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It’s hard to avoid talking about inflation again today. So I won’t.
The word “transitory” has lost any useful meaning. It’s already clear that the inflation we’ve got will be here for longer than any reasonable definition of “transitory” covers.
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But a slightly different question is: how much of our current inflation is being driven by factors that are likely to pass? And what are we stuck with?
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Let’s have a delve.
What if supply chains shake themselves out?
One very obvious problem driving inflation right now is, basically, massive traffic jams. Our system of sending “stuff” around the world has snarled up, largely because of Covid. It doesn’t look terribly promising right now, with the papers outright revelling in headlines like the FT’s “Shortage nation: why the UK is braced for a grim Christmas”.
However, John Dizard, also writing in the FT, reckons that the pig might be moving through the python, as it were. That’s not easy to see right now (and maybe it’s wrong) but Dizard has been analysing port data and reckons that “the worst is over.”
For example, “loaded inbound containers to Long Beach, California, peaked in May at 444,736. By August, that had declined to 407,426.”
What’s the potential knock-on effect of that? Well, says Dizard, the risk is that we end up with an inventory recession. “When all the goods are delivered by those truck drivers coming out of retirement, there will be a huge global pile of stuff that will not be reordered soon.”
This is a logical argument. We closed down the economy; supply lagged demand. Then we reopened; supply lagged demand even more. Traffic jams prevent people from getting what they want right away, which in turn creates the illusion that demand is even stronger than it actually is.
So companies engage in a panicky catch-up. And the problem with that – and the point Dizard is making – is that eventually that means demand will be satiated, and there’ll be too great a supply of goods, at least.
It’s an interesting view, implying further tricky adjustments down the line.
And it makes a great deal of sense: traffic jams clear in time. Assuming we don’t have more Covid lockdowns, and assuming we don’t have politically motivated supply shortages (this is a trickier one to gauge but it’s typically self-defeatist to cut off a source of revenue like this), then you’d expect a return to broad “business as usual” at some point.
Does that argue for an end to inflation? Not necessarily.
Inflation looked transitory in the 1970s too
For one thing, I don’t think supply chains will go back to being what they once were. I still think that “just in case” is replacing “just in time” which means permanently higher costs associated with an element of what would once have been called “redundancy” and now will probably be viewed (more accurately) as “security” being built into the system.
Beyond that, it’s also worth thinking about what happened in the 1970s. I’m not making any predictions about ’70s-style inflation, but I do think that the reaction of policy makers to that era is instructive.
I’m not the only one. Respected economic commentator Stephen Roach (again writing in the FT) points out that there’s a logic to the idea that supply disruptions are transitory. We’ve outlined why above, and it does indeed make sense.
However, the events of the ’70s that resulted in inflation taking off were all transitory too. Arthur Burns, head of the Federal Reserve at the time, started to ask for “core” inflation measures which excluded all the volatile stuff to reveal underlying inflation.
There’s a logic to that. If oil prices are spiking due to geopolitics and weather events, you can argue that it’ll pass. Not only that, but you can also argue that there is nothing central banks could do about them either. I mean, how does raising interest rates lower the price of oil if a cartel or a hurricane is shutting off supply?
And yet, the 1970s was anything but transitory. And in the end, central banks did have to raise rates and they raised them in a brutal manner. That set the stage for a wonderful, lengthy recovery from about 1982 onwards, but it wouldn’t have felt like that at the time.
Overall, the biggest problem, as Dylan Grice of Calderwood Capital has pointed out, is that, like it or not, we don’t really know what causes inflation. And if we don’t know, then it’s hard to conclude either that it’s here to stay, or that it’ll vanish any day now.
I think that’s a very reasonable point. All I’d say though is that, for now, despite the headlines, the level of complacency seems tilted towards the “transitory” camp (the only thing that can really explain bond yields still being as low as they are).
So my feeling is that it makes more sense to be positioning for inflation to last for longer and be more troublesome than anyone expects. Holding some gold is a good idea but I also discussed plenty of other thoughts in yesterday’s email.
