The Breakdown - The Real Story of Inflation Right Now

Episode Date: April 14, 2021

There is perhaps no question more debated in macroeconomics than what sort of inflation we’re likely to see in the coming years. Many are convinced that the combination of a growing money supply, expansionary monetary policy, pent-up demand, reshoring of manufacturing and more are pointing us to a secular inflation era. Others say the forces of deflation and disinflation, like technology and demography, are too strong.  In today’s episode, NLW looks at not only the latest Consumer Price Index numbers released today, but also recent Producer Price Index surveys, wage growth and more to try to put together a more complex, nuanced picture of the likely inflation scenarios going forward. -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

When one really wants to understand this question of inflation, you have to look at some of the long-term shifts, not just the short-term numbers. That's everything from the doubling down on deficit spending by a U.S. government who believes they can push it farther without causing inflation to the shift back to domestic manufacturing. In many ways, the more one can remove oneself from specific short-term inputs and measures like the CPI, the more one is likely to be able to develop a personal theory on where the world is headed. Welcome back to The Breakdown with me.

It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io and produced and distributed by CoinDest. What's going on, guys? It is Tuesday, April 13th, and today we are talking about the real story of inflation right now. New consumer price index or CPI numbers are out from the Bureau of Labor Statistics, and this is the latest entrant into the great inflation debate. I want to discuss the complexity of that conversation, but to do so, we have to go back in time just a little bit. In May of 2020, just a couple of months after assets crashed

around the beginning of COVID-19 lockdowns, Paul Tudor Jones published what I believe will go down as one of the seminal treatises in the history of Bitcoin. The piece was all about what he called the Great Monetary Inflation. Quote, the depth and magnitude of the economic drop-off took modern monetary theory or the direct monetization of massive fiscal spending from the theoretical to practice without any debate. We are witnessing the great monetary inflation, an unprecedented expansion of every form of money, unlike anything

the developed world has ever seen. For those of us in the Bitcoin space, even more significant than the diagnosis was the proposed remedy. PTJ and his team had surprised even themselves by getting convinced about Bitcoin's role in that sort of macroeconomic context. They had turned Bitcoin bulls. This was a seminal moment in the institutional turn towards Bitcoin. And the essential thing wasn't just that an influential hedge fund guru got into a pet asset. It was this setup around inflation that people could see and feel for themselves. A few months later, Stan Druckenmiller went on CNBC and echoed many of these themes.

He said, for the first time in a long, long time, I'm actually worried about inflation. He went as far as to say that he could see inflation getting as high as 5% to 10% for a time. Now, part of the reason that Druckenmiller cited for this was a shift in Fed policy and a new willingness to let inflation run hot. Specifically, the Fed had indicated that rather than shifting monetary policy based on projected inflation, the Fed would only change policy once a target level of inflation had already been achieved. Of course, any monetary policy remediation takes time to have an impact. So in the interim between observation of too hot inflation and actual reduction because the monetary policy kicked in, there could be

some serious inflation spikes. What's more, the Fed also indicated that rather than changing policy based on a particular spike, they were going to act based on sustained average levels over time. So on the one hand, you have a highly accommodative Fed, and on the other hand, a massive expansion of the money supply over the course of the COVID-19 crisis. If you had some more hands, you had another factor as well, pent-up demand that had been stopped short by locked policies. All of these things seem tailor-made for a shift towards inflation, right? There is perhaps nothing more debated in macroeconomics than inflation. Ask three market observers, their thoughts on how likely inflation is, and you'll probably get five answers. That is in part, I think, reflective of

unexpected lessons from the past 12 years. In the wake of the great financial crisis, many were screaming, as many are now, that inflation was the inevitable byproduct of quantitative easing. At least when it comes to consumer price inflation that hasn't been the case. And for some, this broke the causal relationship between quote-unquote money printing and inflation. Ah, but others might say CPI is just one measure of inflation. If you really want to see it, look instead at distortions and elevations and asset prices. We live in a world where everyone has been pushed out on the risk spectrum, where stocks are trading at here-to-fore unseen multiples, where baseball cards are acting like stores of value, where tens of trillion of global sovereign debt is negative yielding.

