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Point/Counterpoint - The Case for Inflation FUD

Point/Counterpoint - The Case for Inflation FUD

June 15, 2021

In the early 1970’s, there was a recurring segment on the CBS TV news program 60 Minutes entitled “Point-Counterpoint”. During this regular feature, two reporters would take opposite sides, debating the same issue. A YouTube link to a segment sample is included below. You may also remember the edgier, satirical version of this from Saturday Night Live’s “Weekend Update”. You will have to look that up on your own if you are interested in a refresher, as decorum prohibits sharing it with our audience today.

Click HERE for Video

Over the next couple of weeks, I am going to use the same format to discuss the economic topic that seems to be on everybody’s mind recently, INFLATION. Today, we are going to make the pro inflation arguments. In our next segment, we will discuss why inflation may not be as big of an issue. Finally, we will discuss how this may play out, and what it would mean to your investment portfolios over our secular time horizon, in the next 3 to 5 years.

There has been a substantial amount of discussion from economists, market strategists and financial media outlets about how hot inflation is running. It is interesting that we have not heard much about inflation over the last 20 to 30 years. Over that time period we have been in a disinflationary environment, where both inflation and interest rates have been steadily falling.

  • US companies plan price rises as inflation pressure builds – Financial Times, 4/26/21
  • Inflation speeds up in April as consumer prices leap 4.2%, fastest since 2008 – CNBC, 5/12/21
  • U.S. inflation soars in April to 13-year high, CPI shows, and reveals fresh stress on the economy– MarketWatch, 5/12/21
  • Producer prices post biggest annual increase on record – FOX Business, 5/13/21

However, recent headlines like those shared above are bringing a new round of inflation, FUD. No, that does not mean Elmer Fudd is hunting for inflation like he would Bugs Bunny. It is an acronym that comes from alarmist headlines that scream Fear, Uncertainty and Doubt, FUD.

Let’s look at several of the arguments that would point towards a higher inflation regime in the future than we have had in our recent past. First of all, economist Peter Boockvar has pointed out that inflation in the service sector of the economy has been relatively stable, at approximately 2.8% over the last 20 years.

Source: Peter Boockvar

Source: Peter Boockvar

Let’s look at several of the arguments that would point towards a higher inflation regime in the future than we have had in our recent past. First of all, economist Peter Boockvar has pointed out that inflation in the service sector of the economy has been relatively stable, at approximately 2.8% over the last 20 years.

This period of lower manufactured goods inflation coincides with China’s entry to the World Trade Organization in 2001. Additionally, the globalization of our supply chains by making things where they can be produced at the lowest cost, furthered this trend. Technology advances and Moore’s Law have continued to drive down the price of many goods while increasing their speed and efficiency at the same time.

Peter discusses what would happen if the cost of goods begins to rise due to a reversal of globalization, higher pent-up demand from COVID lockdowns and stimulus checks along with supply chain constraints. This, along with substantially higher wages that employers are having to pay to entice workers back into the workforce, could create a substantial shift in inflation trends that have been in place since the early 1980s.

The most recent consumer price report, CPI, showed inflation running at 4.2% on a year-over-year basis. Some of this is due to what is known as base effect. We are measuring April 2021 inflation against April 2020, when the economy was suffering a deflationary shock due to the initial coronavirus shutdowns and social distancing requirements. The monthly increase reported was the most since the early 80s. Along with rising wages, supply chain issues are causing the cost of food, fuel, copper, lumber, and other items to rise dramatically. Economist Jim Bianco states that all of this is causing inflation FUD.

Source: Bianco Research

While the Federal Reserve Bank continues to posit that inflation pressures will be transitory, and relatively short term in nature, several indicators and headlines are showing otherwise.

  • Copper Jumps to Record as Growth Bets Supercharge Commodities – Bloomberg, 5/6/21
  • Chicken Shortage Sends Prices Soaring, and Restaurants Can't Keep Up – Wall Street Journal, 5/6/21
  • Used-car prices just saw their biggest monthly price increase in at least 68 years, UBS estimates – Business Insider, 5/6/21
  • 'Pure panic': Lumber prices up a staggering 280% as builders scramble for supply – Fortune, 5/5/21

Both the service sector and manufacturing PMIs were released last week by the Institute for Supply Management. The service sector, which makes up more than 85% of the US economy, grew at an all-time record pace. Additionally, the Price Index was just below its all-time high. There were similar readings in the manufacturing report, both on the Price Index and the Backlog of Orders Index. These, along with anecdotal comments from participants, continue to support the narrative of material shortages, delays, and rising prices.

Higher wage costs, as qualified labor is becoming an increasingly rare commodity, tends to be stickier over time. This makes it harder to be aligned with the Fed’s transitory outlook. Recently, the National Federation for Independent Business job openings report showed a record number of job openings. This is making companies from Amazon to McDonald’s to local gas stations pay signing bonuses just to get people to show up for interviews and a couple of months of work.

Real estate prices are also continuing to rise, as there are huge demands for a depleted inventory of single-family homes. This, along with unprecedented money printing and stimulus, has increased the overall money supply by 21% from a year ago. The Fed continues to buy nearly 50% more bonds every month than they were at the height of the Great Financial Crisis, when the banking system was on the verge of collapse. All of this is causing the dollar to fall while gold and other commodity prices have been rising.

Nobody is suggesting a return to 1970’s style hyperinflation of 8% to 10% a year. However, it is important to remember the rule of 72. If you take your inflation rate and divide it into 72, it will tell you how many years it takes for costs to double. At even a 3% to 4% inflation rate, prices will double every 18 to 24 years. This means that a person retiring today at age 65 would need twice as much income to maintain the same purchasing power just twenty years into their retirement. This could have an enormous impact on the income needed to maintain lifestyle. It could also put significant stress on their investment portfolios. It is difficult to generate that much income when the Fed is keeping interest rates near zero.

If all of this sounds daunting and depressing, it could be. However, in our next segment we will look at the counterpoint side of the argument. There are long-term, structural issues and demographics taking place in the economy which could cause this to not be as bad as it initially seems. Which side of the argument is correct is yet to be seen. It is something we will continue to follow carefully for our trusted friends and clients as we continue “Moving Life Forward”.

© 2021 Jesse Hurst