Prices of everything; a house in Phoenix, a Ford F-150, a plane ticket to New York, have all gone up. That much is true.
Unfortunately pretty much everything else about inflation—a red hot topic these days—is conjecture. And that’s vexing, not just for the dismal scientists (aka economists), but for all of us, because whether or not prices are really rising, by how much and for how long, has massive implications in our lives. Or as Mark Zandi, chief economist at Moody’s Analytics, says: “Inflation is one of the mysteries of economic study and thought. A difficult thing to gauge and forecast and get right. That’s why the risks are high.”
The current debate over inflation really revolves around two questions: First, is this current spate of inflation, just that, a spate—or to use Wall Street’s buzzword of the moment, “transitory,”—or not? (Just to give you an idea of how buzzy, when I Google the word “transitory” the search engine suggests “inflation” after it.) And second, transitory (aka temporary) inflation or not, what does it suggest for the economy and markets?
Before I get into that, let me lay out what’s going on with prices right now. First, know that inflation, which peaked in 1980 at an annualized rate of 13.55%, has been tame for quite some time, specifically 4% or less for nearly 30 years. Which means that anyone 40 years old or younger has no experience with inflation other than maybe from an Econ 101 textbook. Obviously that could be a problem.
As an aside I remember President Ford in 1974 trying to jawbone inflation down with his “Whip Inflation Now” campaign, which featured “Win” buttons, earrings and even ugly sweaters. None of this worked and it took draconian measures by Fed Chair Paul Volcker (raising rates and targeting money supply, as described by Former President of the Federal Reserve Bank of St. Louis, William Poole) to eventually tame inflation and keep it under wraps for all those years.
Until now perhaps. Last week the Labor Department reported that consumer prices (the CPI, or consumer price index) rose 5% in May, the fastest annual rate in nearly 13 years—which was when the economy was overheating from the housing boom which subsequently went bust and sent the economy off a cliff and into the Great Recession. Core inflation, which excludes volatile food and energy prices, was up 3.8%, the biggest increase since May 1992. (For the record, the likelihood of the economy tanking right now is de minimis.)
Used car and truck prices are a major driver of inflation, climbing 7.3% last month and 29.7% over the past year. New car prices are up too, which have pushed up shares of Ford and GM a remarkable 40% plus this year. Clearly Americans want to buy vehicles to go on vacation and get back to work. And Yahoo Finance’s Janna Herron reports that rents are rising at their fastest pace in 15 years.
To be sure, not all prices are climbing. As Yahoo Finance’s Rick Newman points out, prices are not up much at all for health care, education and are basically flat for technology, including computers, smartphones and internet service (an important point which we’ll get back to.)
But that’s the counterpoint really. Americans are obsessed with cars, housing is critical and many of us are experiencing sticker shock booking travel this summer. Higher prices are front and center. Wall Street too is in a tizzy about inflation, and concerns about it and more importantly Federal Reserve policy in response to inflation (see below), sent stocks lower with the S&P 500 down 1.91% this week, its worst week since February.
Given this backdrop, the tension (such as it is) was high when the Fed met this week to deliver its forecast and for Chair Jay Powell to answer questions from the media. Or at least so said hedge fund honcho Paul Tudor Jones, who characterized the proceedings on CNBC as “the most important meeting in [Chairman] Jay Powell’s career, certainly the most important Fed meeting of the past four or five years.” Jones was critical of the Fed, which he believes is now stimulating the economy unnecessarily by keeping interest rates low and by buying financial assets. Unnecessarily, Jones says, because the economy is already running hot and needs no support. The Fed (which is in the transitory camp when it comes to inflation) risks overheating the economy by creating runaway inflation, according to PTJ.
Now I don’t see eye to eye with Jones on this, though I should point out, he’s a billionaire from investing in financial markets, and let’s just say I’m not. I should also point out that Jones, 66, is in fact old enough to remember inflation, never mind that as a young man he called the 1987 stock market crash. So we should all ignore Jones at our peril.
As for what the Fed put forth this past Wednesday, well it wasn’t much, signaling an expectation of raising interest rates twice by the end of 2023 (yes, that is down the road.) And Powell, who’s become much more adept at not rippling the waters these days after some rougher forays earlier in his tenure, didn’t drop any bombshells in the presser.
Which brings us to the question of why the Federal Reserve isn’t so concerned about inflation and thinks it is mostly—here’s that word again—transitory. To answer that, we need to first address why prices are rising right now, which can be summed up in one very familiar abbreviation: COVID-19. When COVID hit last spring the economy collapsed, which crushed demand in sectors like leisure, travel and retail. Now the economy is roaring back to life and businesses can raise prices, certainly over 2020 levels.
“We clearly should’ve expected it,” says William Spriggs, chief economist at the AFL-CIO and a professor of economics at Howard University. “You can’t shut down the economy and think you turn on the switch [without some inflation].”
“We had a pandemic that forced an artificial shutdown of the economy in a way that even the collapse of the financial system and the housing market didn’t, and we had a snapback at a rate we’ve never seen before—not because of the fundamentals driving recovery but because of government,” says Joel Naroff, president and chief economist of Naroff Economics.
COVID had other secondary effects on the economy though, besides just ultimately producing a snapback. For one thing, the pandemic throttled supply chains, specifically the shipping of parts and components from one part of the globe to another. It also confused managers about how much to produce and therefore how many parts to order.