From this perspective, the issue with discussions of inflation is in the terms we use. Specifically, a narrow focus on both the part of policymakers and headline editors on top-line consumer price inflation. That narrow focus obscures the larger inflation story, which, while not necessarily raising the price on consumer goods, is in fact having serious economic consequences in other parts of people's lives. Part of why this is also complicated is that we have radically counter-vailing and conflicting forces that compete with one another. We have, on the one hand, the deflationary forces of technology and demography. Technology is by far the biggest. As technology radically reshapes

efficiency, it brings the cost of consumer goods down, especially when it comes to things like consumer electronics we have all lived inside this reality. Demography can have a deflationary impact in the sense that as populations age, they tend to consume less. Then, of course, there is a disinflationary megatrend. Deflation describes an actual decrease in prices. Disinflation signifies that prices are still rising, but at a decreased rate. Lin Alden often talks about the last 40 years as highly disinflationary based on the process of globalization that move jobs and production to lower-cost areas. Global just-in-time supply chains reduce the speed with which prices increased, but of course, it did so with other types of costs.

The cost of the hollowing out of the American blue-collar worker base, for example. The cost of supply chains that traded efficiency for resiliency. As we saw last year, when we couldn't get medical PPE in America for months at the beginning of the pandemic, there are real consequences to that focus on efficiency over resilience. The point of course is that there are many conflicting forces when it comes to inflation. This is not a clean line in one direction or another. Right now, on the deflation and disinflation side, we continue to have those long-term secular trends of technology and demography. On the inflationary side, however, we have the combination of

higher net incomes due to stimulus, pent-up demands from lockdowns, and we also have even more global macro-inflationary forces. One of those is supply chain shortages. Take, for example, the massive semiconductor shortage right now, which is causing huge problems in everything from consumer electronics to cars. Simply put, most semiconductors are produced in just a couple of countries in foundries that are extremely expensive and time intensive to build more of, and they're backlogged as hell. This creates upward pressure on prices. Looking for the best way to unlock your crypto's liquidity? Nexo.io is exactly what you need.

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for an unwinding of at least some of globalization. Both Trump and Biden ran on promises to shift manufacturing and supply chains back to the U.S., which, while redressing some of that imbalance inefficiency versus resilience that we discussed, comes at the cost of paying more for the things that we're used to getting. The simple reality is that it costs more to make things here in America, and some amount of that price is going to be passed on to the end consumer. And then, of course, we have that sustained asset price inflation. Again, coming back to how Lynn Alden frames it, when she discusses inflation, she asks the question, where does extra money pool? When extra money from an increased money supply pools with the

comparatively wealthy, it ends up, obviously, in financial assets. We've just had an enormously case-shaped economic moment, where the worst off were hit the worst, and the well-to-do not only didn't get hurt as much, but actually in many cases benefited. It is not surprising then that assets have reached historically high valuations, high enough even that the Fed Chair and Treasury Secretary low though they are to do so, have to admit that asset prices are elevated by historic levels. The point of all of this is that despite the best efforts of ideologues and arguers of all stripes on Twitter, you're not going to fit a full, complex, nuanced understanding of inflation in 280 characters. With that, however, let's look at today's CPI news.

The headlines are a doozy. Bloomberg says U.S. consumer prices increase in March by most since 2012. The CPI was up 0.6% from the prior month versus 0.4% gain in February. A jump-in gasoline accounted for almost half of the rise, and this was larger than economists expected. The overall CPI is up 2.6% from March 2020. Something we need to talk about here, however, is the base effect. And certainly you're going to see lots of progressive publications and those who aren't worried about inflation pointing to this right now.

