Because inflation is like ketchup
The analysis by Alessandro Fugnoli, chief strategist of the Kairos fund
There is no continuity between liquids and solids and in between there is a whole world of sticky substances and a whole science that deals with them. Olive oil is less fluid than water, syrup is less fluid than oil, Nutella is even more viscous and so on. Pitch has a very high viscosity and even glass, which we perceive as a solid, can be thought of as a very high viscosity fluid.
When a viscous substance is present in a tube or container, the central part is more fluid and therefore flows faster than the parts close to the walls, but this is only one of the interesting behaviors of viscous fluids. Some of these, like ketchup, are thixotropic. Thixotropy is the property of passing from the state of almost solid pasty fat in the phases of rest to that of semi-liquid gel when we subject the substance to peristaltic movements.
If we try to pour ketchup on eggs, as do the morning Americans , beginning even if nothing comes out completely reverse the bottle. So let's try to shake the container and for a few times nothing continues to come out, if not a few drops. Trying and trying again, in the end, all of a sudden, it comes out too much. In short, it is a difficult art to calculate the right movements to bring out the desired quantity.
Inflation is like ketchup. In the last decade, attempts have been made to raise it (or, to be more precise, it has been declared that they want to raise it) but not much has come out of the bottle because in reality it has not been shaken much. We certainly wanted to avoid deflation, but we also wanted to avoid inflation for fear that it would also bring interest rates with it. High rates in a leveraged world, that is, heavily indebted, would have risked causing high instability. It is true that where there is debt there is also credit, but moments of tension can be created between the two if the creditor begins to lose confidence in the debtor's ability to repay it.
If this time it was decided to try to shake the ketchup bottle with more force, it is because, through the Modern Monetary Theory, we are convinced that, with the appropriate precautions, inflation can be raised without increasing the rates (or making them rise less than inflation). It is enough to ask the central bank to buy government paper in unlimited quantities whenever rates rise above a certain level.
But let's take a step back and go back to the moment when we try to pour ketchup on eggs in the morning and it doesn't come out. Why doesn't it come out? Keynes noted that prices and wages are sticky, not fluid. Even in the presence of a recession and a decline in aggregate demand, prices and wages tend to remain stable for some time even if this ultimately translates into higher unemployment which aggravates the recession. But the opposite is also true. Prices and wages tend to remain stable for some time as aggregate demand picks up. By doing so, they accelerate the recovery of employment and the economic cycle in general.
For a few months now the markets, seeing the impressive succession of fiscal and monetary expansionary measures, have internalized the concept of inflation coming and have adjusted upwards the few rates that can still affect, the long-term ones. Central banks have offered eminently ambiguous explanations, saying with half their mouth that inflation is wanted and welcome and with the other half saying that all is well and there is nothing to see, because the rise in prices will be temporary and due. to a pure base effect, that is to say, the fall in prices last year at this time.
But after getting scared and accusing central banks of being behind the curve, the market gradually calmed down for three reasons. The first is that the positioning on the long side has become more prudent and has therefore better absorbed the first data confirming the recovery in prices (even higher than forecasts). The second is that the US Treasury, having raised a lot in recent months to take advantage of low rates, is slowing down its issuance. The third, which is the deepest and most structural reason, is that the perception is beginning to spread that the increase in inflation will be a long process, a stop and go and also with phases of retreat.
To get an idea of how long and slow these processes can be, it is enough to retrace the two historical phases that precede the current one.
The first, which lasted from the mid-thirties to the end of the seventies, started from the fight against deflation and succeeded in its aim through aggressive demand policies (welfare and rearmament). Prices and wages remained stable until the mid-sixties, then thirty years, then the ketchup of inflation began to emerge more and more abundant and uncontrollable once it reached full employment (actually a few years later).
The second phase, the forty years from 1980 to 2019, was exactly symmetrical. To block ketchup, everything was focused on supply policies (labor flexibility, taxation, technology, globalization, optimization of production chains, immigration) and public demand was kept under control (austerity, prohibition of monetization of public deficits) . The maneuver was successful until 2008, then the deflationary impulses began to get too strong and everything had to be reversed again.
Today we are in the third phase, similar to the first. The focus is all again on demand (monetized public spending, infrastructure, green deals, rearmament) while the supply-side reforms that had been preached, imposed and adopted in the second phase are abandoned one after the other. We deglobalize, protectionism returns (perhaps painted green like the carbon border tax that the European Union is preparing in a hurry to adopt from 2023), work is deflected (sharp increase in minimum wages, resyndicalization, fight against gigs) , the tax burden is increased, redundancy is created in the production chains.
It is clear that we are moving in a context of not only cyclical but structural reflation. However, it is wrong to draw from this the conclusion that prices and wages will rise linearly or even acceleratedly and moreover in a short time. It is wrong not because everything will be fine, as some Candide argues that inflation is dead forever, but because some forces of the second phase will slowly die out (international trade continues to grow) while the reflationary forces of the third phase will ignite. gradually. Technology will continue to work in a deflationary sense, but not necessarily forever if it assumes a monopolistic profile and if it is de facto nationalized in the military industry (in a few sectors inflation is higher than in oligopolistic war technology).
That we have passed from the second to the third phase is also clear from another narrative that takes its cue from viscous fluids. In the 1980s, when it came to bringing down inflation, Bundesbank Governor Karl Otto Pöhl preached that it's easy to get inflation toothpaste out of the tube, but hard to put it back in. Today we are preached exactly the opposite and the central banks tell us that it is difficult to get out of deflation and therefore we must try them all. If inflation arrives one day, it will be very easy to stop it.
Who is right? In reality there is not much difference in the degree of difficulty of the two reversal maneuvers. Getting out of deflation is technically difficult, but getting out of inflation is difficult politically, because it requires a cold-induced recession (if not two after each other, as Volcker did).
In conclusion, the proposals we have been making for some time remain valid. The better the shares of the bonds, the better the credits of the government. Bond yields, after the current pause, will start to rise again, but for this year the most is done. For the next one it depends on how much more ketchup will be stirred.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-linflazione-e-come-il-ketchup/ on Sun, 18 Apr 2021 04:48:20 +0000.