The great inflation debate — part 2


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Since there was such interest in last week’s Swamp Notes inflation debate, I thought I’d continue the topic that Ed began, and add a few thoughts that we didn’t cover the first time round.

Much of the inflation debate today is about timing. Nobody can doubt that prices are rising, and few would say that this will change within the next few months. The bigger question is exactly how long inflation will last — and whether it will abate before the 2022 midterm elections.

But what if we were in an entirely different kind of inflationary cycle, one in which inflation will move up and down in a “complex, noisy and volatile” pattern? It’s a theory put forward in a recent client note by Michael Purves, the chief executive and founder of Tallbacken Capital Advisors, who believes the issue isn’t the presence or absence of serious inflation, but rather “inflation complexity”.

The idea is that, as Ed and I explored last week, there are many different factors in play as we come out of the pandemic, and they aren’t all pointing the same way. Technology, for example, will deflate the value of midtown office buildings. But low mortgage rates will undoubtedly continue to raise house prices — on that note, read my latest column about how a whopping two-thirds of global income is kept in real estate and land.

So, you have two strong forces moving against each other, creating counter-trends which will affect different parts of the population quite differently. Purves points out, for example, that robot installations are up 12 per cent this year. Good for companies trying to keep prices down, not good for a worker who’s been fired and has to deal with rising heat and fuel prices.

Covid throws a huge spanner into the works in terms of trying to predict any of this, as the inflation modelling of the last half century just won’t work. Consider this recent bulletin from two economists at the Bank for International Settlements, which outlines the “bullwhip” effect from the pandemic, during which purchasing shifted almost entirely from services to goods. This created bottlenecks in the supply of commodities, intermediate goods and freight transport.

As the report lays out:

“[These] bottlenecks started out as pandemic-related supply disruptions amid strong demand from the global economic recovery. But they have been aggravated by the attempts of supply chain participants to build buffers in already lean production networks — so-called bullwhip effects.

Bottlenecks have been particularly severe in upstream industries — ie, those that supply inputs used in many other products. These constraints have led to large international spillovers through global value chains.

The direct inflationary effect of bottlenecks will likely be limited after relative prices have adjusted. However, sustained inflationary pressures could emerge if bottlenecks persist long enough to trigger an upward shift in wage growth and inflation expectations.”

(For more, see this Twitter thread from the excellent BIS economist Hyun Song Shin).

That’s a lot of potentially volatile shifting of inflationary and deflationary trends. Now factor in the politics of it all, which will encourage some percentage of self-sufficiency and vertical integration, and thus put more cracks in the neoliberal model of trade.

Purves is betting that this “inflation complexity” will make central bankers err on the side of dovishness, rather than being pushed to interest rate increases that might require a quick backtrack. That could, of course, ultimately contribute to serious inflationary pressure (remember the Weimar Republic!).

As Purves puts it, “in a way, it’s as if the Federal Reserve has suddenly become an [emerging markets] central bank — facing screwed up supply chains, re-localisation, some commodity scariness and labour angst”.

Ed, I feel like I’m in an emerging market country every time I take the Brooklyn-Queens Expressway to the airport. Are there other ways in which America today seems like a developing nation to you?

  • I am with Ross Douthat that “we need new colleges” like the just launched University of Austin, focused on “the fearless pursuit of truth,” without fear or favour.

  • Here’s an interesting piece on why Midwestern factory towns may control the make-up of Congress in the future.

  • I just watched the very beautiful and melancholy film Passing on Netflix, about two black women in the 1920s, one living as the wife of a doctor in Harlem, another passing as white and married to a racist. I highly recommend it.

  • And in the FT, I enjoyed this Lunch with Chris Wallace, though I remain far more optimistic about the Biden administration.

Edward Luce responds

Rana, I am writing this from Abu Dhabi (where I am attending a conference), which has good airports and flawless internet connections. To be brutally honest, I am reminded of the poor quality of US airports and airlines almost whenever I travel abroad, and most of the places that I go. If Biden’s infrastructure bill can upgrade public transport in all forms, it will have achieved one of its main purposes, although it could take a while before we begin to feel the improvement.

Let me get back to the spectre of inflation. I don’t have any special insight, and Michael Purves’ observations strike me as reasonable. The causes of inflation are to do with demand relative to supply, rather than supply chain efficiency per se. So I am not sure technology is inherently deflationary as you argue in your reply to my last note. Either way, we might be facing a very different problem a year from now, when the last two years of fiscal support are withdrawn. It could push the US into a recession in early 2023, as S&P recently warned. If you combine the coming fiscal crunch with sustained high oil prices, things could start to look really ugly — even mildly stagflationary. Since I’m in the Gulf, where Saudi Arabia is keeping oil prices high (in league with Russia, it seems), this ominous prospect is at the forefront of my mind. I think it’s fair to say neither Mohammed bin Salman nor Vladimir Putin would like to see Biden re-elected.

Your feedback

And now a word from our Swampians . . .

In response to ‘Turns out Larry Summers was right’:

“Ed Luce makes an important call to avoid ‘circling the wagons’ but simplifies things a little too much. First, he makes it seem like the March stimulus was immediately and wholly converted to demand. How much of the increased demand was wealthy savers reading How to Spend It, who would have been looking to spend anyway, as opposed to people who were still struggling without jobs due to no fault of their own and actually used the money to survive? Summers’s take was more or less rejected, but it was taken seriously, and much more seriously than those who would write him off as ‘a hidebound neoliberal’ would have wished (and much more seriously than voices of dissent on the right . . . In any case, with both Summers and Taliban 2.0, it would have been wrong to blindly cling to a perspective from decades ago without reassessing. It’s taken political and public health catastrophes, but for the first time in decades we’re seeing mainstream politicians flirt with the idea that our social contract was breached and forgotten long ago, and that we need enormous investment to catch up. I think more people are circling the wagons around that idea as opposed to tribalism and fear of Trump.”—Joe Jackson, Rocky Hill, New Jersey

“Enjoyed very much your discussion of Larry Summers and whether he is a neoliberal, and agree with you on the inflationary overuse of the term —and the way in which neoliberalism as a modern term of abuse has changed almost 180 degrees from what it meant in the 1930s, when it was conceived as a policy framework that would limit abuse of competition, credit expansion, etc and in this way defend democracy.” — Harold James, Princeton, New Jersey

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