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The inflation versus deflation cases

12 Oct 2021 1 month(s) ago

Inflation looks like it is intensifying, but there are competing theories about what the future holds.

The subject consuming the global financial markets is what is going to happen to inflation? In the short term, there is little doubt that inflation is rising sharply, at least in the Northern hemisphere. It is not so evident in Australia, but we will not remain immune, especially from high energy prices.

For decades, many industries suffered from global oversupply, which kept a lid on prices. There was plenty of asset inflation – indeed it was out of control – but not so much consumer price inflation.

But that has switched. Inflation in the OECD area rose to 4.3% in the 12 months to August 2021. That is above the range that most central banks are required to follow before they intervene. In normal circumstances they would be raising interest rates, although of course these circumstances are anything but normal.

Australia's inflation rate is heading towards 4%, above the Reserve Bank's target range of 2-3%:

The supply demand equation in the global economy is changing for the first time in decades. In many industry sectors underlying production is weakening, partly because of soaring energy prices that are leading to shutdowns in many countries. Supply chains are also under great stress. To give some idea of the change, a cargo ship of LNG costs $281 million. It was just $10 million in 2020. Small wonder that companies like Kraft Heinz are saying they will have to raise prices. In the United States there are also looming food shortages, which will make matters worse.

The combination of high energy prices and labour shortages – exacerbated by mandating vaccines on reluctant workers, which is an ethical abomination – are obstructing the supply chains and pushing up costs. The Economist says:

“For a decade after the financial crisis the world economy’s problem was a lack of spending. Worried households paid down their debts, governments imposed austerity and wary firms held back investment, especially in physical capacity, while hiring from a seemingly infinite pool of workers. Now spending has come roaring back, as governments have stimulated the economy and consumers let rip.

“The surge in demand is so powerful that supply is struggling to keep up. Lorry drivers are getting signing bonuses, an armada of container ships is anchored off California waiting for ports to clear and energy prices are spiralling upwards. As rising inflation spooks investors, the gluts of the 2010s have given way to a shortage economy.”

But how permanent will this be? Is it just an after shock of the ‘pandemic’ or is something more structural occurring? Economist Michael Pento says the immediate cause of inflation is a $10.4 trillion of global stimulus that “has unleashed a furious but lopsided rebound in which consumers are spending more on goods than normal, stretching global supply chains that have been starved of investment.”

He continues:

“Demand for electronic goods has boomed during the pandemic but a shortage of the microchips inside them has struck industrial production in some exporting economies, such as Taiwan. The spread of the Delta variant has shut down clothing factories in parts of Asia. In the rich world migration is down, stimulus has filled bank accounts and not enough workers fancy shifting from out.”

Pento thinks money is being devalued:

“Inflation is all about the destruction of confidence in a fiat currency’s purchasing power. And there is no better way to do that than for the government to massively increase the supply of money and place it directly into the hands of its citizenry. That is exactly what occurred in the wake of the global COVID-19 pandemic. The U.S. government handed out the equivalent of $50,000 to every American family in various forms of loans, grants, stimulus checks, enhanced unemployment, tax rebates, and debt forbearance measures. In other words, helicopter money and Modern Monetary Theory (MMT) were deployed—and in a big way. The result was the largest increase of inflation in 40 years.”

But Pento thinks this stimulus, handing money directly to people, is “all in the rear view mirror”. He sees deflation as the future threat:

“The idea that Consumer Price Inflation is now a permanent issue is not grounded in science. As already mentioned, inflation comes from a rapid and sustained increase in the broad money supply, which causes falling confidence in the purchasing power of a currency. At least for now, that function is attenuating.

“After all, what exactly is there about a global pandemic that would cause inflation to become a more permanent issue in the U.S. economy? In the 11 years leading up to the pandemic, inflation was not a daunting issue—it was contained within the canyons of Wall Street. In fact, the Fed was extremely concerned the rate of Consumer Price Inflation was too low. And, that the economy was in peril of falling into some kind of deflationary death spiral. This is despite ultra-low borrowing costs and money printing from the Fed.”

So, take your pick. Maybe inflation in the short term and weaker, or even negative prices in the medium term? It depends on just how much harm has been done to global production systems, and whether globalisation will be sharply reversed. It looks like the appetite for economic nationalism is becoming stronger.  Also, high energy prices are quite likely to continue, and that is definitely inflationary.


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