We NEED inflation
A higher-price regime can offer benefits.
[Vacation time! So, in place of my normal weekly, I’m offering this special on inflation. My regular column will return a week from Friday.]
What?! Who says that (besides the new-regime Fed)? Strategas Research, for one. It views higher inflation as a matter of national security. Forty years ago, the U.S. toppled the Soviets by breaking the back of inflation and forcing the dollar up, causing oil prices to plummet. Unable to pay for military expenditures and meet demands at home as oil revenues plunged and import prices soared, the Iron Curtain fell. Now, the U.S. faces another Cold War, this time with China, and dollar depreciation could play the same role in the Chinese economy as dollar appreciation did in the USSR. Higher inflation and a gradual debasement of the dollar versus global currencies could price Chinese exports out of markets and raise prices it pays for energy and food. Another potential benefit: with federal debt-to-GDP above 100% and climbing, inflation that’s not even close to being priced into the market could represent a stealthy tax increase on wealthier investors. Saying it can’t think of a single instance in which a developed economy rightsized its debt load without devaluing its currency since 1971, when the U.S. decoupled the dollar from gold, Strategas concludes the U.S. needs inflation to run hot.
Transitory or not?? Inflation expectations and wages are key drivers of persistent inflation, and both have been climbing. The New York Fed says consumers expect rents, health care and gas prices to rise more than 9% over the next 12 months, trailed closely by food (+7%). Interestingly, the over-60 age cohort that lived through 1970s’ double-digit inflation was the one most worried about higher future inflation. Also worried, low-to-moderate income households, where a much larger share of the family budget goes to housing, food and energy. After four decades of disinflation, the evidence is still thin on whether inflation expectations are turning in any sustainable way. University of Michigan surveys asking whether it’s a good time to buy a home, furniture and car were all down significantly in July. If you think prices are going to keep going up, you should buy now ... although, home sales have stalled despite record low mortgage rates and used-car purchases show signs of peaking. Mannheim’s used-car price index, which tends to lead CPI by four months, fell 1.2% in June. As for wages, average hourly earnings rose 3.6% year-over-year in June, nearly double May’s rate, as companies struggled to find workers. Many are raising wages and offering signing bonuses. Wage inflation is required for inflation to be sticky.
But wait! Companies are finding ways to be more efficient. Some restaurants are asking customers to place orders electronically, either via devices at the table or by phone. The use of Zoom, Teams and other remote-work technologies that exploded during the pandemic are now part of everyday work life, helping companies cut back on travel and entertainment expenses as employees return to offices. Overall, corporations are coping with staff and supply disruptions and other price pressures through automation, new workplace technologies and practices, and the use of more local sourcing whenever they can. Just as the 1970s was a decade of relatively high unemployment, falling productivity and a wage-price spiral, these adjustments are fueling a productivity boom that should keep inflation relatively subdued despite a scarcity of labor over the course of the decade, Yardeni says. Even though surprised by the magnitude of the acceleration in prices, Fed Chair Powell and other policymakers maintain they want inflation to run hot for a while to lift GDP out of the sub-2% growth rate where it’s lingered since 2008. This should help boost opportunities for more Americans. That it also may help devalue the dollar and debt, plus win a Cold War? Hot. Hot. Hot. Could be just the thing.
I was there in the ’70s When a house goes up for sale in Hilton Head, S.C., the buyer often has to have cash (pre-approved mortgages are too slow), be able to pay on the spot and bid over the ask to have a chance. This is classic inflation psychology, buying before prices rise further. Something a generation of Americans have never really seen.
Dividend aristocrats With the correlation between bond and equity returns positive, “bond-like” equities are starting to replace bonds in some asset allocation strategies, with a focus on so-called “dividend aristocrats”—established S&P 500 companies with a history of paying and raising dividends. Yardeni says abnormally high government debt and deficits represent inflation risk (“inflate” away the debt, as discussed above) that could further encourage this switch.
A hungry nation is not a happy nation TIS Group thinks food is the big unpriced inflation risk to the U.S. and China. America’s drought, which is extending across much of the Western U.S., can create inflation of a type which the Fed can’t fix. And food inflation is a major societal risk for countries such as China that import a significant amount of food.