I’ve invented a new word for what’s coming: Inflession (add to dictionary) is a combination of recession and inflation, characterized by low unemployment and very low interest rates.
Sound strange? The yield curve warned us months ago (when first inverted) that a recession was in the offing. The economy was bound to revert to the mean sometime but the coronavirus has triggered something more pronounced that just a slowdown. Low unemployment has more to do with demographics than GDP. Governments were (and still remain) loathe to let interest rates normalize for fear of causing political unpopularity – masking their true motives by citing worries of instability.
But inflation is under control you say? Is it? Take a good look at the table below of producer prices from the U.S. Bureau of Labor Statistics. I’ve highlighted the interesting bits – where the annual change in prices is 5% or above.
There are some really big numbers for items that average people really need:
For the year ended January 2020, within final demand foods, prices for fresh and dry vegetables increased 21.4 percent, while prices for pork increased 14.9 percent. Over that period, prices for eggs for fresh use decreased 22.1 percent and prices for fresh fruits and melons decreased 9.3 percent.
Within energy, prices for gasoline increased 23.1 percent and prices for home heating oil and distillates increased 12.0 percent for the year ended January 2020. Prices for liquefied petroleum gas decreased 32.5 percent.
The FED may want to lower the level of interest rates to fight the run from assets but is it wise? The scenario we’re facing is unprecedented (as far as I can recall but then memory isn’t what it used to be). In 1933 for instance the rate of interest was a low 1.73% nominal, but the real rate was much higher than today because inflation was (negative) -2.96%. The real rate now is negative.
Despite the differences, one can foresee the possibility that we suffer a collapse of investment (like in 1933) and a drop in real exports (-11.2% back in 1933). How can there be inflation under our current circumstances? More demand than supply for one. In 1933 it was the reverse, i.e. more supply than demand (and massive unemployment). But it’s really the correlation between money supply (M2) and inflation (CPI) that is the problem, with a substantial lag as Milton Friedman told us. We’ve had far too much liquidity pumped into the system and its beginning to show up in all the wrong places.
What this boils down to is a bigger mess than central banks around the globe bargained for. There’s no telling how long it will take for this to sort itself out. In the meantime, the markets (i.e. you and me) will bear the brunt of this predicament. Inflation expectations have been falling…and they will prove wrong.