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A Perfect Storm ?

06/12/2021

Inflation Jumps to 13-year High” blared the front-page headline on The Wall Street Journal.  Although alarmist, it is something Wall Street is paying close attention to .  . . or is it?

According the Monetarist school of economics, inflation results when you have too much money chasing too few goods.  Alternatively, goods available for sale will absorb the money available to buy them, generally speaking.  Our budget deficits have exploded and the Fed has financed that by buying the Treasury bonds.  The result is a huge increase in the money supply.  It is called “Demand-Pull Inflation” where the demand for things to buy exceeds the supply of things to buy.  I have not been worried about this type of inflation, as we experienced a sudden, one-time burst in the money supply.  Nobody expects that to last.  Economists hope this bout of Demand-Pull Inflation will be transitory.

The current supply chain problems were expected but few expected those problems to be as severe they are.  When available goods are in short supply, buyers will “bid-up” or increase the price they are willing to pay and then pass on their increased costs to their customers.  This is called “Cost-Push Inflation”.  I have not been worried about this type of inflation . . . so far.

I am concerned that the 1 – 2 punch of temporary Demand-Pull Inflation, followed by Cost-Push Inflation may increase “Inflationary Expectations”.  When that happens, consumers know they will pay more later, so they buy now, increasing Demand-Pull Inflation.  Inflationary Expectations are pernicious and hard to control.  When the Fed intentionally caused the recession in 1980, it was to tamp down Inflationary Expectations.  They could do that again, and I hope they would.  A short-term recession is better than long-term inflation.  When the Fed releases their minutes after each meeting, the standard language is that “inflationary expectations remain well-anchored.”  When that language changes, watch out!

Oddly, when the inflationary jump was announced, one would expect interest rates to rise and the stock market to fall.  It did the reverse — interest rates dropped while stocks rose.  This “what, me worry?” attitude is uncharacteristic of Wall Street.  My read is that Wall Street is just too preoccupied with clear short-term issues and not with fuzzy longer-term issues.  The take-away is that Wall Street thinks it is still too early to react.  They’re right!

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