Are you chill about inflation, now that the US consumer price index (CPI) jumped to 5.4% in June, a 13 year high, and following a 5% rise the previous month? The word ‘inflation’ was mentioned on 87% of the earnings conference calls tracked by Bloomberg in July, compared with 33% a year ago. Clearly inflation is on investors’ minds.
Maybe it’s not the CPI we should be worried about, but wholesale prices – the producer price index in the US went up by 7.3% last month, the biggest annualised gain since 2010. That suggests prices in the shops are going higher in the coming months.
In the UK, The Guardian newspaper ran a provocative – or maybe rhetorical – headline on 18 July, directly addressing the Bank of England governor, Andrew Bailey: “Inflation isn’t out of control yet, governor, but can you reassure us it won’t be?” The UK’s official figure for consumer price inflation (CPI) in June was 2.5%. The Guardian added that “forecasters agree 3% is a nailed-on certainty this year, with a few saying 4% will be seen”.
The UK’s CPI doesn’t take account of the rise in house prices, which went up by 10.7% in May compared to the same month last year. In the US, the S&P Case-Shiller national home price index rose by 14.6% in April, year-on-year, after it went up by 13.3% in March.
Jamie Dimon, CEO of JP Morgan Chase bank, told a conference call in July that inflation may be worse than the Fed anticipates but “it won’t make any difference” if jobs are plentiful and growth remains strong. Maybe Dimon is tossing his hat into the ring as a candidate for the position of chairman of the US Federal Reserve in 2022, when Jerome Powell’s tenure expires. Powell looks like a shoo-in for re-nomination in charge of the Fed. A survey in April of 34 fund strategists and economists showed 74% of them thought that President Joe Biden would re-select Powell. In any case, Dimon has a comfortable $1.8 billion cushion against rising prices.
As for the Eurozone, the “harmonised index of consumer prices” was at an annual rate of just 1.9% in June, down from 2% in May. The European Central Bank (ECB) is due to meet on Thursday this week. The expectation is that it will continue staying ultra-dovish; 2% inflation remains its target. Average annual inflation in the Eurozone has been just 0.9% since 2013, compared with 1.9% in the US. The Eurozone contracted by almost 7% in 2020. It will recover much of that lost ground this year – but real growth still eludes it, despite all the European Central Bank’s efforts.
Keep an eye on it
Jerome Powell’s job hangs on how he steers the US economy through the troubled waters of the next 12 months. He seems pretty relaxed about inflation. He said recently: “if people believe that prices will be pretty stable, then they will be — because they won’t ask for very high wage increases and people who sell things won’t be asking for high price increases… Once that psychology sets in, it tends to perpetuate itself”. That’s either a thunderbolt of profundity or breathtakingly naïve. The US Treasury Secretary, Janet Yellen, is singing the same song. She said last week “we will have several more months of rapid inflation… I think over the medium term, we’ll see inflation decline back toward normal levels. But, of course, we have to keep a careful eye on it”.
Yellen is almost 75; Powell is 68. Both of them therefore can clearly remember the 1970s, when the US was in the grip of double-digit inflation. Americans then took to wearing badges reading ‘whip inflation now’. It might be time to get those old badges down from the attic.
That inflation was broken only by very painful, recession-causing action by a former chairman of the Federal Reserve, Paul Volcker. Volcker pushed interest rates to 20% to kill inflation. “At some point this dam is going to break and the psychology is going to change”, said Volcker. Almost four million jobs were lost in the recessions that followed as people learned some Volcker-psychology.
Today, no-one knows which direction inflation is headed, nor even what its real level is. Official CPI stats, based on a basket of goods which has changed over time, are questioned by some people. John Williams, founder of ShadowStats in the US argues that, if the methodology once used by the US government, with an unchanged basket of goods was applied today, then inflation would be revealed as much higher, around 13.5%. It “will get quite a bit worse” in his words.
