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”.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
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”.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
Equity release rates drop – is it worth unlocking cash from your home?
News Lifetime mortgage rates are falling from their record highs - is equity release worth another look?
By Marc Shoffman Published
Hargreaves Lansdown launches fixed-term cash ISA product
savings/hargreaves-lansdown-fixed-cash-isa-launch Investment platform Hargreaves Lansdown is to offer fixed term cash ISAs via its Active Savings platform paying 4.8%, tax free - but is it any good?
By Kalpana Fitzpatrick Published
The jury's out on the AI summit at Bletchley Park
World governments gathered for an AI summit at Bletchley Park in November, but were they too focused on threats at the expense of economic benefits?
By Simon Wilson Published
As a market correction begins, money is on the move.
The force of a market correction is equal and opposite to the delusion that preceded it, so we can imagine that the correction will also be unparalleled.
By Bill Bonner Published
How small businesses can retain staff in a competitive job market
Small businesses are struggling to retain staff and compete against large companies with deep pockets.
By David Prosser Published
The French economy's Macron bubble is bursting
Cheap debt and a luxury boom have flattered the French economy. That streak of luck is running out.
By Matthew Lynn Published
K-pop hitman Bang Si-hyuk aims to repeat BTS phenomenon
Bang Si-hyuk created the world’s biggest boy band, BTS, making K-pop music a global sensation and himself very rich. Can he repeat the trick with a girl band?
By Jane Lewis Published
Nudge theory – how does it hold up, 15 years later?
Nudge theory, the revolutionary theory of how governments can get you to change your behavior for your own good, is now 15 years old. How does it stand up?
By Stuart Watkins Published
Betting on US politics – who'll be the next US President?
In the latest betting on US politics, with just over a year until the next US presidential election, punters pick Donald Trump as the favourite.
By Dr Matthew Partridge Published
UK wages grow at a record pace
The latest UK wages data will add pressure on the BoE to push interest rates even higher.
By Nicole García Mérida Published