A prime example here is what happened to the chip (semiconductor) and auto industries which I wrote about last month. Car makers thought no one would buy vehicles during the pandemic and pared back their orders with chipmakers, (which were having a tough time shipping their chips anyway.) Turned out the car guys were wrong, millions of people wanted cars and trucks, but the automakers didn’t have enough chips for their cars and had to curb production. Fewer vehicles and strong demand led to higher new car prices, which cascaded to used car prices then to car rental rates. Net net, all the friction and slowness of getting things delivered now adds to costs which causes companies to raise prices.
Another secondary effect of COVID which has been inflationary comes from employment, which I got into a bit last week. We all know millions were thrown out of work by COVID last year, many of whom were backstopped by government payments that could add up to $600 a week (state and federal.) These folks have been none too keen on coming back to work for minimum wage, or $290 a week. So to lure them back employers are having to pay more, which puts more money in people’s pockets which allows stores for example to raise prices.
Anti-inflation forces
But here’s the big-time question: If COVID was temporary, and therefore its effects are temporary and inflation is one of its effects then doesn’t it follow, ipso facto, that inflation is (OK I’ll say it again), transitory?
I say yes, (with a bit of a caveat.) And most economists, like Claudia Sahm, a senior fellow at the Jain Family Institute and a former Federal Reserve economist, agree. “‘Transitory’ has become a buzzword,” she says. “It is important to be more concrete about what we mean by that. We’re probably going to see in the next few months inflation numbers that are bigger than average, but as long as they keep stepping down, that’s the sign of it being transitory. If we didn’t see any sign of inflation stepping down some, it would’ve started feeling like ‘Houston, we have a problem.’”
To buttress my argument beyond that above “if-then” syllogism, let’s take a look at why inflation has been so low for the past three decades.
To me this is mostly obvious. Prices have been tamped down by the greatest anti-inflation force of our lifetime, that being technology, specifically the explosion of consumer technology. Think about it. The first wave of technology, a good example would be IBM mainframes, saved big companies money in back-office functions, savings which they mostly kept for themselves (higher profits) and their shareholders. But the four great landmark events in the advent of consumer technology; the introduction of the PC in 1974 (MITS Altair), the Netscape IPO of 1995, Google search in 1998, and the launch of the iPhone in 2007 (I remember Steve Jobs demoing it to me like it was yesterday), greatly accelerated, broadened and deepened this deflationary trend.
Not only has technology been pushing down the cost of everything from drilling for oil, to manufacturing clothes to farming, and allowing for the creation of groundbreaking (and deflationary) competitors like Uber, Airbnb and Netflix, but it also let consumers find—on their phones—the most affordable trip to Hawaii, the least expensive haircut or the best deal on Nikes.
So technology has reduced the cost of almost everything and will continue to do so the rest of our lifetime. Bottom line: Unless something terrible happens, the power of technology will outweigh and outlive COVID.
There is one mitigating factor and that is globalism, which is connected to both technology and COVID. Let me briefly explain.
After World War II, most of humanity has become more and more connected in terms of trade, communication, travel, etc. (See supply chain above.) Technology of course was a major enabler here; better ships, planes and faster internet, all of which as it grew more potent, accelerated globalism. Another element was the introduction of political constructs like the World Trade Organization and NAFTA. (I think of the Clinton administration and China joining the WTO in 2001 as perhaps the high-water marks of globalization.)
Like its technological cousin, globalism has deflationary effects particularly on the labor front as companies could more and more easily find lowest cost countries to produce goods and source materials. And like technology, globalization seemed inexorable, which it was, until it wasn’t. Political winds, manifested by the likes of Brexit and leaders like Putin, Xi Jinping, Erdogan, Bolsonaro, Duterte and of course Donald Trump have caused globalism to wane and anti-globalism and nationalism to wax.
The internet too, once seen as only a great connector, has also become a global divider, as the world increasingly fractures into Chinese, U.S. and European walled digital zones when it comes to social media and search for example. Security risks, privacy, spying and hacking of course divide us further here too.
So technology, which had made globalism stronger and stronger, now also makes it weaker and weaker.
COVID plays a role in rethinking globalism as it exposes vulnerabilities in the supply chain. Companies that were rethinking their manufacturing in China but considering another country, are now wondering if it just makes sense to repatriate the whole shebang. Supply chains that were optimized for cost only are being rethought with security and reliability being factored in and that costs money.
How significant is this decline in globalization and how permanent is it? Good questions. But my point here is whether or not “globalism disrupted” is transitory (!) or not, it could push prices up, (in the short and intermediate run at least), as cost is sacrificed for predictability. Longer term I say Americans are a resourceful people. We’ll figure out how to make cost effective stuff in the U.S. It’s also likely that globalism will trend upward again, though perhaps not as unfettered as it once was.
More downward pressure on pricing could come from shifts in employment practices. Mark Zandi points out that “the work-from-anywhere dynamic could depress wage growth and prices. If I don’t need to work in New York anymore and could live in Tampa, it stands to reason my wage could get cut or I won’t get the same wage increase in the future.”
And so what is Zandi’s take on transitory? “What we’re observing now is prices going back to pre-pandemic,” he says. “The price spikes we’re experiencing now will continue for the next few months through summer but certainly by the end of year, this time next year, they will have disappeared. I do think underlying inflation will be higher post-pandemic than pre-pandemic, but that’s a feature not a bug.”
I don’t disagree. To me it’s simple: The technology wave I’ve described above is bigger than COVID and bigger than the rise and fall of globalism. And that is why, ladies and gentlemen, I believe inflation will be transitory, certainly in the long run. (Though I’m well aware of what John Maynard Keynes said about the long run.)