Inflation could be Here to Stay and There’s Not Much We can do About It

The outlook for economic growth looks bleak for much of the world, especially in the developed West. Inflation has reached highs not seen for decades. Putin’s invasion of Ukraine, reshoring of industry, supply chain disruptions and OPEC’s production cuts have all been contributing factors. Growth has been steady or stagnant for many developed western nations, now many countries are facing stagflation.

A while back, Huw Pill – Chief Economist at the Bank of England publicly stated that people needed to accept that they were poorer. There was much outrage and the soundbite was paraded as a middle finger to the poor. It was considered unfair and distasteful to criticise people for wanting a pay rise . However, I find myself agreeing with this message, at least in the way I believe it was intended. A pay rise in an economy that hasn’t grown is meaningless unless that wealth is redistributed from elsewhere. But supposing this was done, demand would likely still increase for the same basic goods and services which would contribute to inflation. Few people appreciate the big picture when they think about large scale pay rises in an economy. Bringing inflation down requires that people spend less. The pie is not getting any bigger and may shrink in the near future but most people either don’t realise this or don’t want to believe it. I’d add that this in intended in the least mean-spirited way possible. I do believe that inequality needs to be addressed and people on low incomes deserve a better standard of living but that cannot materialise out of nowhere. Wealth cannot be created out of thin air.

Inflation fundamentally is about money outpacing the things it is meant to pay for. If everyone gets a pay rise, no one does. Central Banks know that inflation has to be brought down so that demand is in line with supply. This means higher interest rates and quantitative tightening (selling of bonds and securities). Borrowing is more costly. Saving is more rewarding. We may initially believe our buying power is unchanged but persistent inflation can quickly dissuade us of that illusion. On an international outlook, a country that does not take inflation seriously will not have its currency taken seriously. Just look at the Turkish Lira or the British pound after the post budget GILT crisis.

Having a risk free way of growing savings makes saving more accessible to poorer households and individuals. More expensive borrowing acts almost like a vetting process for businesses separating profitable from unprofitable ideas. Higher interest rates can drive efficiency back into economies. Tech companies rallied on the stock market, through their customer growth, continued to make losses due to low fees and reckless spending. An era of cheap money has rewarded bad businesses and reduced due diligence in the investing world.

Over the past couple of decades, cheap money policies have been employed as the go-to medicine to economic slowdown in the west. Covid in particular lead to record breaking stimulus injections. Just when things were getting back to normal, the unexpected side effects of post pandemic retirement, supply-chain issues and a bumpy start to businesses getting back on their feet. There is a pervasive feeling with rising costs for individuals and businesses that the economy has been derailed bringing us into an era of uncertainty and lower standards of living.

Inflation, seemingly, was viewed by central banks as a thing of the past until its recent re-emergence. It has remained so low for so long that the possibility interest rates might have to be raised seemed beyond reckoning. Low interest rates and quantitative easing have arguably fuelled an asset price bubble of huge proportion largely benefiting the already well-off. Edward Chancellor’s tour de force on interest rates, The Price of Time provides great insights into the purpose of interest rates and why they are important. Kept artificially low, interest rates, he argues has led to improper allocation of resources such as the endless money flows into unprofitable tech. Meanwhile central bankers have argued QE is the correct approach and that a state of deflation would be worse. Inflation is clearly back but it has never been acknowledged that central banks played a role in asset price inflation. Whether to appear in control or out of embarrassment, central banks have made their excuses and tried to rinse their hands of responsibility.

Unsurprisingly, politicians are blamed for the economic fallout. This is unfair in my opinion, not because I think central banks are the real villains (government stimulus got us in this mess too). I see the current situation as a side effect of external shocks that are simply outside of anyone’s control. Support is insufficient, economic policies have failed, growth has been stagnant. These points do have some merit and better decisions could have been made. Like with the 2008 financial crisis, the external shock from the fallout of the housing market crash was extremely difficult to predict. Gordon Brown, the UK prime minister at the time rallied governments around the world to stimulate economies simultaneously to get the world economy rolling again. The coordinated response was considered a huge success even though a prolonged recession ensued and pain was still great for many households. The Labour government was voted out at the next election, most likely down to a faltering economy which, even with the best governing in the world, could not be rescued. Likewise, the Ukraine war was unforeseen and out of the West’s control. Fragmentation of world markets as deglobalisation takes place is a consequence of heightened security concerns and rising labour costs that detract from the once high appeal of countries like China.

It had been assumed that the current economy had become so reliant on cheap money that it couldn’t survive interest rate hikes. Hikes like those introduced in the past year. Contrary to expectations, unemployment has remained low and a second financial crisis has not come. Germany and the UK have suffered disproportionately. Germany’s overreliance on Russian oil and gas severely hampered the strong industrial sector that so much of the German economy relies on. The UK is still reeling from the impact of Brexit and the deteriorating appeal for international corporations to do business here.

Peter Zeihan, the geopolitical strategist and now prominent public figure thanks to his books and YouTube channel, has been one of the biggest doomers when it comes to economic growth and the future of international relations. In his book The End of The World is just the Beginning he paints a picture of rising commodity prices, strained tensions between regions and increasing reshoring of industry causing further inflation. One of the bleakest developments is the energy transition to net zero with the required investment and the unreliability of renewables. Many governments have been non-committal to plans or simply don’t have the solar or wind potential in their country. Nuclear and safe and effective and low carbon energy source has been shunned out of use despite its low cost and proven safety.

While it may appear that I am blaming central bankers more than politicians, the truth as I see it is an intractable problem. Both will tell us what we want to hear to the extent that they can. Regardless of whether we choose to tackle inflation there is pain. Unlike past eras of inflation when price rises were driven by overheating of the economy, supply shocks have been more responsible this time. But combined with juiced demand from stimulus, inflation was inevitable. The pain may be greater if we ignore inflation but the external shocks and the deglobalisation of the economy will continue to make many things more expensive. As hard as it is to predict the state of the economy in a year, never mind a decade, things don’t look good. My intention with this post was to highlight the futility of the situation. While I could well be wrong, it will take a serious improvement in relations, demographics and maybe even technology. Inflation may slow with time but the rise in prices may never return to what they used to be.

*Disclaimer: This is based on my opinions and view of the facts and should not be taken as financial advice.