Central banks have admitted that they can no longer describe inflation as “transitory” with a straight face. But they still seem to be confident that they can tackle it without too much trouble. A new paper from Vincent Deluard, analyst at US financial services group StoneX, titled Inflation is inflationary, suggests it’s not as simple as that.
First, Deluard looks at US consumer price index data going back to 1871, a period during which inflation averaged 2.2% a year. Overall, he finds that inflation follows a “random walk” pattern. In other words, you cannot reliably predict its future path by extrapolating from today’s data.
However, once inflation goes above 7%, “things get weird”. First, inflation becomes “a lot less stable when it is elevated”. Second, “high prices beget higher prices”. The data no longer follows a random walk. Instead, once inflation is high, “the best forecast is that inflation will keep rising”.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Rising prices change behaviour
Deluard confirms this is the case globally by using World Bank data going back to 1960. He finds that inflation has spiked above 7%, after five years of price stability, on 352 occasions. How easy is it to tackle once it gets to these levels? The answer is: “not very”. Inflation averaged less than 3% for each of the subsequent five years in only 12% of cases. At the other end of the scale, in 33% of cases, inflation went on to average more than 10% for the next five years. So faith that central banks can return inflation to “normal” levels – or at least, do so without causing a lot of pain in the process – appears to be misplaced.
These findings make intuitive sense. When prices are stable or rising at a barely noticeable rate, everything ticks along smoothly. But once prices start rising at a noticeable rate, it has an impact on the behaviour of people and companies. “Consumers front-run their purchases to avoid paying more later. Creditors bill their clients faster. Workers bargain for pre-emptive wage increases.” In short, the velocity of money – the rate at which it is changing hands – shoots up.
What does this imply for investors? If you haven’t done so already, it makes sense to prepare for more persistent inflation, just in case. Gold is one useful inflation hedge which we’ve always recommended you hold. On the equities side, higher inflation implies that the current rotation from “growth” to “value” – perhaps best demonstrated by the FTSE 100’s outperformance of the Nasdaq this year – is likely to continue. As James Ferguson of MacroStrategy Partnership notes, “value stocks... have good inflation-fighting credentials, outperforming growth during the inflationary 1970s and 1980s”.
-
What is the 25x retirement rule and does it work?The 25x retirement rule has been around for decades but many experts question if it is a suitable strategy
-
When is the self-assessment tax return deadline?If you are self-employed, rent out a property or earn income from savings or investments, you may need to complete a self-assessment tax return. We run through the deadlines you need to know about
-
The financial crisis in UK universities – what can be done?UK universities are running out of cash and have begun to shed staff; bankruptcies look likely. What’s gone wrong, and what should be done about it?
-
'Governments are launching an assault on the independence of central banks'Opinion Say goodbye to the era of central bank orthodoxy and hello to the new era of central bank dependency, says Jeremy McKeown
-
Why investors can no longer trust traditional statistical indicatorsOpinion The statistical indicators and data investors have relied on for decades are no longer fit for purpose. It's time to move on, says Helen Thomas
-
The most likely outcome of the AI boom is a big fallOpinion Like the dotcom boom of the late 1990s, AI is not paying off – despite huge investments being made in the hope of creating AI-based wealth
-
The rise of Robin Zeng: China’s billionaire battery kingRobin Zeng, a pioneer in EV batteries, is vying with Li Ka-shing for the title of Hong Kong’s richest person. He is typical of a new kind of tycoon in China
-
How retail investors can gain exposure to Lloyd’s of LondonIt’s hard for retail investors to get in on the action at Lloyd’s of London. Here are some of the ways to gain exposure
-
The goal of business is not profit, but virtueOpinion Serve your customers well, and the profits will follow, according to a new book. It rarely works the other way around, says Stuart Watkins
-
Earnings estimates are a rigged game – especially in the USThe number of US stocks beating earnings estimates tells us only that guidance has deliberately been set too low
