa: To contribute to a perk.

Merryn: and then you will send them a book.

Pippa: Exactly.

Merryn: OK same thing. Pippa, thank you very much.

Pippa: Thank you.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.