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The Economy

Inflation: Over by Christmas?

(Nerthuz/Getty Images)

As Isaac Schorr noted on the home page this morning, today’s inflation news is . . . not good:

The Consumer Price Index (CPI), which tracks the cost of a variety of consumer goods as well as housing and energy prices, has risen 4.2 percent from a year ago, notably higher than the estimated 3.6 percent. It is the largest yearly increase since September 2008.

Even controlling for food and energy prices, the CPI was up three percent, higher than the estimated 2.3 percent. The 0.9 percent CPI increase from March, again controlling for food and energy prices, is the highest since April 1982.

This data comports with Americans’ everyday experiences. On Tuesday, the average price of a gallon of gas rose to $2.99, the highest figure since November 2014.

The news also contradicts the Biden administration’s line on the risk of inflation — that it’s nearly nonexistent . . .

The hope, of course, is that this is just a blip, the product of baseline effects, temporary supply-chain disruptions, and (once again, temporarily) distorted labor markets; but now might be the moment to re-up a piece by John Cochrane and Kevin Hassett that we ran a couple of weeks ago on Capital Matters.

In particular, when it comes to assessing the extent to which this jump in inflation might be more than a blip, it is worth paying attention to this passage in that piece:

When demand soars and supply is constrained, inflation will rise. When people question policy and find it feckless, they expect more inflation, and inflation grows more and becomes entrenched. Persistent inflation grows suddenly, unexpectedly and intractably, just as it did in the 1970s.

I don’t believe that I am the only person to think that additional spending of as much as $6 trillion might be on the “feckless” side, and that is before we get to what the Fed is (or is not) doing.

Here is an extract from an article by Ambrose Evans-Pritchard, writing in yesterday’s Daily Telegraph:

Jamie Fahy from Citigroup says inflation is flashing red and the Fed has fallen “behind the curve”. Money is being printed to fund government spending that goes directly into the veins of the economy, or for transfers to poorer Americans with a higher propensity to spend. To all intents and purposes it is helicopter money. The character of QE has self-evidently changed.

Mr Fahy said the immediate inflationary build up is likely to end in one of two ways. Either the Fed blinks, turns hawkish, and winds down QE earlier than it now suggests. This would trigger a taper tantrum and major sell-off in asset markets. Citigroup thinks it could be comparable to the Bernanke tantrum in 2013, a memory that dollar debtors and emerging markets would rather forget.

Or the Fed persists with loose money regardless, stoking a consumption boom that sucks in imports and leads to a balance of payments scare. This second course would send the dollar into a tailspin and potentially lead to a vicious circle as China, Japan, and the eurozone stop recycling a large part of their $720bn combined current account surpluses into the US debt markets.

Such a monetary boom would be much more painful in the end. Mr Fahy says a little inflation may be elixir for stock markets but this turns toxic once the CPI index crosses 4pc. At that point bonds and equities both deteriorate, and there is nowhere to hide in a conventional portfolio. “It could be a painful adjustment process from the current frothy valuations,” he said.

It is worth remembering that Wall Street equities lost half their value in real terms in the decade after the onset of the Great Inflation in 1967. I keep hearing claims that this is nothing like the “guns and butter” fiscal expansion of the Johnson era but actually Joe Biden’s $6 trillion plans are an order of magnitude greater, if defined by deficit-to-GDP ratios . . .

Commodity inflation is by now beyond doubt. Lumber futures have risen fivefold from their pre-pandemic level to over $1,600 (per 1,000 board feet). This alone has pushed up the cost of a new home by $24,000. Record prices for copper and iron ore add a further layer of cost.

New US home prices are rising faster (11pc) than during the final parabolic phase of the subprime property bubble in 2006 — a modest affair in retrospect. The property surge is enabled by ample Fed liquidity and by bond yield compression that has held down the standard 15-year Freddie Mac fixed mortgage rate to 2.3pc — half the level two years ago.

There is plenty more in Evans-Pritchard’s piece to think about, none of it reassuring. Sadly, the article is paywalled, but I will add his conclusion:

Janet Yellen explained in a speech as Fed chief in 2015 how inflation pauperises households and pensioners that depend on fixed incomes to survive, and how it eats into the real earnings of poorer workers least able to defend themselves.

She also argued that the Fed was ultimately responsible for the destructive consequences of the Great Inflation in the 1960s and 1970s. In her words the institution allowed chronically over-heated labour and product markets to crystallise what was otherwise just a commodity shock. It caused an “inflationary psychology” to take hold.

Hmm.

Hmm, indeed.

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