This “temporary” inflation turns into an inflationary spiral
Get used to higher inflation. My thoughts on the biggest mess I’ve seen in decades.
By Wolf Richter. Here is the transcript of my podcast from Sunday, July 11, THE WOLF STREET REPORT.
This year, inflation has exploded with force and the past four months have seen the highest rate of inflation since the 1980s.
The consumer price index – the CPI – rose 5% year-on-year in May. The June reading will be out in a few days [update: June CPI came in at 5.4%]. 5% of annual inflation is bad enough. But the pace of inflation over the past four months has been much higher, reaching over 8% on an annualized basis.
Certainly, some inflation measures will slow down in the near future, giving everyone false hopes, before picking up again. The first surge in inflation always seems temporary. But during these early bouts of inflation, that’s when the triggers for “persistent” inflation – namely the inflationary mindset and inflation expectations – are triggered.
So now the Fed repeats over and over again that this is temporary and will go away on its own because it was caused by temporary factors namely a demand shock that happened because the government has shed $ 5,000 billion in borrowed stimulus money since March of last year; and because the Fed printed $ 4 trillion over the same period and cut interest rates to 0%.
This moolah has boosted consumption tremendously and caused an historic spike in demand for goods, and there are now cascading shortages of semiconductor ammunition, made worse by container shortages and transportation bottlenecks.
But fiscal and monetary stimuli are still ongoing. The government and the Fed are still fully on the accelerator.
There are all kinds of temporary issues that are causing the price to spike here and there. Supply chain bottlenecks, difficulties for companies to hire staff, shortages, various increases in raw materials and price increases for services that have nothing to do with the shortages. Contractors and professional service providers increase their fees, and they can suddenly do it and get away with not losing clients.
And these price increases are accelerating now. Businesses raise prices, businesses and consumers pay those higher prices, and businesses pay higher wages, while the government stimulates demand with deficit spending, and the Fed stimulates demand with money printing and interest rates at 0%, and no one is resisting price increases anymore.
And so much money has been created and distributed that the price doesn’t even matter anymore.
People pay anything, even for discretionary purchases that they don’t have to buy, like cars. Most people could easily wait a few years instead of buying a car now, but now the whole mindset has changed, and they want to buy now, regardless of the price.
And this change in mindset has pushed up the prices of used vehicles by more than 30%. I have never seen anything so close, and I was present when inflation ravaged the economy in the late 1970s and early 1980s, until the Fed Volcker the eventually cracked down, triggering a very brutal double-dip recession that ultimately took inflation out of breath.
So now we have these cascading price spikes from product to product and service to service. This surge in inflation is rooted in and adapting to the inflation expectations of business and consumer policymakers, and in this way inflation becomes persistent.
Even economists now get the message. According to a the Wall Street newspaper According to a poll of these economists, their average forecast for the end of next year in terms of core inflation – which excludes food and energy – has risen to 3.2%.
But wait… They use the lowest inflation measure available in the United States, namely the “core PCE” inflation measure that the Fed uses as a target and which is normally well below the standard CPI cited in the media.
This PCE core inflation measure, the lowest measure in the country, along with March, April and May combined, produced an annualized PCE base inflation rate of 6.4%, which means that if price increases continue for 12 months at the rate of these three months, the annual inflation rate would be 6.4%. That’s more than three times the Fed’s target of 2%.
This is the highest three-month annualized inflation rate since August 1983.
Thus, these economists interviewed by the the Wall Street newspaper also assume that inflation will decline from the current rate and drop to 3.2% by the end of 2020, that would still be the highest inflation rate since the early 1990s, and that’s fine below current inflation, and this assumes the best-case scenario that inflation is falling from the current rate.
“We are currently in a phase of transition,” one of these economists told the the Wall Street newspaper. “We are moving into a period of inflation and higher interest rates than we have experienced in the past 20 years.”
No kidding. Even economists are tackling it. But not the Fed, at least not publicly.
It therefore appears to economists that the global inflationary environment is not transitory, but persistent, although some of the factors that triggered the triggering of the inflationary cascade are transitory. And this higher inflation is a generational change.
People who became adults in the 1990s or later have never experienced this kind of inflation. They don’t know what it’s like when the prices go up, one item here, and then the next day another item or service over there.
For some people, pay increases offset inflation, and that includes performance and productivity based pay increases that were supposed to get you to buy more goods and services, but you need every penny of it. this increase in performance just to maintain your standard of living.
And for others, wages are not increasing enough to compensate for inflation, and they must reduce their standard of living.
Businesses are facing rampant cost increases.
There is now a lot of clamor among economists and Wall Streeters that the Fed will wait too long, fall too far behind the curve, continue to stimulate for too long despite soaring inflation, and thus trigger an inflation spiral that would be difficult. to master. , and that these belated efforts to bring inflation under control when it is totally out of control would ruin the economy and asset prices.
They are do not worried about hyperinflation. They worry about 5%, 7%, 10% inflation for years. That kind of inflation would blow all kinds of assumptions out of the water. No one is ready for this.
This kind of inflation makes long-term planning difficult for businesses, and it’s a drag on the economy, and it’s a drag on real consumer spending.
Long-term interest rates will rise to meet and exceed these inflation levels, if markets are allowed to react to inflation; either the Fed suppresses long-term interest rates by buying assets, and this will heat up inflation further, and investors like pension funds and insurers who invest in bonds, will see the purchasing power of their investments fade, when they gain 2% for years in an environment of inflation of 8%.
It is more likely that the markets will eventually react to inflation to some extent, causing interest rates to rise, which is the way to curb inflation, but which will make borrowing much more difficult. of companies rated for garbage. , triggering waves of faults. Defaults and higher borrowing costs would affect stock prices.
And consumers, my God, even those whose incomes keep pace with inflation. When inflation persists at 5 or 8% and the markets are allowed to react, mortgage rates rise to meet or exceed these inflation levels. With house prices very high right now, these higher rates would move the house payments totally out of reach for potential buyers, and demand would dry up.
For the market to relax, home prices would have to come down to bring those mortgage payments back within reach. There is a whole generation of home buyers and sellers, real estate professionals, loan officers and mortgage brokers who have never experienced anything like this.
This move towards higher inflation can be very disruptive to the economy, to household and business planning, and to spending patterns.
This persistent inflation is what is being triggered right now by fiscal and monetary stimulus and temporary inflation spikes. And the Fed, by officially putting this problem on “ignore”, is making matters worse.
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