June 30, 2021 | Transitory Inflation

There’s a lot of bets these days on higher inflation and higher interest rates. After being plagued for over a decade with a zero interest rate policy, a new combination of government spending and central bank QE purchases are poised to send inflation higher. So far that’s been the winning trade, with CPI inflation printing close to 4%. However, it seems not everyone is convinced we have an inflation problem.

The European Central Bank, one of the most important central banks, doubled down on their views this past week. “Inflation has picked up over recent months in the euro area, largely owing to temporary factors, including strong increases in energy prices. Headline inflation is likely to increase further towards the autumn, continuing to reflect temporary factors,” noted president of the ECB, Christine Lagarde.

More importantly, Lagarde added, “Negative interest rates have often been criticized because of their potential side effects. Our assessment continues to be positive as the benefits continue to outweigh the costs.”

This begs a couple questions. If inflation is truly transitory are we looking at another decade of zero interest rate policy? What does that mean for risk assets? More importantly how do we define transitory?

According to the Merriam-Webster dictionary, transitory means:
1. Of brief duration
2. Tending to pass away

It does not define transitory as a specific duration, therefor the length of transitory is seemingly in the eye of the beholder. In other words, what length of time do central banks deem as “transitory”?

Theres another problem too, does anyone really understands inflation, or what causes it? There are a lot of smart people who talk about money supply and money velocity, but i’m convinced this is just an educated guess at best. Inflation is as much a psychological phenomenon as anything.

Once people begin to lose faith in the value of fiat currency things begin to unwind pretty quick. Just look at Venezuela or Argentina today.

Then there’s the question of how we measure inflation. Is the CPI index really an accurate measure of inflation?

History is rife with examples of inflationary crises, they are almost always the same. Governments debase the currency, asset prices rise, and consumer goods eventually follow-suit. Is this where we are today? Sure sounds like it.

This brings us to the precarious situation we find ourselves in today. Global debt to GDP sits at 355%. An enormous mountain of debt that will unleash an avalanche of bankruptcies should higher interest rates materialize. Central banks either need to shrink the numerator (debt) or grow the denominator (GDP) in order to lower this ratio. Raising interest rates which increases debt servicing costs and thus slows growth, accomplishes neither. It really is that simple.

Inflation will be transitory for as long as central banks and governments can get away with it. You might not see it in the CPI, but you certainly will in asset markets.

Three Things I’m Watching:

1. Global debt to GDP sits at 355%. (Source: Financial Post)

2. Lumber prices extend their fall, now down more than 50%. Capital Economics forecasts that lumber prices will drop to $600 per 1,000 board feet by the end of 2021. (Source: Bloomberg)

3. So much for taper talk. The Fed just added the largest amount of assets to its balance sheet in over a year. $200B in the last 4-weeks. (Source: Tavi Costa, Crescat)

Steve Saretsky June 30th, 2021

Posted In: Steve Saretsky Blog

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