Having the greatest respect for the work of Edward Chancellor, we appreciate the opportunity to occasionally feature him on this blog. Recently, he has been contemplating the return of inflation. While immediate losses to income are a deflationary force, the dynamics that determine price are more complex long-term. His most contemporary views are discussed in this recent interview. His more thorough perspective is below. Such swans as this define entire eras of investment.
25 June 2020, By Edward Chancellor
The massive fiscal deficits and money-printing engendered by the coronavirus pandemic should see off the threat of deflation. Rather, the spectre of inflation now beckons. While its potential horrors should not be downplayed, the return of inflation is the best way to resolve the great economic imbalances and social discontents that beset our world.
Some $10 trillion worth of fiscal support is propping things up during the pandemic year. Fiscal deficits in the United States and elsewhere have blown out. Governments are not financing themselves with tax hikes or by drawing on private savings, but rather have turned to printing money. The U.S. money supply is expanding at its fastest rate since the Second World War. The newly printed money isn’t trapped in Wall Street, as was the case with the Federal Reserve’s quantitative easing programmes, but goes directly to Main Street as the government guarantees emergency lending by commercial banks.
The inflation risk is further heightened by America’s ongoing trade war with China, the world’s top supplier of cheap manufactured goods. In the short term, high levels of unemployment in the West and a severe worldwide recession – the International Monetary Fund expects global output to shrink by nearly 5% this year – may dampen inflationary pressures but won’t extinguish them. Once the velocity of money reverts to its pre-coronavirus levels, investment strategist Russell Napier of Orlock Advisors predicts price rises in the developed world could exceed 4% next year.
Four decades have passed since the great inflation of the 1970s. It’s worth recalling the ill effects of that era. Wealth was randomly redistributed between inflation’s winners and losers. Debtors did well at the expense of lenders. Savings held in cash and bonds were wiped out. Treasuries became known as “certificates of confiscation.” As interest rates soared, stock market valuations collapsed. The Dow Jones Industrial Average didn’t rise between 1965 and 1980 – in August 1979 a BusinessWeek headline famously observed “The Death of Equities: How Inflation is Destroying the Stock Market”. Bubbles formed in inflation-beating assets, such as gold and silver.
Inflation wasn’t good for business either. Price signals were interrupted, profits corrupted and capital misallocated. During the 1970s, U.S. productivity growth limped along at 1% per annum, roughly a third of its postwar average. The Fed’s stop-and-go attempts to control inflation resulted in frequent economic downturns – the United States experienced four recessions between 1969 and 1982. The fact that inflation continued to rise at a time of high unemployment gave rise to the term “stagflation”.
The economic crisis inflamed social conflicts, as powerful forces scrambled to maintain their share of a shrinking pie. Unions battled with employers. Workers did better than pensioners. As the price of energy, food and raw materials climbed faster than incomes, “the consequences fell more cruelly on the poor, who paid a large proportion of their income on food, fuel and shelter,” observed economic historian David Hackett Fischer in his book, “The Great Wave”. Fischer notes that the “three trends Americans identified as the most urgent social problems facing the nation – crime, drugs and family disruption – all correlated with the rates of inflation.”
As the Nobel laureate economist Friedrich Hayek commented at the time, inflation acted like a drug, requiring larger and larger doses to provide the same amount of stimulus. By unleashing inflation, Hayek said, the authorities found themselves “holding a tiger by the tail” – it was impossible to hold on but dangerous to let go. Eventually, the Fed under Chairman Paul Volcker found the courage to slay this tiger. But Volcker’s attempt to control the money supply sent commercial lending rates above 20%. It took double-digit rates of unemployment and two severe recessions to reach price stability.
At first sight, it seems incredible that policymakers today should risk another such outbreak. But it’s not so surprising. Many of the curses associated with inflation already exist. Since Lehman Brothers went bust, productivity has slumped back to 1970s levels. Inequality has climbed. An opioid epidemic has brought about so many “deaths of despair” that U.S. life expectancy contracted. The destabilisation of social values and widespread loss of trust found in the 1970s are evident. To paraphrase MIT economist Robert Solow, we can see inflation everywhere except in the consumer price index.
Inflation is a complex phenomenon. Its causes are part monetary and part economic. But it’s also a symptom of the collapse of social order – not just in the 1970s, but in earlier periods such as Weimar Germany and Revolutionary France. Before every great crisis, Fischer notes a period of growing imbalances and increasing instability. Today, the world is faced with extreme economic imbalances.
Excessive debt levels, which brought about the 2008 collapse, have continued rising. This year, global debt will climb at the fastest rate ever. Ultra-low interest rates have led to capital being misallocated. In the era of zero interest rates, saving for retirement has become nigh impossible. In many countries, the younger generation can’t get a foot on the housing ladder.
The penultimate stage of every price revolution, according to Fischer, is marked by dark visions and restless dreams. Sects and cults, often angry and irrational, multiply rapidly. Intellectuals turn against their societies. Young people give way to alienation and cultural anomie. This all sounds depressingly familiar. The final stage may be triggered by some minor disturbance, he suggests, such as a change in the weather, an epidemic, or an incompetent president.
It’s nearly quarter of a century since Fischer wrote these prophetic words. At the time, he mooted that the 20th century’s price revolution had yet to reach its climax. The Covid-19 pandemic may yet do the trick. And once inflation has taken its toll, many of today’s economic imbalances will pass away and the social discontents will abate, as they have in the past. The ride won’t be comfortable, but it can’t be avoided.