09 Aug Coronanomics 201.2
Inflation and deflation are often thought of as macroeconomic trends that impact broadly on national economies. Not always so. Although historians are prone to define periods broadly as inflationary or deflationary, they most often are doing so by measuring only labor and retail price movements. These narrow economic phenomena occasionally morph into broader, macroeconomic spectacles and sometimes even lead to hyperinflationary periods, but that is not what is happening in 2020 … at least, not yet.
Many analysts therefore are screaming “INFLATION IS COMING!”
Many other analysts, however, are screaming “WE’RE IN AN AGE OF DEFLATION!”
The answer is … both are right.
Covid-19’s decimation of employment is deflationary. We are, indeed, living in a period of deflation, one built on a multi-decade foundation of (1) globalization that devastated the middle class, reducing wages and wage growth, (2) a slowing global economy that led to weaker commodity prices (notably energy prices) and created a negative feedback loop by reducing jobs and economic activity, (3) selective government intervention in a variety of industries that reduced prices, and (4) technological innovation/automation that significantly deflated costs. The follow-on impact of Covid-19 – the destruction of jobs, wages and economic activity – has undercut consumption and deprived workers of cash flow (concomitantly reducing the velocity of money – which is deflationary) and thereby battered demand for a broad range of goods and services … and also reduced the flow of rent and mortgage payments that are the a mainstay of the American economy … even after the collapse of the housing bubble in 2008-2009. This too has reverberating economic consequences. The excess of supply over demand has led 70% of CEOs to report that they are likely to cancel capital investment plans and resulted in a decline in prices and incomes over a cascading array of economic essentials – in short, deflation. With incomes diving and people shut-in because of draconian health and travel realities restrictions, spending has suffered (as evidenced by a rapidly-increasing savings rate, a belated effort by Americans to rebuild their cash cushions – a 2019 Federal Reserve survey found that only 61% of Americans have enough cash to cover an unexpected $400 expense). Credit card, auto loan, student loan and mortgage delinquencies would be skyrocketing were it not for temporary suspensions imposed by Federal and State governments, suspensions that at some point must be lifted in order for local economies to restart … and for a variety of businesses to survive. Despite these existing debt and cash-flow burdens, credit card debt is increasing at a record rate as Americans deal with stagnant and, for some, non-existent income. Unless there’s a V-shaped recovery – which appears unlikely at this time – those debts will turn into massive defaults. Those defaults in turn will lead to charge-offs for lenders … which will echo in further business failures and job cuts that will have a spiraling effect on the economy. With a declining wage-base and decreased job opportunities, excess production will create rising inventories and force down prices. Should this occur, prospective buyers will come to anticipate lower prices … and will wait to make purchases, which will generate a deflationary vortex of prices and economic activity.
The Federal Reserve will not allow that to happen. Fears of a deflationary spiral have been its policy focus for over a decade, since the Great Recession …, but the Federal Reserve’s attempt to create an inflation rate of even 2% has been phenomenally unsuccessful. No matter how great the efforts of Central Bankers – and their efforts have seen the printing of enormous quantities of fiat currencies and a reduction in interest rates to previously unthinkable negative levels (all of which has been intended to increase the velocity of money – that is, to create inflation) – the global economy instead has been experiencing progressively lower rates of inflation … a precursor to today’s deflation.
TLR warned in June 2019 that “Deflation is Coming,” reasoning that when it comes, Central Bankers would rely ever more heavily on the tools they had employed to support the global economy over the past ten years … by printing almost limitless amounts of fiat currency (adopting the almost universally-derided Modern Monetary Theory (see “Will Modern Monetary Theory Work?” in the April 10, 2019 TLR and “They’re All Keynsians Now” in the March 27, 2019 TLR)), reducing interest rates to or below zero, and promising once again to “do whatever it takes” to keep the economy moving ever upwards. Those are precisely the steps that they’ve taken. The Central Bankers now have the Sisyphean task of pushing the boulder of deflationary forces up the economic mountain … with Sisyphus having had the easier job … and avoiding the danger that, if pushed too far, the boulder will rocket downward after it crests the peak.
