This kind of inflation is new for a lot of people in the U.S. and Europe. The high levels that typified the 1970s have not been a feature. Even though inflation has raised prices of a basic car in the U.K. since 1980 about 500%, the creeping inflation we’ve “enjoyed” for so long does not have your eyes bugging out at retail or when you fill up with gas or get a utility bill like the inflation that’s in full flow now.
For the record, I did say here on Forbes that this was on the way and here it is, so what I’m about to say is not coming from the type of punditry that predicts what has just happened.
The call is: do the Fed and others have a game plan that will work in detail or are they winging it and likely to suffer a terrible “lack of policy failure.” A central bank failure means we will crash into depression or rocket into hyperinflation, so it’s the key call.
My thesis is this: Inflation is always and everywhere a government policy, which is kind of a paraphrase of Milton Friedman’s maxim that inflation is always a monetary phenomenon.
Governments make inflation and it is always because of some kind of necessity, good or bad.
My thesis is what we have to do is a consequence of the policy to rebalance sovereign debt to GDP and ease down the real value of public deficits, reset expectation and bridge the economic chasm created and still being created by Covid. (Inflation follows every major global disaster if you care to check.)
The system needs several years of inflation at these levels to get to a point where it can be brought back down to 2%-3%. Three years if you are hasty, five years is doable and if things don’t go right it could easily be ten years. As such, money is going to take at least a 100%+ haircut in buying power.
This is the plan but how can inflation be controlled at these levels, what are the levers?
You might say it’s interest rates, but this is totally wrong. Every country in the world with high inflation has high interest rates and inflation stays high and interest stays high. It’s money supply. You can cut money supply with high interest rates, which is the old way of doing it, but you can raise interest rates independent of money supply and increase money supply independent of rates.
This is what is going to happen to keep inflation at these levels for the years to come.
The question is: how?
The answer might be this: In 2008, the then “unorthodox monetary policy”’ of quantitative easing (QE), which is now the orthodoxy, was used to support economies going through a liquidity crisis. It didn’t create inflation when everyone expected it. Why? This increase of money supply did increase inflation but in financial assets, bonds, stocks and real estate. These assets have very low velocity of stimulus, but these assets support current conditions by providing collateral to borrowers in trouble and the asset price uplift trickles down rather than set off an orgy of spending at the liquor store.
So the way to drain money from the system is to let these assets take a haircut and with a little luck the bubble deflates rather than bursts.
The current stock correction has already drained $8 trillion in U.S. wealth and a similar amount in the current bond-aggeddon I’m sure, though I haven’t calculated it. This will have a trickle down drag on inflation and leaves the central banks with a mechanism to drain the excess money supply from the system while preserving interest rates and, much more importantly, short-term liquidity operations available to stave off systemic damaging panics.
Liquidity sets asset prices which sets inflation trajectory. As that trajectory will be to hold inflation at these levels, the question is where on, say, the S&P 500 the liquidity is turned on and where it is turned off.
Below is my guess:
You can think of it this way: how long will it take to get beyond the effects of the loss of wealth created by Covid? That’s how long we will have inflation and how long we will be in a volatile market moving to adjust. That adjustment might look just great if you look at the numbers, but when you take inflation into account they will show that a 20% hole was punched into the wealth of nations and all the thrashing about we are going to have to cope with will be getting beyond that setback in the smoothest way possible.
And it’s going to be bumpy, but likely not catastrophic.