Inflation is Back — Who’s Afraid of the Big Bad Inflation?

Inflation is Back — Who’s Afraid of the Big Bad Inflation?

Inflation is back. But is it here to stay? That is the question facing investors now.

Even central bankers can no longer deny prices are surging. US inflation data was the first surprise. CNBC covered the inflation figures like this:

The increase in the annual headline CPI rate was the fastest since September 2008, while the monthly gain in core inflation was the largest since 1981.

Producer prices were up even more, 6.2%. The UK’s CPI more than doubled too.

What’s especially concerning is that the drivers of the recent inflation are globally shared prices. CNBC covered energy: ‘Energy prices overall jumped 25% from a year earlier, including a 49.6% increase for gasoline and 37.3% for fuel oil.’ No wonder consumer prices went up…

Other commodities, including copper, are surging too. The red metal is known as Dr Copper because the copper price has a PhD in economic forecasting, especially on inflation. It’s proven a good measure of inflation to come in the past, in other words.

The number of newspaper headlines about inflation is spiking even more than the inflation itself.

The UK’s Telegraph:

‘The inflation warning signs are flashing red — but central banks don’t seem to care’


‘This time the US really is heading into a serious inflation storm’


‘Bond Vigilantes Swarm European Economies Where Inflation Is Hot’

The Financial Times:

‘There are reasons to worry about US inflation’

Here’s another one:

‘Larry Summers accuses Federal Reserve of “dangerous complacency” over inflation’


‘Signs of inflation emerge as Chinese producer prices leap’

Yahoo Finance:

‘US producer prices surge 6.2% in April, highest since 2010’

So inflation really is surging…will it stick around, run out of control and cause some serious trouble in financial markets?

This isn’t even inflation, yet

Now I hate to be an inflation party pooper, but we need to make something clear. Rising prices is not inflation. For a simple reason: Prices can rise for all sorts of reasons. But inflation is only one of them.

Consider, for example, just hypothetically speaking, if the world experienced a pandemic and many nations went into lockdown or isolationism. This would have a severe effect on the supply of goods, making some prices rise. Similarly, when the pandemic and lockdowns end, demand spikes onto fallen supply. Again, prices rise.

The is not inflation. It’s just supply and demand, doing its thing.

The distinction is important for many reasons. For one, if central banks try to rein in inflation that is really just supply and demand shifting, this creates dangerous distortions.

The supply and demand system of a free market functions using prices. Prices decide what gets produced, where, how, for whom, by whom, at what cost and every other question facing our economy, as if directed by an invisible hand.

That invisible hand is really just the profit motive, which is all about prices. All the information needed to allocate resources in our economies comes down to that one guiding and deciding factor of prices.

This is why communism and socialism fail, by the way. They don’t have prices; so economic allocation questions become impossible to answer rationally. But that’s another story.

If prices are meddled with by central bankers, you get misallocations in the economy. The people in the economy make irrational decisions, misguided by the false prices. Central bankers trying to offset deflation from technological progress might keep interest rates too low, inflating a housing bubble, for example.

Or, as is more relevant to today, if central bankers raise interest rates because inflation is spiking, but the reason for the inflation spike is supply and demand shifting after lockdowns and a pandemic, then central bankers could undermine a recovery.

This is what the economist Milton Friedman meant when he argued ‘inflation is always and everywhere a monetary phenomenon’. Sure, prices go up and down, but that’s often supply and demand reshuffling the economy.

Inflation is rising prices caused by monetary factors. It is the falling value of money, not the price of things going up due to supply and demand. Don’t confuse the symptom for the disease.

Yes, of course central bankers have been busy fiddling with monetary factors. To a record extent. More on that next weekend though.

My point here is that we don’t know whether the inflation spike around the world is just the economy sorting itself out after the biggest government interventions since the world wars, or if it really is a monetary phenomenon.

Transitory…to what?

Right now, central bankers are arguing that inflation is ‘transitory’. They believe the price spikes are from one-off pandemic factors.

Jim Rickards recently agreed in his newsletter — and he very rarely agrees with central bankers:

In fact, real inflation is nowhere in sight. The surge in CPI reported on May 12 was driven predominately by base effects and energy prices.

April 2020 marked one of the steepest output declines in US history. Consumer prices plunged. In April 2021, many of those prices recovered especially in the areas of travel, airfares, hotels, restaurants and other services that were almost completely shut down in 2020. Year-over-year price gains off the low 2020 base are to be expected. They are also transitory because the 2020 output collapse was transitory.

As we move into the third quarter of 2021, the new base will reflect the strong growth in Q3 2020. That’s a much steeper hill to climb for inflation metrics. Inflation will come down sharply and the ten-year note yield will come down with it.

So Jim expects inflation to fall again soon, before its real run begins next year.

But here’s my problem with the idea that inflation is transitory. Inflation can be a momentum driven phenomenon. And just because prices are spiking because of lockdowns unlocking, doesn’t mean proper inflation isn’t right around the corner too…

In fact, I think it is right around the corner. The current consumer price spike may be the trigger for what happens next. More on that next week…

Until next time,

Nick Hubble Signature

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend

PS: Australian real estate expert, Catherine Cashmore, reveals why she thinks we could see the biggest property boom of our lifetimes — over the next five years. Click here to learn more.