What’s going on, and where we are headed, isn’t something you can look up on Google. With the media, including the financial press, complete polarized you get either “What, me worry?” from the mainstream or “The sky
is falling has already fallen!” from the right alternative. Neither with a scrap of decent analysis attached.
Inflation, or not? It’s beyond doubt, except maybe to CNN, that there are widespread price increases out there. If you’re on one side, it’s evidence of galloping stagflation, if on the other – what increases?
Neither mentions the possibility that some of the increases are legitimate price signals. That’s the normal market process that simultaneously pushes down demand and encourages more production.
Is there a good reason for multiple, simultaneous price signals across the economy? You bet. We’re in the midst of the worst supply and distribution chain thrash since World War II. With production of both raw commodities and intermediate products shut down or curtailed by the pandemic / panic, and transportation disrupted globally, seemingly remote corners of the economy have stalled for lack of components. (E.g., you can’t have a new SUV because certain silicon chips that drive the dashboard displays have gone in short supply.) At the same time, ‘stimmy’ money injected bursts of demand in patterns that were not typical.
At the best of times, multi-stage supply and distribution chains are notorious for instability when hit with sharp changes in demand or supply. There’s a classic educational simulation called the Beer Game that highlights the issue. Supply chain management systems have been introduced in recent decades to make flow down the chain more transparent, in order to reduce instability. But instead of taking advantage by improving robustness, it’s been used to create ‘lean’ supply and distribution chains that tie up the minimum of capital in inventory. Spread those chains out over the globe, introduce the Wuflu and watch chaos erupt.
The thrash is going to continue for some time. The US is rapidly dumping the lockdowns and masks, but not so in many places that are part of the global economy. Looked at in this way, higher prices in many cases are a big sign saying “Don’t buy this now unless you REALLY need it” while the thrash dies down.
This is definitely occurring. While it’s a pain in the rear it will eventually work out, and hopefully some lessons will have been learned about the need for robustness. But it can also be covering up a couple of less benign reasons for price rises:
The first is price signals reflecting supply changes due to hostile government intervention. The obvious one right now is energy costs. It took only a few weeks for the Biden* administration’s attack on the industry, fracking in particular, to put up prices at the pump as the market anticipates less abundance in the future. Similar is the increase in labor costs as the government pays people more to sit at home than to get back to their entry level jobs. Both of these are insidious as they are cost components in practically every business.
The second malignant reason is of course monetary inflation. With the Federal government spending like a drunken sailor with an unlimited credit card, and Fed trying to keep the market liquid during COVID mania, the money supply has ballooned. But it’s over-simplifying to say “Ah, ha! Inflation!” Because what has collapsed at the same time is the velocity of money, in other words how quickly money flows through the economy. Cash that simply sits on account somewhere is not creating effective demand.
If velocity takes off, then we are indeed at risk of general inflation, but right now it looks more like a liquidity trap. What we are seeing is asset inflation, as the cash gets parked in equities, speculative cryptocurrencies, or real estate. The last is also compounded by side-effects of COVID: Work from home has accelerated the Big Sort of Americans into ideological clusters, skewing regional demands at the same time as construction supply chains and labor were thrashed.
So what might increase velocity and detonate the inflation bomb that is certainly ticking away? The transient price shifts created by the supply thrash probably won’t do it, unless they persist long and widely enough to create an inflationary psychology (a point on which the right side is not helping at all). What those shifts are doing is increasing uncertainly, which typically slows investment and growth.
Once the transients die out, what kind of economy is likely? We have an administration with regulatory and taxation policies as bad or worse than Obama’s, and pursuing foreign policies that are likely to increase global instability. It seems reasonable to expect, at best, a slow growth environment such as Obama produced after the 2008 crash or at worst, a Carteresque malaise and stagnation. With many businesses having involuntarily downsized during COVID, it will be very tempting to keep the wallet closed rather than rebuild to the levels of the Trump economy.
(This started as a ‘thinking into the keyboard’ exercise to ponder my own investment strategy, and grew to the level of a post. What do you think is going on?)