Breaking News #2: The Drumbeat of Inflation

Great talk, and highly educational, thanks.

It seems that, historically, there are different types of inflation. The relatively orderly type experienced by France in 1926-7, the US after 1934, and the US after 1971 were no picnic, but not nearly as pernicious as that experienced by developing countries around the world. The West may be said to be in decline, but when it comes to managing core monetary and financial processes, I think it’s still unrivaled.

An inflation done right will reduce the real value of debts and stabilize the system. This is not to praise inflation, but it can be better than the alternative pathways to a new stable regime.

Just finished listening. Really like the format as well as the content.

I really do believe in the importance of understanding the “water we swim in” and the media’s ability to nudge etc. I get that it is very possible that the media is prematurely calling off inflation and I EVEN get that a resurgence of inflation probably represents max pain for market investors.

And yet, I am uneasy about the big picture. About whether or not this is really, when it comes right down to it, “simply” a story about central banks’ uneasy fight against inflation. And about whether an inflation-come-back is the max pain scenario.

It seems to me, that on some fundamental level, this is a discussion about whether the natural state of our global and domestic economies is inflationary or deflationary. Not just about the how to navigate the fluctuations between inflation and deflation but about how the economy would behave if we stopped tinkering with it. And I think on that question I am leaning towards worrying about deflation rather than inflation. I mean, I read (and re-read many times) the ET “Things fall apart” series and I totally get that inflation carries more risks for investors than deflation. Deflation being practically good for investment assets in the short run at least and all. But I am increasingly concerned that the central bank action that has saved all of us during low inflation/deflationary periods in the past have run its course and when we tally the costs of their actions on society at large they are too high.

I read this article with interest: Technological progress, globalization and low-inflation: Evidence from the United States - PMC.

Granted, it is coming out of China/Bejing but it does a decent job of attempting to detangle the effect of globalisation from the effect of technology.

I know that inflation is the problem we are dealing with right now. And that it is brutal for many, including investors. But the idea that deflation is not a concern for investors because the central banks know how to solve that seems a little outdated in the current environment of giant/record government debts and low growth.

I have made similar comments on slightly other topics in the past, so apologies for the repetition - but at what point on the (exponential?) curve of technological innovation/ age of AI do we start to count the deflationary effects it will the cause of in our economy? Should it not at least be considered when we analyse the possibility of further inflationary shocks?

From my own analysis of general “news” on the one hand, and the constant flow of market analysis in my professional sphere it seems to me that these two narratives are entirely bifurcated. In the general media there is at least here in the UK plenty of coverage of the dangers of persistently high inflation, but very little talk about what will happen if the next event is a more conventional deflationary crisis. Can the current global order survive another central bank “rescue operation”?

Personally, I am starting to think that central banks are in their heart of hearts counting on being able to “control” the “technological innovation genie in the bottle” to their advantage. Counting on their ability to be able to do what Sataya Nadella described in Microsoft’s 2022 Annual Report/Letter:

Technology is a deflationary force in an inflationary economy. Every organization in every industry will need to infuse technology into every business process and function so they can do more with less.

In the coming years, technology as a percentage of GDP will double from 5% to 10% and beyond, as technology moves from a back-office cost center to a defining feature of every product and service. But even more important will be technology’s influence on the other 90% of the world’s economy. From communications and commerce, to logistics, financial services, energy, healthcare, and entertainment, digital technology will power the entire global economy as every company becomes a software company in its own right.

Among material from various investment houses, I come across views akin to the following from Janus Henderson:

… we agree entirely with the sentiments of Satya Nadella, CEO of Microsoft, that “technology is a deflationary force in an inflationary economy.” We believe that in the long term, investment in digital transformation, productivity and resource optimisation tools will be viewed as areas of spending to combat rather than fuel inflation.

I’m struggling to make my own point here…but in essence I guess I am questioning whether the common knowledge around inflation, and the likelihood that it will come down, is correct but for different reasons than those focused on in the media? Perhaps we are fighting a long term battle with deflation not inflation, and the magic trick to be performed by the powers at be is the one that convinces us that prudent central bank action will bring inflation back down, not the persistent march of technological innovation. In this scenario I find the most disturbing thought to be the view that we will be able to “roll out” innovation in an orderly fashion…and not in a way that will cause our democracy to crumble. That is after all in my opinion the max-pain scenario for everyone, investors included.

I appreciate your kind feedback, even as I sense that we may not agree completely on what the most pressing concern will be going forward. Your interpretation of my point was generous to say the least.

It was a bit of an unorganised rant, so I will limit my follow up to this clarification:

When I express more concern about deflation than inflation, I do so from the perspective of someone who thinks that technological innovation’s influence over long term inflation/deflation trends is increasing at an alarming rate that has yet to be fully incorporated into current inflation expectations, AND I believe that the options available for central bank action in the face of a deflationary recession are limited by current debt loads and the partially “exhausted” common knowledge of how much “power” central banks have to defeat deflation.

Where I see the biggest risk for inflation representing “max pain” is in a scenario where trust/confidence in fiat currencies are diminished to such an extent that the dollar (pound, euro, whatever…) no longer acts like a store of value. Because in the “old days” the currency did not change its value, only the price of whatever product you wanted to buy.

A fall in the value of your currency of course masquerades as an increase in the price of a product but the two are very different phenomenons. And the status quo is reliant on observers not accurately observing that the oh-so-necessary process of deleveraging is happening instead via the steady fall in the value of the currency itself.

The reason we are all here, to behold the amazing effects of narratives on real world phenomena, is of course closely related to the magic trick / process of steady devaluation of currency. But I guess I think that this process, rather than the process of “the price of things, running amok” warrants separate discussion. After all, the failure of something to be a store of value is something which is most likely to be a problem during deflationary times. because deflation itself increases the likelihood of default.

Hence why I worry about the “greater evil” at this precise moment in time. When the age of AI is really only just coming into fruition…

The main points remains of course, it was a very good podcast episode.

Do you remain in contact with the British (Scottish headquarter) investment house Ruffer? A former colleague now co-manages their main fund. A lot of my views on inflation were formed by reading Jonathan Ruffer’s notes on market conditions from 98-09.

Em.

But economics is a stunted science. Its form does not evolve as it naturally would. Its practitioners are not free to express at the limits of their cognition.
Physics has relate, relation, relative, relativity.
Economics has inflate, inflation, yet no inflative or inflativity.
Maybe English will lose this little skirmish?

A very public inflationship.