Is the recent spike in inflation data and recent price moves in many products and commodities transitory? Is the reopening of supply chain disruptions going to relieve shortages? When is the Fed going to act?
These questions are being debated more than ever, with both sides digging in on their views. To be honest, I am surprised this debate started so late. I wrote about the impact of the fed and treasury actions to the pandemic over a year ago and have not wavered in that opinion. While I try to stay away from predicting exact levels for various inflation measures, I think the general direction is clearly higher! Much higher! However, less talked about and in my opinion, probably more important is the long-term impact of all the support programs, stimulus programs and infrastructure spending on secular labor market trends, capital deployment and achieving equilibrium price levels. I believe this could have an impact on how society, labor and capital have worked together as Adam Smith explained centuries ago.
Super hyperinflation has already begun:
If you’ve heard me speak over the past 6 months, you know one of my favorite definitions of inflation is “too much money, chasing too few goods.” The stimulus plan and covid relief funds, or what I refer to as “Mailbox” Money”, has exasperated the too much money and the supply chain break down, and consumption habits changing so quickly has created the too few goods.
This scenario could be the most extreme example of the definition of inflation. Factor in higher wages and the Fed offering unlimited liquidity, forgivable loans and tax credits, and higher inflation is not my only concern. To me, the unintended consequences are enormous if not incomprehensible.
We have already seen unprecedented price moves in things like lumber, oil, natural gas and substantial moves in copper, soybeans and cattle. Housing prices are up 19.8% over the past 12 months and many supermarkets, home supply stores and even large box stores are announcing price increases. If you look at the CRB indices you can see they are directionally similar to stocks but the trajectory has not caught up yet, which I believe suggests there might be more room to run for prices.
The CPI, which captures a basket of common goods and adjusts for seasonality and high volatility goods has risen 6.8% y/y, the highest since 1990. In my view, CPI will not accurately reflect the inflation ahead, since it will be very uneven as the relationships between assets break down and favor the goods consumed by the higher end consumers, even though the lower quartile is more likely to spend more when they make more.
Prices are somewhat inelastic on the downside, but wages are very inelastic, meaning they are less flexible to being reduced. So even if inflation levels come off the boil and supply chains are restored, prices are unlikely to come down very much; best case scenario in my opinion is they don’t continue to rise.
Supply chain “interruptions”
The supply chain getting back “online” is not a silver bullet in my eyes. Supply chain interruption are not like a conveyor belt that can simply be turned on once they’ve been shut down. When the economy starts to recover, ships can’t just cruise into ports and dump their cargo. Some supplies are perishable and other goods will become obsolete and need to be returned and recreated from scratch. Sure, some supplies are sitting around waiting to be delivered, but businesses and consumers have had to adjust or change some of their buying habits and consumption habits. They have become creative for solving for products in short supply. This is rendering lower demand for certain types of materials and supplies and increasing demand for others – much of it not anticipated. It would not surprise me if it took 3 years or more for the global supply channels to get fully back online and in sync.
Asset Price movements
During times of high inflation, we generally see the increase in most goods and services like we are seeing now. However, unlike inflationary times in the past where lower income consumers spend more of their disposable income on certain goods, these goods will experience lower levels of prices hikes than goods consumed by higher income earners. Beach front homes, private jets and Rolex watches will experience exponentially higher prices. More notably, it will be played out in the materials used for the high-end goods. This uneven price relationship will continue down the income chain and reflect what I call the steak to hamburger spread; the price of a steak compared to the price of a hamburger. Steaks will appreciate at multiples of what hamburgers appreciate. If steaks are $50 and hamburgers are $10 that $40 spread will go to $120.
Money printed vs money risked or earned.
Mailbox money, PPP low interest loans and even forgivable loans will play a different role to expand the economy than money earned and money invested. Growing the pie is good for everyone, including the government, and those that do deserve a larger piece. During the pandemic, liquidity suddenly made available, and money mailed to people had a similar impact and reward as risking your own capital or earning wages from labor. To be clear, I was and still am in favor of most of the programs that were used to sustain the economy and people’s quality of life. It was a good decision! However, we need to be prepared for what it means for the future and the possible consequences. In the future, the markets can correct some of this by rewarding labor and risk capital greater than money borrowed and invested that normally could not have been made available under normal circumstances. Support programs that competed with full time wages cannot ultimately remain steady, and adjustments will be made to correct this. Of course, we are already seeing higher wages as one mechanism, but we will also have greater appreciation of assets that this sector typically owns. I believe the type of inflation we will see will reflect these different types of income and wealth creation.
Interest rates and inflation rates:
Interest rates oscillate: they go from high to low and back again. We just completed a full cycle with rates hitting lows in the early 60s followed by highs in the early 80’s. I believe we just hit the round trip low in 2020 and I believe rates are headed higher for decades. Perhaps not to the 18% we saw in the 1980s, but much higher than a few 100 basis points. Rates will go higher than most are expecting, as they will need to be high enough for bonds to compete with stocks. Additionally, with all the debt being amassed, there will eventually be a flood of bonds on the market. The Fed cannot buy unlimited amounts of debt without creating bigger problems elsewhere.
Philosophical thoughts
There is no such thing as perpetual motion, a trillion is a very big number and unlimited doesn’t exist. The relationship between capital, labor and resources has changed for better or worse. But if we don’t have a plan moving forward, I believe the role of economics as a system to distribute scarce resources will be replaced. And you can extrapolate from there….
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