The base effect refers to the notion that when you have stats that are measured year over year, the base of when they start can make them look much more severe than the implication should be. In short, March and April of last year saw historic economic crisis. Many prices actually went down. We're now coming up to the season where all year-over-year numbers are going to reflect that really crazy base situation. This is likely to persist for all of Q2, which was the worst of last year. Anything that is compared to Q2 or months within Q2 of last year is likely to look more extreme and severe than it otherwise would. If you reset your time horizon to two years or three years, we might still actually actually. actually be under the long-term trend. Of course, when it comes to inflation, even if one wanted

to write off the bigger-than-expected jumps as an issue of this base effect, there are other indicators that are worrying many. Another survey showed that inflation-adjusted hourly earnings increased 1.5% in March from a year earlier. That's the smallest gain in more than a year, and of course, less than that inflation rate, meaning that those hourly earners have less purchasing power than they did a year ago. Another part of why prices rise is. is the cost of production rising. So how does that look? Last week, we saw the largest recorded product price increase in nine and a half years. The producer price index jumped 1.0% month month and 4.2% year over year. It's the biggest year on year rise since September 2011. Within that,

goods prices rose 1.7%. The headline on CNBC about this? U.S. producer inflation heats up in March as prices increase broadly. Now, even within this, there are all lot of sub-stories that we need to understand. Let's take the example of lumber. According to the National Association of Home Builders, since last April, lumber costs have spiked 180%. This reflects a boom in new home construction. The pandemic has created historically short supply in housing. We already had a low supply of housing going into the pandemic, and now you have two additional factors that are making it worse. The first is further supply constraints because people are, one, re-evaluating whether they really want to move, given how low inventory is right now and how just

generally up in the air things still feel. And two, even if they do want to move, they're not willing to show their house because of COVID-19. The other factor is that in addition to reduce supply, you're also seeing increased demand because the large-scale shift to work from home means people are getting out of cities and making different decisions about where they want to live. So again, that CPI may be explainable away with the base effect, but there's still a lot going on inflation that is more complex. So finally, let's talk about narrative and perception, because of course these matter greatly when it comes to policymaker response and likely future action. On the policymaker side, at least from the Democrats, there is a very consistent narrative. Any inflation is likely to be

very temporary and settle back down. A blog post by members of the Council of Economic Advisors basically said as much. Inflation is going up because of a combination of, one, the base effect, two, some continued supply chain disruptions, and three, pent up demand for services. Quote, such a transitory rise in inflation would be consistent with some prior episodes in American history coming out of a pandemic or when the labor market had quickly shifted, such as demobilization from wars. We will, however, carefully monitor both actual price changes and inflation expectations for any sign of unexpected price pressures that might arise as America leaves the pandemic behind and enters the next economic expansion.

However, the perception of Americans is different. Bloomberg's headline yesterday, Blair's growing share of Americans see risk of highest inflation in years. The number of U.S. consumers who see inflation exceeding 4% in the year ahead rose to 44% last month. It's the highest since September 2013 when they first started tracking this data. Now, what's important about perceptions among average people is that it can influence the consumer decisions they make. If you think everything is likely to be more expensive a year from now, well, then you buy it now. And in so doing, create higher demand for the product which potentially increases the price. There is an aspect, in other words, of self-fulfilling prophecy to inflation expectations because of consumer behaviors

that follow from what they believe. So where does this all leave us? Of course, the simple conclusion is that the inflation story is extraordinarily complex. These topline numbers almost certainly do not accurately portray the full breadth of that story. What's more, when one really wants to understand this question of inflation, you have to look at some of the long, terms shifts, not just the short-term numbers. That's everything from the doubling down on deficit spending by a U.S. government who believes they can push it farther without causing inflation, to the shift back to domestic manufacturing. In many ways, the more one can remove oneself from specific short-term inputs and measures like the CPI, the more one is likely to be able to develop

a personal theory on where the world is headed. It strikes me that the biggest determinant in how you view the inflation question is not short-term CPI, but what you think the impact and externalities of increased government spending are in the long term. In other words, we're back to MMT versus Bitcoin. But that is the subject for another show. For now, I appreciate you guys listening. I hope you're doing well. Until tomorrow, be safe and take care of each other.

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