I’m going to discuss inflation again this morning.
It’s a big issue – it really matters to your portfolio.
Some people think it’s going to go away as soon as the pandemic upheaval is behind us. That’s how Janet Yellen, now US Treasury secretary, is trying to rationalise it: “If we want to get inflation down, I think continuing to make progress against the pandemic is the most important thing we can do,” she told CBS at the weekend.
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But I don’t think it’s going away. Pandemic or no, I don’t think it’s going to be transitory at all.
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Here’s why.
The two big mistakes that the “transitory” camp is making
I’ll caveat all of this by saying that this is, of course, just my opinion. I have a tendency to be an inflationista, and that’s something you should be aware of. I like to think that I learn from my mistakes – but don’t we all?
With that out of the way, I think there are a couple of key errors being made by people who think that inflation will come down before it becomes a significant problem.
One mistake is the idea that this is all purely supply-chain driven, and that it’ll all shake out given time. It’s clear that supply chains are a big factor and that parts of the chain are getting back into balance (lots of commodities and other costs are down from their peaks).
But this is not all there is to it – as I’ll get to in a minute, the backdrop is far more inflationary than it has been for years.
The other mistake that people are making (to my mind at least) is the idea that central banks are dedicated to keeping inflation down. A lot of this is political (the dubious theoretical trade-off between employment and inflation figures rapidly turns this into a left vs right issue).
But some of it is just the assumption that controlling inflation is what central banks do, so surely even if inflation takes off, they’ll raise rates, and therefore they’ll choke it off, and therefore it won’t become a problem?
I’d question whether central banks really care that much about inflation in the first instance. History suggests that what central banks really care about is avoiding market turbulence – they consistently err in favour of bubbles, and over-compensate during busts. Inflation barely comes into it.
But even if you disagree with that level of cynicism, I’d remind you of a saying that always comes up in the wake of financial crises, which is that “generals always fight the last war”. Central banks have spent the last decade (and longer than that, if you’re in Japan) trying to create inflation and stave off deflation. If that doesn’t leave them with an inflationary bias, I don’t know what will.
You can see why they feel like this. After all, they feel as though they tossed everything – including the kitchen sink – at the system after 2009, and it still didn’t create inflation.
But if you compare now to then, you rapidly realise that it was a very different world. And that’s the fundamental reason to believe that inflation is a much bigger risk than the “transitory” narrative makes out.
We live in a much more inflationary world
Here’s what’s different; you can boil it down pretty simply. Why was the world disinflationary in the wake of the global financial crisis? We had what looked like loose monetary policy, but we had relatively tight fiscal policy (”austerity”). So governments were at least ostensibly worried about deficits and were attempting to rein in the public finances.
More importantly, on the monetary policy side, we also had a broken banking system. So put very simply, a lot of that apparently loose money was being diverted to fixing bank balance sheets rather than funding anything else.
But now the banks are fixed; indeed, they have been for a while. So that aspect of the backdrop has changed. As for monetary policy itself, it’s been even looser than it was following the great financial crisis. As for fiscal policy, “austerity” is a bad word and governments now see it as their mission to convert the entire global energy system to renewables.
So in fact, today’s backdrop is a lot nearer to what we had in the 1970s than it is to what we had in the 2010s.
What did we have in the 1970s? Loose monetary policy (the scrapping of the gold standard) plus loose fiscal policy. What do we have now? Loose monetary policy (quantitative easing) plus loose fiscal policy (Covid spending, green infrastructure spending).
I don’t think you need to overcomplicate it much more than that.
Does that mean inflation will just go up non-stop? No, of course not. Some bits will come back under control – the big scary one for governments tends to be fuel prices, so they’ll do what they can to get oil prices under control.
But other bits will go up in price. We talk about wage-price spirals – and I can see that potentially being a factor. But there are also just plain old price increases. If you’re a company, and demand isn’t choked off when you hike the price of a product, then you will carry on increasing prices.
Competition eventually kicks in to prevent pure profiteering, but maybe we’re going to find that the level at which it kicks in has gone up. If workers are hard to come by and raw materials are more expensive and you need a “just-in-case” rather than a “just-in-time” inventory system, then you are going to need to generate bigger margins than was once the case.
In short – I think anyone who sees inflation as transitory this time round, is underestimating how significantly the backdrop has changed. And if it wasn’t for the fact that we’ve all got accustomed to a very disinflationary world, I think the warning sirens would be blaring much much louder than they already are.
This is an issue that will no doubt come up repeatedly in our expert panel discussions at the MoneyWeek Wealth Summit. Merryn and I will also be on hand to field your questions all day – so please do sign up now if you haven’t already got your ticket!
