Email of the day on inflationary pressures
Comment of the Day

June 11 2021

Commentary by Eoin Treacy

Email of the day on inflationary pressures

It has been a while since our last meeting in London. Gillian and I are spending the little time that may be left for us in Lugano.

Since early this year I am in discussion with our banker friends about the risk of inflation and all that goes with it. Being closer to 90 than 80 I have seen and felt what inflation does to people’s savings and the social structure of the countries affected.

Debt levels around the world are at catastrophic heights and some of my friends in the banking world are of the opinion that debt will never be paid back - utter nonsense in my mind. The Federal Reserve Banks of the world are no longer controlled by the people in charge but by politicians who, if they have any knowledge of economics and finance, are scared stiff. Rolling over is the motto of present days because what would happen if interest rates would rise to normal levels is too terrible to imagine.

The G7 15% min. tax is not solving the problem but at least it’s indicating that some people are aware of the enormity of the debt and try to do something about it.

The U.S. inflation figure for May 2021 has been commented by John Authers today - see attachment -; what are your thoughts?

The other and much bigger problem for everything that lives on our planet - I call it ‘spaceship earth’ - is also very much on my radar but we leave that for another day.

Wishing you a pleasant weekend.

Eoin Treacy's view

Thank you for attached report and article. I hope you are both enjoying the contemplative life in the beauty of Lugano. I’ve been saying for months that we all have to take the economic figures of the 2nd and 3rd quarters with a degree of scepticism. Year over year comparisons are effectively useless when last year represented a shutdown of the entire global economy.

As I discussed in the audio last night, if we look at month over month comparisons there is a lot less cause of alarm at inflation. That does not mean there are no inflationary pressures. However, they are showing up in the kinds of places central bankers don’t like to look.

Let’s focus on a simple example. I took my eldest daughter to a fencing tournament in Austin in December 2019. The cost of the flight for the two of us was $919. To fly to Dallas in February 2021 was $173. In March the fare dropped to $120.

By all accounts, airfares are now recovering. To my mind $919 was expensive and was probably seasonally influenced, but $120 is bargain basement pricing. Prices could quadruple and still only approximate the rates ahead of the pandemic. It’s hardly a broad bold sign of inflation if airfares, hotel and rental car rates and restaurants recover. That’s just normal in a recovery. The same thing happened after 9/11 and everyone worried about persistent inflation and the threat of financial repression.

Lumber prices have peaked, the labour union induced slowdowns at port facilities will improve and trade will resume to more normal conditions. Where we will see inflationary pressures rise is in wage demand growth. Giving people more money in unemployment benefits than they can earn from working will have the knock-on effect of raising expectations and a sense of entitlement. That is not going to dissipate any time soon.

Just about all of the USA’s outsized benefits expire in September. Evictions are about to start up too. Average rents are likely to rise because landlords will want a cushion to protect them from malingerers in future.

Meanwhile much of the massive stimulus was saved by consumers. That represents fuel for spending over at least the next couple of years. It’s creating demand for everything from home goods to vacations, cars and real estate.

Perhaps the biggest source of inflation is the shortage of semiconductors. Automotive companies are slowing down production. Prices and margins are rising as a result. It could take a couple of years to balance the market.

Additionally, we are looking at the real prospect of commodity price inflation. China is now releasing inventory from its state stockpiles in an effort to contain domestic input prices and inflation at the factory gate. That may contribute to a correction in prices as they unwind overbought conditions following an impressive rebound.

The plan to remake the entire global infrastructure in service to the climate lobby is going to be inordinately expensive. To come even close to achieving the stated goals of carbon neutrality, massive infrastructure development will be required. Inventory management by China is likely to have a limited effect in the face of that spending.
The biggest challenge for China is the number of young new workers is declining every year on a secular basis. That suggests the years when emerging Asia exported deflation to the world are over.

Shipping rates continue to hold the breakout. The full repercussions of IMO2020 emissions rules were delayed because of the pandemic but are now being felt and that represents a significant ongoing source of higher costs overall.

On top of that the imposition of carbon costs, regardless of the motivation, represents a significant additional cost which will be passed on to consumers. Inflation is indeed a monetary phenomenon but it is also a psychological phenomenon. In order for a trend to emerge consumers need to start believing that inflation is not transitory. The biggest sign of inflation is precautionary buying. Housing and cars are part of that but it is when companies abandon just in time inventory management that we will have clear evidence of inflationary policy feeding through to real world effects.

The reason inflation did not take off in the post credit crisis recovery was because banks could not engage in their traditional credit multiplier role. They are under no such limitation today and only need ample demand to lend out their record deposits. The global economic recovery will create that demand.

The only clear conclusion is we are at the dawn of a new inflationary cycle. The pieces are falling into place for a replay of the early 1970s. A global minimum tax, if it is passed is a fig leaf compared to the brazen spending plans being adopted by governments. Ultimately, the debts are always paid back. The question is only ever about the method. Radically debased currencies are the starting point and rising geopolitical tensions will also eventually need to be addressed.

I completely agree with the conclusion governments are in no position to tolerate higher borrowing costs. They need inflation. It is the only way interest rates will ever be normalised and not before the trend is well established. The Dollar jumped today in advance of the Fed meeting on Wednesday. That suggests some repositioning as a precaution against the potential they surprise everyone by shaving purchases of mortgages.

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