Because a little inflation is not a curse
It is too early to talk about inflation with a capital letter. The same rise in commodities should not be overemphasized. The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds
We see stray cats on the street. We know the cartoon cat Felix and the blueberry cat from the landing neighbors. In addition, we all have a general idea of what a cat is, so much so that we could draw one, perhaps stylized.
The difficulties begin when we try to establish the relationship between the individual cats we have seen in life and the idea of a cat that we find in our heads. The idea of a cat is innate, some say, and individual cats are only pale imperfect copies of the ideal cat, eternal and perfect in its splendor. Let's not talk nonsense, others answer, there are really only Mirtillo, Fritz and Birillo, single cats. The Cat with a capital letter that the Platonists like does not really exist, say Roscellino and Occam, it is just a concept of convenience that we form in the head and which is useful for communicating. Aristotle, a man of compromise, chooses an intermediate position and argues that individual cats carry the universal Cat as a real essence inside.
On this delicate question, still debated today in analytic philosophy, not shelves but entire libraries of books have been written. Is the universal ante rem, in re or post rem? Does it precede the single thing, is it inherent in this or is it a simple breath of voice, a flatus vocis?
And since metaphysics, even when we throw it out the door, always comes back through the window, in the financial markets these days there is nothing more than discussing a purely ontological question. Does Inflation exist with a capital letter or are there only inflation with a lower case, those of individual things?
Those who are afraid or want to frighten insists on inflation with a capital letter, the monster that evokes unfortunate memories in those who lived it in the seventies and even more fearful ghosts, as mysterious and never lived, in the youngest ones. they just studied in books. The ultra-expansive fiscal and monetary policies, say those who theorize the start of a long cycle of inflation, are here to stay for the whole decade and will not stop until it is too late, that is, when inflation has become structural.
Those who want to reassure emphasize that yes, all right, there is the inflation of oil, that of timber and copper, that of food, that of semiconductors now unavailable for cars, that of a good part of financial assets, that of houses (14 per cent in America), that of steel, that of minimum hourly wages at 15 dollars and it could go on for a long time. However 1) the rest is calm 2) the single inflation is limited and 3) they are probably temporary 4) there is no more fearful inflation, wage inflation, because the Phillips curve is dead 5) there is therefore none structural inflation and more 6) even if there were, it would be welcome because it helps us to pay off debts, especially the public ones that swelled during the pandemic and 7) inflation disturbs the stock market only if it raises rates, but this once the central banks will control the curve and not let the 10-year Treasury rise above 2 per cent.
Among the nominalists (those who oppose the idea of inflation with a capital) is Powell, both out of conviction (he was the first central banker to send the Phillips curve into the attic) and, perhaps, in order not to be replaced the next year at the head of the Fed by an ultracolomba, like Brainard could be. Unemployment, Brainard points out, is not at 6.4 percent as the Employment Report tells us, but around 10 if we take into account the millions of people who have left the workforce (who have given up looking for a job), in in particular, women who have decided to stay at home to follow their young children or children of school age who find kindergartens and schools closed. With 10 percent effective unemployment, Brainard continues, wage inflation is unlikely to rise seriously for much longer. If wage inflation appears high today, it is only because the reduction in employment has been concentrated in recent months in the lowest paid part of the workforce.
Faced with such contrasting visions, those who invest must remain pragmatic and open and remember some points.
The first is that even a temporary flare-up of inflation can do damage, from which some assets, typically real ones, defend themselves better than others, such as fixed-rate bonds.
It should also be borne in mind that the most insidious inflation, the one that is initially underestimated, begins slowly and only gains strength after many years, then accelerating only in the presence of external shocks. The inflation of the 1970s was actually born in the early 1960s. It was Kennedy who launched the expensive Apollo program to go to the moon and it was his successor Johnson who launched the war on poverty with the great program of the Great Society and, at the same time, doubled military spending to finance the war in Vietnam.
The expansionary fiscal policies began in a context that had already been years of full employment throughout the West but, despite this, it was only in the late 1960s that the phase of trade union battles for wage improvements began. Despite the now evident overheating of aggregate demand (which had caused a deterioration in the US current account and the depreciation of the dollar in 1971), a supply shock (the 1973 oil embargo) was also necessary to produce that pernicious structural inflation ( with the chase between prices and wages and widespread indexing) which was then managed to stop only at the beginning of the Eighties with two recessions one after the other and with two decades of positive real rates.
This time it will take at least two to three years to return to full employment although it is certain that we will, because it is a top priority of the Biden administration. Full employment, as we have seen, is a necessary but not yet sufficient condition for wage inflation to occur. Before excluding the latter entirely from the short-term horizon, however, we remind you that the tax package that is about to be approved in Congress will bring the minimum hourly wage from 7.25 to 15 dollars, while other regulations in preparation will favor the re-union of companies . When we are in full employment, in other words, unions may be more entrenched in the world of work than today.
Alongside this, we started with great momentum on the front of the re-regulation of business activities, a further factor that pushes up the costs and therefore the downstream prices (or which, alternatively, compresses the profits). Another area in which the liberal and disinflationary policies of the past decades have been reversed is that of global production chains. If until now we all went to produce in the cheapest place, now it turns out that it is risky to produce components for pharmaceuticals in China and semiconductors in a Taiwan that America is perhaps preparing to abandon to China by the end of the decade. Now everyone wants to produce semiconductors at home, but a factory costs tens of billions and will still produce at higher costs than Taiwan's. Moving from optimization to redundancy reduces structural price volatility, but increases its level.
As you can see, it is too early to talk about inflation with a capital letter. The same rise in commodities should not be overemphasized. In fact, it is perfectly physiological that, in the first half of an expansive cycle, raw materials accompany the economy and stock exchanges upwards, except for a decoupling and begin to decline towards the middle of the cycle, while stock exchanges continue to rise.
However, it is reckless, on the other hand, to emphatically proclaim that prices will remain stable forever and not to carefully monitor all those bricks that are piling up in the inflation yard even if construction work has not yet begun.
In practice, as we have been repeating for some time, a benign view of inflation can be adopted for the first half of the decade (between 2.5 and 3.5, with some temporary bets higher but also with moments of pause), remaining open to possibility that, for the second half, an external shock or the accumulation of the effects of expansionary policies could create the conditions for inflation that takes root more robustly.
In short, it is good that the market has begun to familiarize itself with the oncoming inflation which, at this point, will no longer be a shock. This familiarization process is taking place in a relatively orderly manner, with a penalty limited to the most speculative sectors of technology only. For some time to come, the stock exchanges will oscillate between interest rate anxiety and euphoria over beautiful growth data. On the other hand, we are not so far from that level of 1.50-1.60 on the Treasury which should be sufficient for now to absorb the charge of inflation that has been created so far. Once rates stabilize, the stock markets will resume their growth towards new highs.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/inflazione-maledizione-fugnoli/ on Sun, 28 Feb 2021 07:00:17 +0000.