If you’re of the opinion – as we are – that inflation is going to make a comeback in the post-pandemic era, it begs a very obvious question: how? What will trigger this long-term rise in inflation? After all, a lot of the problems following the pandemic will be short-lived. And it’s not clear that the big disinflationary forces have gone away.
So what’s going to move us into this “new era”? It’s a good question. However, I also think it’s a bit of a red herring.
What could create lasting inflation?
What will trigger lasting inflation post-pandemic? You might agree that consumer demand will rocket. After all, there are a lot of savings. And even if they’re not evenly distributed, household balance sheets are unquestionably healthier on aggregate than following your typical recession. So this isn’t an outlandish or even controversial point of view.
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You might agree that supply chains have been disrupted. No one can lay their hands on enough microchips. Low vaccination rates among sailors are apparently another big issue (about half of the staff onboard ships come from developing countries with a slow vaccine roll-out apparently, says the International Chamber of Shipping) which could keep supply chains wobbly for a while. That said, these are both temporary issues. Prices will spike as consumers splurge and supply chains lag. But consumers will go back to “normal” spending eventually and supply chains will heal.
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You can argue that globalisation had already peaked and perhaps been dealt a final blow by the pandemic. You can also make the argument that ageing populations are not necessarily as disinflationary as people think. I am inclined to agree with both of these arguments (at least to an extent) but for many others they are a lot more contentious.
So if the short-term problems go away, why should we be so convinced that inflation is likely to be a longer-term issue than immediate circumstances indicate? The answer is simple: inflation is coming because that’s what everyone wants now.
Inflation is now the end goal
The most important driver of inflation in the future is the change in narrative. In 2008, debt was the enemy. It was the big threat. Everyone was worried about it. Toxic debt had caused the banking crisis and investors were worried that the next step after the banking crisis would be sovereign debt crises across the globe.
This is why “austerity” became the watchword. It would be fascinating if we could play out the counterfactuals, and look at what would have happened if a nation had adopted the full-on “print and be damned” approach during the crisis. I still suspect that going it alone would have been disastrous for any one nation.
However, nearly 13 years on from the collapse of Lehman Brothers, debt doesn’t matter. Indeed, the new spin on debt is that it effectively doesn’t even exist at a sovereign level. A developed-world government with its own currency doesn’t need to borrow money. It can spend what it likes. It simply cannot go bankrupt (this is a simplification of modern monetary theory – MMT – but for the likes of us, that’s all it means in practical terms).
There is no limit to what a central bank can print to fund a government’s spending. The only limit is inflation. So until it takes off, we don’t need to worry about it. In fact, we have a duty to keep spending until we reach full employment. Hence the Federal Reserve’s recent remit change to focus on employment. That’s a massive shift in mindset. And ultimately, this is what will result in inflation over the long run.
Governments, central banks, and to a great extent, markets, are no longer concerned about debt. The so-called “bond vigilantes” who are blamed for pushing up long-term interest rates by selling out of government bonds, are not driving up borrowing costs with the goal of restraining profligate governments.
Instead, investors are just demanding that the Fed prove itself. They actively want the Fed to put a cap on yields so that they can feel safe in betting on the “financial repression/reflation/inflation” trade. They want the Fed to take practical steps to emphasise that inflation is now the goal.
So they’re not so much “bond vigilantes” as “Fed-baiters”. They want to test the Fed’s limits. And eventually they will get their answer when the Fed decides rates have got too high and it’s time to slap them down.
In short, inflation will come – at some point – because that’s now the aim. And that’s why you should make sure that your portfolio is prepared, because what worked in the past 40 years is unlikely to work anywhere near as well for the next 40.
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