I’ve never traveled to Latin America, although Chile and Peru are both top bucket list destinations. However, I am having the experience of rapidly rising prices and shortages of everything at home, similar to a third-world country.
Name an item and it is increasing in price - if you can even find it. Houses, furniture, rent, cars, gasoline, food, services, the list goes on.
I read that fifty percent of the US population was born after 1981, so they have never experienced a meaningful inflation episode like we’re seeing now. Older folks, however, are having flashbacks to the 1970s, the last time inflation was headline news and a regular conversation topic.
The Wall Street Journal wrote an excellent article this month chronicling the serious inflation conditions in the US during the 1970s. It was a difficult time. Meat prices spiked nearly 40% in the early 1970s, which prompted a panicked President Nixon to enact national price controls, which only drove up meat prices higher for several more years. And any one of age can remember the severe gasoline shortage and long gas station lines due to the Arab oil embargo in 1974.
There were actually street protests across the US over rising prices, like you regularly see on TV in Argentina. Wild.
Incompetent monetary policy, the decoupling the US dollar from the gold standard, the cost of the Vietnam War and reckless fiscal spending starting in the late 1960s led to a decade of misery due to unrelenting inflation.
Rising living costs led to worker demands for higher wages, which caused a wage-cost spiral that fueled even higher prices and an out-of-control inflation scenario and lower living standards for the average American in the ‘70s.
The situation was finally brought to heel by a pugnacious new Fed Reserve Chairman, Paul Volker, who took bold steps to raise interest rates to uncomfortably high levels in 1979, forcing a nasty but cathartic recession in the early 1980s. Volker’s historic leadership effectively mothballed the term inflation from our national conscience for four decades.
To be sure, inflation is raging in 2021. The most recent government annual core inflation rate - excluding food and energy - for May was 5.0%, the highest reading since 2008 and the official inflation rate may reach double digits by the end of 2021. Yikes.
An economist joke is that Fed Reserve members must not eat or drive, which explains why they exclude food and gas from the inflation equation.
The key question among economists is whether the inflation shoots are temporary, stoked by economic bottlenecks, supply chain disruptions, pent up demand, a short-term spending spree and a serious but temporary labor shortage.
Alternatively, are the inflation shoots structural in nature, owing to unprecedented money spending/printing to combat the COVID pandemic that has unleashed an economic virus that can’t be easily controlled? If it is structural in nature, then damaging inflation similar to the 1970s could be forming.
Two divergent inflation opinion camps have formed - transitory and structural. The Fed Reserve is in the transitory camp, believing that core inflation may run uncomfortably high for a couple years then will subside due to their policy control levers. Other “don’t worry” pundits argue the recent high inflation numbers are distorted by the baseline effect, in which prices are just now recovering from their 2020 collapse. There’s credence to that argument for sure and the US bond market is not wigging out about the inflation outlook past 2022, at least not yet.
The doomsday camp is equally sure that the US in for a sustained period of high inflation due to an overheating economy fueled by trillions of newly printed dollars pumped into the US economy, a falling US dollar and de-globalization forces. They also argue the current labor shortage is structural, not temporary, which is forcing wages permanently higher and creating wage-driven inflation for the first time since the 1970s.
As for me, I think camping is overrated, I like my memory form mattress too much.
We’re adopting a middle position between these inflation camps. I’ll never forget/forgive Ben Bernanke, then Fed Reserve Chairman, announcing in May 2008 with confidence he didn’t see any troubling signs of an economic recessions, months before the Great Financial Crisis began. It was one of the worst policy calls in US history and casts doubt about the Fed Reserve’s ability to reverse their crazy loose money policy and control inflation via future policy moves, especially in these unprecedented policy times.
Make no mistake about it, the Fed wants inflation to stick around for a while. By one estimate, the Fed is purchasing fifty percent of all new Treasury debt issuance (!), which means they’re still printing massive volumes of money to finance mind-boggling US fiscal deficits; there aren’t enough other bond investors around the globe willing to do so anymore.
The out-of-control growth of US government debt in the past decade has the Fed worried about Japan-style chronic deflation, which is not a good scenario either.
We believe the labor shortage is real and structural, leading to permanently higher wage expenses for business, which will lead to price increases. That’s not good or bad thing, it just is. An inflation factor offset to higher wages is the aging US population; Boomers are now in full downsizing mode (I can attest) and are spending less and less.
There are so many inflation factor crosswinds, our investment weathervane is spinning out of control
Inflation - both actual and expectations - is an important component of investment management so we’re watching inflation developments closely. Remember the market adage, “bull markets do not die of old age, they’re murdered”. The most likely suspect for the inevitable killing of the great bull market of 2020-21 will be the Fed Reserve when they announce higher interest rates after reaching their inflation target.
In the meantime, we still like real asset investments that are prospering in 2021 amidst all this talk of inflation and riding the economic recovery wave.
Until next time, be well….Tim