Is inflation here to stay?

A new paper suggests that unless workers gain more bargaining power, inflation won’t be sustained.

Is inflation here to stay? It’s the biggest question in markets right now. At MoneyWeek, we’re of the view that the answer is “yes, probably” – we’re moving into a more inflationary era and central banks will be happy to tolerate it. However, not everyone agrees. Among the sceptics are James Montier and Philip Pilkington of US asset manager GMO, who have just published a paper titled “Inflation – Tall Tales and True Causes”. 

Montier and Pilkington don’t deny that inflation is and will be higher in the short term as the economy reopens. They draw an analogy with rationing in Britain after World War II. “Like a lockdown, rationing represents an arbitrary restriction of supply in an economy.” When it ended, demand for rationed products surged, driving prices of those goods higher in the first couple of years after rationing ended. Using this experience as a rough guide, the pair suggest that US inflation could rise to between 3.5% and 4.5% as lockdown eases – which is what’s happening. However, supply and demand should balance in time, making this a “temporary” increase. 

What would it take to make inflation stick? Montier and Pilkington argue that neither monetary nor fiscal policy hold the answers. Instead the main issue is wages. The pair note that “to raise wages workers need to have bargaining power against their employer”. Low unemployment helps workers on this front, but it’s not sufficient, say Montier and Pilkington. Unions are another key element. And given today’s low rates of unionisation and propensity to strike, “we think it is unlikely for a long-term wage-price spiral (a key ingredient in inflations)” to take hold. 

Are they right? At this stage it’s hard to be confident. The mechanism to drive wages higher may not be obvious, but as Martin Sandbu notes in the Financial Times, “the fact that nobody predicted [the current labour shortages] is itself significant. [Economists] are still scrambling to understand what is going on”. As for the role of unions, in a recent interview with The Market NZZ, analyst Russell Napier argues that inflation encourages unionisation rather than the other way around. “People banded together and joined unions to protect themselves from inflation. When there is no inflation, you don’t need to be in a union. I think we will see more unionisation again.”

Also, you don’t need to see 1970s-level inflation to have a big effect on portfolios. Just shifting from constant disinflationary pressure to a more inflationary world would make a huge difference to which assets thrive (see the column for more on how today’s most bubbly assets might fare in such a shift). The uncertainty is one reason why we still think that owning a bit of gold is a good idea.

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