Inflation: Has the force awakened?

06-15-2021
Inflation: Has the force awakened?

Will it be different this time?

 

What happens when the world is cooped up – in some cases against its will – for more than a year? We are now getting answers to this global experiment. To no one’s surprise, it turns out many are increasingly unwilling to delay gratification, accepting their Covid restrictions with the same indignation as teenagers putting down their smart phones at supper time.

With no release valve, it was bound to happen this way. How long can many handle a continual blur of Zoom, Peloton classes, and our own cooking? To be clear, these are problems of the “First World” variety. And the broader issue is deeply complex, full of trial, error, and human tragedy. Depending on virus developments, different nations are re-opening on staggered timelines and proceeding at varying speeds. While America’s restrictions are eroding at warp speed velocity, the Trudeau government is only now contemplating the conditions to loosen constraints along the world’s longest international border. In a few regions like India and Brazil, the pandemic has even tightened its grip.

But never before has the world witnessed such a globally connected phenomenon. For the first time in history, all of humanity, informed by the near universal reach of digitization, has come together, fixated on the same existential threat, consumed by the same fears and anxieties, awaiting the same miracles of modern science.

Now, with a broader vaccine rollout gathering momentum and teaching our collective cells new tricks, the possibility of herd immunity is no longer fanciful. The taste of pent-up anticipation is palpable. People are ravenous to rediscover the world they once knew. Buoyed by the potential of relaxed summer restrictions and flush with stimulus checks, long-deprived consumers are ready to unleash their pre-pandemic mix of spending (apparently teeth whiteners and travel bags are now flying off the shelves). If there ever was an approaching time to indulge, this is it.

As the world steps out into life after lockdown (gingerly for some and brazenly for others), it is also no surprise that inflation is now soaring all around the world. The U.S. Bureau of Labor Statistics’ latest inflation report, normally an exceptionally boring affair, could not resist the superlatives: consumer prices rose 4.2% in April from a year earlier, the most since 2008; used vehicles soared the most on record, dating all the way back to 1953; and core inflation, which excludes food and fuel, jumped in April from a month earlier by the most since 1982.

A pandemic price shock

Clearly, the inflationary environment has changed. But the burning question is the stickiness of all of this. Over a short-term horizon, we find ourselves in the rare position of agreeing with the Fed. Base effects and bottleneck surges are driving a temporary surge in prices. The reality is that the world has just experienced a systemic price shock. Incoming inflation figures simply reflect the rebound from a highly abnormal and severely depressed period a year ago (let’s agree to finally call it what it is – a V-shaped recovery). Recessions have always caused supply-side withdrawals, setting the stage for price increases in the subsequent recoveries. This is nothing new or surprising.

The above is different from a general rise in price levels, which usually stems from excess aggregate demand. And it is certainly different from the galloping inflation of the late 1960s and 1970s (which peaked at 14% in 1980). Back then, there was no slack in the economy, which was running 2% above capacity on average. And a series of inflationary shocks plagued the economy – escalating costs of the Vietnam war, a doubling of the oil price in 1970 alone, and ultimately, the breakdown of the Bretton Woods system in 1971 (where the U.S. unilaterally terminated convertibility of the U.S. dollar to gold).

The miracle of globalization

Another key difference from the 1970s is that national economies were essentially closed. For most countries, imports were a tiny percentage of GDP (just 3.5% for the U.S.). Contrast that with today’s hyperconnected world. Imports have become an important safety valve to relieve shortages and their associated price pressures.

We are witnessing this phenomenon in real time. Never mind the miracle of modern science; stand in wonder of the miracle of globalization. If, in March 2020, someone had provided a preview of the following year, what would have struck you about global production and supply chains: how poorly they fared or how well?

The virus initiated a serious collapse in the services sector, resulting in an explosive growth in retail goods. Most would have predicted that a global lockdown would have been the end of consumer life. Instead, this author’s Amazon.com order history over the last 12 months is a brimming mélange of garage organizers, weighted blankets, Swedish roasted coffee, Vitamix blenders, Aztec sea salt, air pods, a sous vide water oven, gardening tools, plenty of lockdown snacks, and a John Maynard Keynes biography (The Price of Peace: Money, Democracy, and the Life of John Maynard Keynes, by Zachary D. Carter, highly recommended beach reading) – all with delivery times that would make Dominos wince.

What about the pinch points in global supply chains? In most areas, supply has caught up with freakish demand (masks, hand sanitizer, and toilet paper). Other areas like semiconductor chips are more serious as consumer spending on electronics has surged, and shortages have been exacerbated by the U.S.-China tech war. But here, too, the world economy is rebalancing quickly as the recovery process broadens out and various sub-sectors adjust. Markets are still underestimating the speed and flexibility of the global supply and production response.

The early takeaway of the pandemic was the vulnerability of globalization. The ultimate lesson will be its underrated resilience.

Next time: Investment strategy for a regime change.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

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