In taking on that Sisyphusian task, Fed Chairman Powell reiterated only a week ago that “we are committed to using our full range of tools to support the economy in this challenging time…. We have held our policy rate near zero since mid-March and have stated that we will keep it there until we are confident the economy has weathered recent events and is on track to achieve our … goals.” He added, “Fundamentally, [Covid-19] is a disinflationary shock…. There’s a lot of discussion over how this might lead to inflation over time. We see core inflation dropping to 1%. I do think for some time we’re going to be struggling against disinflationary pressures rather than inflationary pressures.” As a result, Chairman Powell announced that the Fed has abandoned its strategy of pre-emptively lifting interest rates to head off inflation, a practice it has followed for over three decades.
Translation: Deflation is here, but inflation is coming. The only question is … when?
To many analysts, the Fed’s radical change-in-policy signals imminence, the imminence of potentially explosive inflation. Powell has stated that the Fed for the first time in its history will not be the leader in implementing contractive monetary measures. His concern is that the Fed’s withdrawal of stimulus at this time could cause a massive recession that could morph into a Depression and lead to social, civil and international unrest. The Fed therefore will not attempt to anticipate and dampen inflationary expectations. Instead, it will be a follower, allowing – rather, encouraging – inflationary pressures to build and erupt before even considering fashioning a response. Analysts have noted that “this means that if inflation is running under 2% for a while, the Fed is going to allow it to run over 2%…. [If] analysts warn of rate hikes when inflation finally shoots above 2%, none will be forthcoming…. There will be more stimulus, and more stimulus, and more monetization, and more monetization,” all of which is and will continue to fuel hoped-for, and clearly inevitable, inflation.
Money supply growth today is surging at the same time as output is declining and global supply lines are withering. Money-printing is designed to create demand, and that’s precisely what the global economy needs today in order to avoid spiraling deflation. Interest rates and money supply growth already are at unprecedented levels. Federal and State government spending policy have created and are creating ever-greater out-of-control unrepayable deficits and debts. Global supply chains are in disarray, creating spot shortages that are only now beginning to filter through the world’s price structure. With an end to globalization, the world is in the early stages of a large number of significant changes that necessarily are disruptive and that in the near-term will adversely affect all aspects of the economy. With today’s shrinking output, economic theory would predict inflation. Is this therefore the best time for the Federal Reserve to place America’s economy on cruise control and allow it to navigate autonomously … as Chairman Powell has stated?
The Fed is pursuing a cogent, well-thought-out and historically-proven economic plan. Prior to 9/11, America’s national debt stood at $5.7 trillion. U.S. Federal debt now stands at more than $25 trillion … and growing. Over the past 19 years America has added State and local debt obligations that exceed $100 trillion – which is rapidly growing – and has outstanding corporate debt of ~$30 trillion, student loan debt of over $1.5 trillion, mortgage debt of over $9 trillion, auto loans of over $1 trillion, and credit card debt of over $1 trillion. With unrepayable government, corporate and individual debt, inflation is the sensible cure, the only way to avoid default. Look most recently at the period from 1945 to 1980 when the U.S. managed to monetize its enormous WWII, Korean War and Vietnam War debts. It did so by ushering in inflation …, an inflation that admittedly got out-of-control in the 1970s, but that did its job … and was tamed. During that 35-year period, government bonds lost 85% of their value. We are now in a similar period.
It’s an economic maxim that risk increases slowly and anticipates an event that happens quickly. The same is true of inflation: it begins slowly … and then happens quickly. It happens when the public comes to believe that prices are likely to continue increasing. Inflation and deflation work together in cycles. The tipping point between the two arrives when the public perception changes. That time is not today, but it is fast approaching.
Finally (from a good friend)