There are as many learned economists telling us to relax, nothing to see here, move along quietly, as there are equally expert pundits telling us we are going to hell in a handcart. The former chief economist of the IMF (International Monetary Fund) and now Professor of economics at Harvard, Kenneth Rogoff, said last week “mildly elevated inflation more likely signals that things are going well than that we are doomed. There is no reason for the Fed to squash it too quickly… US inflation today is much more like good news than bad”.
On the other hand, another esteemed academic, Professor Steve Hanke, who teaches applied economics at Johns Hopkins University, warned in May that: “more – perhaps much more – inflation will enter the system”. Who should we believe?
Psychology – what people expect will happen and how much that influences what they do – is only half of it. It’s also a matter of how much money is sloshing around. It’s unfashionable to link inflation to increased money supply – modern monetary theory, which de facto seems to have taken hold of central bank thinking, asserts that running deficits and creating more fiat currency doesn’t matter, so long as an economy keeps growing. So central banks create more fiat money: almost one in five Dollars in existence was created in 2020.
All these extra trillions of Dollars, Pounds and other fiat currencies have been injected into the system. Not all will be stashed under the mattress. Some of it has been or will be spent – on cars, holidays, houses, whatever. According to the New York Federal Reserve bank roughly a third of all stimulus payments received by Americans has been used to pay down debt, while 25% has been spent on consumption. As Steve Hanke said in May this year, “money growth will lead in the first nine months to asset‐price inflation”. We’ve seen that, in houses and equity valuations. “Then, a second stage will set in. Over the 18 months after a monetary injection, economic activity will pick up”. That’s what central bankers are hoping. “Ultimately, the prices of goods and services will increase. That usually takes between one and two years after the injection”.
We may be in for a nasty surprise – not inflation but stagflation: stagnant economic growth combined with inflation. The Eurozone has been trying to get its economy to return to growth, with little success, for years. We have had a demand shock – strong demand for just about everything from basic agricommodities to semiconductors – as economies re-open. The stimulus from the Fed (and the central banks of other countries) has been fuelled by running up ever greater debts. The official figure for US national debt is close to $29 trillion, but another source, taking into account unfunded Social Security and Medicare pledges, puts it at more than $133 trillion.
A Minsky moment
Hyman Minsky, who died in 1996, lived a fairly obscure life as an American academic economist. His name became familiar during the 2008 financial disaster. Minsky posited that economies are inherently unstable. During periods of bullish speculation they shift from financial stability to fragility and then into crisis, thanks to speculative bubbles in asset prices. 2008 was a classic Minsky ‘moment’.
At the moment everything in the garden looks rosy. But maybe we are headed for a fresh Minsky ‘moment’? The euphoria following the pandemic, and the continuing loose monetary policies to prevent outright collapse are building bubbles on several fronts. Economies are rebounding, admittedly at different speeds, and we are in danger of being carried away by headlines that shout about strong growth. But maybe this is a house of cards? Is real underlying productivity rising so strongly?
In this febrile moment, poised as the world is between signs of economic recovery from COVID-19 and alarms about fresh variants, the Fed is between a rock and a hard place – push up interest rates to choke off inflation and risk stifling economic recovery and killing off many ‘zombie’ companies, or leave interest rates at their rock-bottom level and watch inflation steadily climb higher. As Nouriel Roubini, another eminent economist brain, wrote at the end of June: “years of ultra-loose fiscal and monetary policies have put the global economy on track for a slow-motion train wreck in the coming years. When the crash comes, the stagflation of the 1970s will be combined with the spiralling debt crises of the post-2008 era, leaving major central banks in an impossible position… this slow-motion train wreck looks unavoidable”.
Roubini envisages our future to be stagflation – low or no economic growth, combined with rising prices. What to do to protect oneself in such turbulent times? The purchasing power of fiat money continues to slide; asset bubbles are everywhere. While gold has had its ups and downs, when down can obviously have a negative effect on purchasing power, the overall trajectory for the past 50 years at least has been up, while fiat currencies have relentlessly been down. Our mantra is that gold is security and Glint its key; but Boy Scouts have an equally sound motto: “Be prepared”.