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After the Hayne Royal Commission many advisers decided to steer away from large dealer groups in favour of becoming self-licensed. In the last six months, however, that trend has taken an abrupt turn.
Six common misconceptions about inflation
Inflation has been garnering headlines throughout the world in 2022. Economists, journalists, and investors across the entire asset-class spectrum are all seeking to understand the implications of an inflation rate that has reached multi-decade highs. Yet despite all the headlines, the concept, trends and issues remain poorly understood, that is, according to a recent white paper by global fixed income manager Western Asset Management.
Published this week and authored by Western economist Michael Bazdarich, the paper seeks to clarify six of the most common misconceptions about inflation, with important implications for portfolio management. “The underlying forces responsible for rising inflation may not be widely understood,” he begins, noting that despite being an easy target, inflation is not due to any “supposed miscreants by the Federal Reserve.”
The first misconception, he says, is the idea that inflation has been flaring for more than the last 12 months. A closer look at the inflation data, on even a medium-term basis, shows that the price increases in late 2020 and early 2021 were “merely a rebound from the even larger, temporary declines experienced during the shutdown.”
“No one talked about or feared deflation,” Bazdarich says, hence it is “inaccurate” to flag the price rises over this period as a national policy problem that the Fed needed to deal with. While many of these price reversals have passed, and prices have flared up again, it is the more recent gains over and above the COVID falls that should potentially be a target of policy.
The second is the assumption that “an increase in the money supply must equal higher inflation.” While the relationship between the stock or supply of money and inflation is clear, what is less clear is that the actions of the Fed have been the central driver in this. Bazdarich notes, “I believe that even in the absence of extraordinary Fed policy measures, merely the reopening of the US economy would have allowed nominal spending to retrace the declines that occurred during the shutdown.”
He highlights the fact that on a net basis, since before the pandemic there has been no real acceleration in spending versus prior trends. So, if growth in the supply of money by the Fed was actually stimulating the economy, surely spending should have accelerated above pre-COVID levels? “This has not happened. As a result, I conclude that despite intentions to the contrary, Fed policy has not served to stimulate either the economy or inflation in the past two years.”
The Reserve Bank of Australia (RBA) has consistently linked its interest rate decisions to wage growth, which remains muted in Australia, which relates to the third misconception, that such growth always leads to inflation. This fact is outright disputed by data and research, showing that “rapid wage growth is a consequence of inflation, not a cause of it.” Bazdarich says there is “no evidence for increases in wages autonomously driving higher inflation” and that most of the increases in 2022 have been following the same trajectory as after the GFC.
That is, like our disrupted supply chains, “the labor market has shifted to a sellers’ (employees’) market” due to a combination of fiscal policy and unemployment support. He expects the end of the expansive unemployment benefits to result in a boost to labor supply, all-but-reversing the shortage in place at the current time, saying this has “already begun.”
Supply chains are clearly the cause of the current burst of inflation, but assumptions that they will cause sustained inflation are misguided. “The increase in goods prices occurring over the last four months can be attributed to the supply-chain disruptions and port congestion the US experienced in 2021,” with the point being that as disruptions ease, supply will increase and likely result in a reversal of recent price increases.
“Commodity prices have predicted nine out of the last zero inflation increases,” said US economist Paul Samuelson, addressing the fact that commodities act incredibly predictably, rising in economic recoveries and falling in recessions. Rather than contributing to inflation, “the markets that are seeing higher prices now than in 2010 are the very markets where supply-chain disruptions are at work,” not due to some expectation of higher prices, Bazdarich says.
Finally, and likely most powerfully, is the assertion that Fed policy is too expansive, causing the economy to run “too hot.” This is quickly disproven by the fact that aggregate demand remains at the same level as before COVID-19, meaning that despite “loose” monetary and fiscal policy, very little has actually made it into the real economy. In fact, data has confirmed that “each time extraordinary federal aid was provided, personal savings rose by as much as or more than the federal aid provided.” That is, when people receive a one-off payment, they tend to save the majority of it, rather than spend as they do when they receive a pay increase.
It is clear that the Fed and other central banks were “unable to stimulate either economic growth or inflation” after the GFC, and the evidence suggests this is the case once again. For this reason, Bazdarich concludes by saying, “I believe the recent price burst will die out of its own momentum, or lack thereof. I do not think it will be an enduring problem for the fixed-income markets.”
