Money & Markets: Inflation is here; what happens next?

It was a long time ago when I first wrote about inflation here. At that point, many respected authorities were claiming deflation was imminent. Then the call was transitory inflation, then followed mea culpas about not seeing it coming.

Well, here it is and inflation is everywhere in the headlines. It appears there is no consensus on what is going to happen next.

Here is my thesis.

Typically it’s cresting. It is my observation that attention in accidents is at its peak after they have happened, not before or during. The very moment of peak interest is exactly when is over and hopefully in a repair phase.

I am lucky here that my readers appreciate the second, third and fourth derivatives when many are struggling with the first.

I keep coming back to this, but inflation is always a result of government policy. The private sector simply has no control over it. They can get their inflation expectation as high as they like, go on strike, blow cash and credit on speeding sprees, but if money isn’t created/printed prices cannot rise.

In the past if there was no more gold, there were no price rises, but as soon as new gold was found up they went. Unlike gold, creating new paper and digital money (most money is already digital) is easy and very useful. Don’t be flim-flammed; inflation is extremely useful too, especially if you do not want your economy to collapse in a heap of recession/depression after a crisis or war. It is also pretty good if you want your economy hopping or you want to up your tax take through stealth. It is especially useful if you want to default on your debts without defaulting. If you have a debt-to-GDP problem, inflation is your friend.

If you don’t print new money you don’t get new inflation.

If new money creation was halted today, in a year inflation would be zero or even negative, thanks to the resultant economic seizures.

It isn’t going to be halted anywhere because governments are still taking on pretty spicy levels of new debt and that new debt has to be facilitated with new money. The good news is that the level of new money being created is way down on Covid pandemic levels. As such, inflation will fall.

The fly in the ointment is ‘inflation expectations’, the scapegoat of inflation. Inflation expectations are what you and I have, and if they are high inflation goes up. Nope, it’s not government’s fault for swamping the world with more money, it’s our fault for wishing prices up. Didn’t we just know it was our fault? These expectations are a part of the system, so it’s the job of the ‘regulators’ to terrify the populace into a doomy view while they work through their inflation trajectories. Inflation will wash out of the system if they stick to their plans, but only once inflation has chewed through the spending legacy of the pandemic. That is two to three years.

This period will have lower inflation than the shock 11 per cent right now, I’m guessing 5-7 per cent, and once the job is done it will go back to 2-3 per cent.

The difference between now and the 1970s is that central banks do now know what they are doing, and governments are not littered with economically illiterate ideologues or clogged by old stick-in-the-muds still hankering for the gold standard.

The modern public sector is a well-run but voracious beast which hungers for resources and knows no bounds. Happily it does understand there are optimal equilibrium points and they have to be achieved for the optimisation of their priorities. Obviously, money is central to that, and it is monetary policy which will be a key medium-term tool to repair post-pandemic economies.

The upshot for engineers, and for that matter anyone who wishes to navigate their finances, is that inflation will crest in the coming months, drop back but remain elevated for an ‘unexpectedly’ long time, but that it will go away within a reasonable time frame. So, inflation will not be a bump in the road, nor an unnavigable mountain route. It’s going to be a significant hill involving downshifting of gears.

The key thought to me is that this period will not be some uncontrollable careening journey but rather a well-planned one. As such, more inflation is not a reason to get too defensive, simply an environment to cope with.

For many businesses the key will be the ability and will to put up prices. Well-run businesses will be quick off the mark, doing just fine, while weak businesses will quail at doing so and find themselves in a perilous position.

The thing about inflation, both good and bad, is that it increases volatility and risk, which means the quick do well but the inertial go to the wall.

As a reader of E&T, you’re bound to do just fine.