Inflation Worriers Will Be Wrong for a Second Time
They warned of soaring prices after the financial crisis when deflation was the bigger risk. It probably is again.
Bloomberg, May 11, 2020
The contrarians tend to yell loudest when markets run into trouble. Sometimes they’re right and they make fortunes, with reputations to match. Much of the time, however, that doesn’t happen. Instead of riches, what’s left is a track record of mediocrity or losses.
The market turmoil during the coronavirus pandemic is no different. This time it’s the reappearance of those peddling dire predictions of raging inflation.
I just don’t see it.
The conditions that typically cause a spike in the consumer price index are simply not present: Inflation occurs when prices rise because of increasing production costs amid higher prices for raw materials or wages. Another is when consumers become willing to pay more for goods and services, perhaps because they have more money after monetary easing or fiscal stimulus.
The conditions today are the very opposite of what typically causes inflation. There has been a stunning decline in consumer demand, a collapse in energy prices and a plunge in discretionary spending.
The money recently injected into the economy by Congress and the Federal Reserve doesn’t make up for the earnings power that’s been destroyed. And no one should make the mistake of extrapolating price increases for a few items, such as toilet paper or sanitary wipes, for broader inflation. That’s just microeconomics at work, balancing supply and temporarily elevated demand.
Let’s go back to the last time the inflation hand-wringers showed up, after the financial crisis of 2008-09. The warnings came loud and furious. And it wasn’t just inflation that was a threat, but ruinous, Weimar Republic-style hyperinflation. One of best examples of this can be found here.
Not only were these folks wrong, they were profoundly and fundamentally wrong, demonstrating a deep misunderstanding of how economies function.
Similar alarms are now being sounded.
Consider Tim Congdon, chairman of the Institute of International Monetary Research at the University of Buckingham, England. He warns that “the Federal Reserve has poured money into the economy at the fastest rate in the past 200 years . . . history suggests the U.S. will soon see an inflation boom.”
Meanwhile, David Kelly, chief global strategist of JPMorgan’s asset management unit, thinks we have created an inflation bomb. It is just waiting for a spark to ignite it. The huge fiscal stimulus in addition to the monetary expansion could be it, in his telling.
Legendary investor Paul Tudor Jones has been buying Bitcoins because it reminds him of investing in gold in the 1970 as a hedge against inflation.
Former member of the Bank of England’s Monetary Policy Committee, Charles Goodhart, is warning that “Inflation could exceed 5% in 2021, and perhaps even reach 10% – outcomes resembling the aftermaths of World Wars I and II.”
All of these folks seem to be missing what motivated this unprecedented monetary and fiscal stimulus: The single greatest economic collapse in U.S. history.
The conditions after both world wars were quite different from today: There was huge pent-up demand because of war-time rationing followed by a burst of spending once hostilities ended. Both are classic examples of too much money chasing too little supply.
Underlying many of these analyses is the assumption that the $2 trillion fiscal stimulus and the Federal Reserve’s monetary easing will pump too much money into the economy.
Yet that money just barely replaces the lost business incomes and wages, which most recipients are using to pay for basics such as rent, food and medicine. Even the small businesses that received Paycheck Protection Program funds are afraid to spend it.
The main reason to doubt the return of inflation is really very straightforward. Although the numbers are not yet in yet, let’s take a guess at how much damage this recession has done. The financial crisis caused the economy to contract by 4%. This blow is much worse and might reduce gross domestic product by as much at 10% — possibly more.
That’s an enormous hole to dig out of, and it will likely take many years to return to pre-pandemic levels of demand. Does anyone think the U.S. will be back to the same levels of confidence and spending in a year, even if there is a vaccine or cure for Covid-19 — neither of which is certain?
Even a return to 95% of 2019 levels within a year may be too sanguine.
In other words, this is a deflationary scenario and with none of the obvious conditions that create even modest inflation.
I am not suggesting that some inflation is impossible. No, I’m only saying that 5% or 10% inflation requires a series of very different, and probably unlikely, events to occur: We quickly get a treatment and a vaccine that is available to everyone immediately; all the workers who were laid off are quickly rehired and start producing at the same level as before with no deterioration in their skills; a tax cut for the middle class encourages more discretionary spending; Congress doesn’t know when to ratchet back the fiscal spigot and the Fed stops paying attention to its 2% inflation target. And while we’re at it, it’s worth noting that inflation expectations have been heading lower, and there’s concern that the U.S., like some other developed nations, will soon have negative interest rates.
For those of you who remain concerned about the inflation threat, take solace. First, you will get lots of warnings; inflation shows up in various data series like the BLS Consumer price index and the MIT’s billion price project pretty early in the cycle. We don’t just go from 2% to 5 or 10% overnight. And second, you can always hedge against inflation with Treasury Inflation-Protected Securities (TIPS).
There are lots of things we should be worried about at the moment. But inflation probably isn’t one of them.
I originally published this at Bloomberg, May 11, 2020. All of my Bloomberg columns can be found here and here.