We’ve been talking a lot about the inflationary boom (which will eventually turn into a bust, as all things cyclical do) that we think lies ahead.
But of course, we don’t have a crystal ball. Inflation – and something more than “transitory” – looks highly probable to me.
But I might be plain wrong. Or something might happen to derail the whole story.
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So maybe it’s time to talk about the risks to this scenario.
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The never-ending lockdown
The case for an inflationary boom is quite simple. Governments responded to the global pandemic by shutting the economy down. They then – in various ways – compensated most (not all) of the people and businesses who were hit by this.
A combination of remote-working technology and copious money-printing means that in aggregate (and incredibly unusually), people are coming out of this recession with their balance sheets either in the same position, or in much healthier positions, than they went into it.
So as the economy re-opens – and we’ve already seen this – you’d expect spending to shoot up as people make up for lost time.
On top of that, supply chains have been disrupted. This isn’t just the case for goods; it’s the case for labour, too: the global mobility of labour has collapsed. This is even before you consider the “deglobalisation” forces that were in place prior to the pandemic.
Meanwhile, governments are spending big (or regulating big so that other people have to do the same) on making the world “greener”.
So we have higher-than-usual demand, meeting tighter-than-usual supply. That’s a recipe for an inflationary boom (or at least in the early stages, before we slide unhappily into a stagflationary one, depending on what happens).
What are the risks to this scenario?
First, there’s the risk of the never-ending lockdown. England has just extended lockdown by four weeks. Scotland is making noises about not being back to normal until at least September.
I’m not a data analyst so I’m not going to even try to unpick this in terms of the statistics. But I think it’s fair to say that lockdown has become another emergency economic measure in the sense that zero interest rates and money printing were an emergency monetary measure.
We locked down the economy to avoid a catastrophic meltdown in the ability of our systems – most obviously, but not only, our healthcare system – to cope.
We’re now locking down – with about 60% of the population having received at least one jab, and more than 40% having had both – as a precautionary stance, because of the Delta/Indian variant.
I’m not hyperbolic about this. But we need to be careful about how used to this our governments become. And how comfortable we become with it all – apparently 70% of the population supports this further lockdown which seems shockingly high to me. I suspect it’s mostly down to the framing of the question but if not, that’s a worry.
I’m not a big one for arguments based on psychology or confidence. Raw money is usually the key driver of any economic or investment development. But if we have rolling lockdowns until the summer is over, you’d have to wonder about whether we’ll all have started to wilt by then.
Of course, you’d have to start talking about extending “stimulus” even further. That perhaps points to a more stagflationary outcome as investors genuinely start to question fiscal sustainability.
Anyway. That’s one risk.
What if governments run out of steam?
Second, there’s more of an economic risk. And that’s the risk that government spending falters. As Louis-Vincent Gave points out on Gavekal this morning, we’ve all been assuming that governments are going to go out of their way to blow huge amounts on “green stimulus”.
That’s one reason (though far from the only one) behind the surge in commodity prices this year.
Gave notes that the assumption has been that “green spending” will be mostly effective at driving up prices rather than creating productive investments.
(If it does work productively – in that we replace oil with a clean energy source which matches or beats oil for both energy efficiency and cost – then we can all crack open the champagne, as we’ll genuinely have moved into a post-oil world and a deflationary boom of epic proportions.)
However, says Gave, there’s another scenario. What if governments simply don’t manage to spend as much on green stimulus as expected? After all, Joe Biden’s infrastructure package is getting nibbled away as it tries to get through the US political system. Meanwhile, China has already been tightening up monetary policy because it fears the destabilising impact of inflation.
Finally, notes Gave, “Russia is just months away from starting to pump natural gas through the Nord Stream 2 pipeline”. And “if Germany can now access cheap and plentiful Russian gas, will German politicians still advocate gargantuan green energy spending at the European Union level?”
This is an interesting question. It implies that commodity prices would still head higher but that supply would be less constrained and that demand for “green” commodities like copper might not be as massive as expected.
It also implies that the forces of “austerity” (in relative terms – the idea that anything about today’s government spending is “austere” is laughable) might be more potent than expected. Which would in turn at least reduce the inflationary impulse.
Anyway – these are just two factors, beyond the obvious one of central banks abruptly decided to raise interest rates, that could derail the “inflationary boom” scenario. I think the key things to watch out for are the pace of re-opening, and signs of proper pushback against government spending plans.
We’ll have a lot more on prospects for the green revolution and its side effects in upcoming issues of MoneyWeek magazine. If you’re not already a subscriber, get your first six issues free here.
