The Breakdown - With Inflation at 40-Year Highs, How De-Russianization Has Changed the Narrative

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io, Arculus, and FTX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, March 10th, and today we are talking about the highest inflation print in 40 years. And more importantly, how everything going on right now with Russia and Ukraine is changing. the inflation narrative. Now, before we get into that, if you are enjoying the breakdown, please go subscribe, rate, or review the show, or if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find a link of the show notes or go to bit.

Starting point is 00:00:49 bit.combe, slash breakdown pod. Also, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Okay, so to today's topic, inflation is something we've obviously been tracking very closely on the breakdown. In fact, inflation has, in some way or another, been the dominant macro theme since shortly after the COVID-19 shutdowns. Almost immediately in the wake of massive central bank intervention, people started thinking about the medium-term implications of all that government spent. This is a story we've repeated ad nauseum.

Starting point is 00:01:28 Paul Tudor Jones, great monetary inflation, thesis, Michael Saylor's melting ice cube, and so on and so forth. This was the inflation narrative was what drove the Bitcoin and later crypto bull market coming out of 2020 going into 2021. And of course, throughout last year, 2021, the biggest debate in macro was whether inflation was transitory or not. On the one side, you had central bankers who were arguing that, yes, it was transitory. It was the effect, in other words, of supply chain disruptions coming out of the COVID-19, crisis and a simple dislocation between demand and supply. Their thinking was that coming off of shutdowns, all that pent-up demand, was all of a sudden meeting the lack of capacity because

Starting point is 00:02:12 the suppliers had been forced to shut down as well, who said that even if some of those causes were true, even if it was about supply chain dislocations, those things were unlikely to resolve themselves on anything resembling the time frame that the central bankers had in mind. Now, by the end of last year, there had been a shift in tone. And that shift was caused by the simple fact of the increasing politics around the inflation issue. 2021 is, of course, an election year in the United States, and that makes all the difference in the world. We really started to see the tone shift on inflation coming from the U.S. government around the renomination of Jerome Powell at the end of the year. The transitory word was retired, and instead the discourse from the powers that be were all about

Starting point is 00:02:57 how Powell and the central bank had the tools to fight inflation, which, by the way, the Biden administration agreed, was a top priority. This was followed by faster tapering of bond purchases, as well as increased expectation of rate cuts. And by the time we got to the beginning of January, we discovered that the Fed was actually already talking about quantitative tightening, removing liquidity from the economy. During this time, we've had a steady crescendo of biggest inflation census stories. Every month when we find out the inflation print from the month, month previous. It's the biggest one in first 30, then 35, then 37, then 39 years. Well, we got February's numbers today, and again, it's a new, bigger number. 7.9% inflation year over year.

Starting point is 00:03:42 That's a 40-year high, up from 7.5% in January, and it rose 0.8% month over month. Core inflation, which excludes food and energy, increased 6.4%. By the way, the idea of excluding the two most important things in most people's budgets has always seemed insane to me, but here we are. What's more economists are worrying about a few of the specific category numbers, gasoline prices were up 6.6%. Food was up 1% and rent was up 0.6%, which may not sound like a lot, but is in fact the largest since 1987. Wages continued their pattern of going up without being able to keep up with inflation. Inflation adjusted average hourly wages dropped 2.6%. This is their 11th straight decrease and the largest total drop since last May. On the whole, services were up

Starting point is 00:04:33 4.8% their biggest jump since 1991, while goods inflation rose by 13%, the most since 1980. This includes the largest ever annual increase in the price of new cars and trucks. There are some crazy individual items in this list. Year over year used cars were up 41.2% gasoline. Gasoline, 138%, gas utilities, 23.8%, meat, fish, eggs, 13%, new cars, 12.4%. Electricity, 9%, food at home, 8.6%. Food away from home, 6.8%. Apparel, 6.6%, transportation, 6.6%, and shelter 4.7%. Keep in mind, these are official numbers, and many other sources have these numbers being underestimated, particularly in areas like rent, where dated the apartment list just as one, for example, suggests rents are up 18% over the last year,

Starting point is 00:05:30 with home prices up 19%. By the way, that list that I just read was from a tweet from Charlie Villaljo, who is himself quite a skeptic of the official numbers. Nexo is the go-to platform for all things crypto. Invest in the hottest coins out there and start earning risk-free interest of up to 20% APR, paid out daily. Need cash ASAP, but don't want to sell? Use your crypto as collateral.

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Starting point is 00:07:23 Were there nothing else just the follow-through of the pandemic, this would already be highly politicized. we would see recriminations, accusations, people competing to explain high inflation, as well as pin that inflation on their political opponents. But since the last time we looked at these big inflation print numbers, the world has changed in a fairly significant way. We are in the midst of a massive der-rushification of the global economy that has simply huge implications for inflation and the global economy. The simplest and most obvious area is, of course, around energy. Russia exports about 5 million barrels a day, representing about 5% of the world's supply of oil. Russia also supplies 40% of Europe's natural gas, and so if there were nothing else,

Starting point is 00:08:10 leaving all of that behind would be an insane hit for the global economy to take. But it's not just that. Russia is also a top three grain exporter in the world, something like 12% of the world's calories come from Russia and Ukraine combined. Russia is also the world's largest exporter of two of the three main types of fertilizer globally. This is a commodity which was already six or seven times as expensive as the year before, and is obviously pretty important when it comes to how we feed the world. Then there are the platinum group metals that are used in electronics and catalytic converters, which means, by the way,

Starting point is 00:08:42 that cars aren't getting cheaper any time soon. Russia is also a top exporter in refined copper, seed oils, coal, and so much more. This is going to significantly increase disruptions and inflation. These things that were already expensive like cars are just going to get more so, and that's to say nothing of parts of the world like Egypt, where a huge amount of their food comes from Russia and Ukraine that are likely to face even bigger issues. This derrushification is going to increase both the economic and the political aspects of inflation. On the economic side, gas has increased 19% this month to $4.32 a gallon on average.

Starting point is 00:09:20 AAA did a survey and found that most Americans will change their lifestyle above $4 a gallon, and at $5 a gallon, over three quarters say they would need to adjust. In some parts of the country like California, the average price is already over $5. Russia, however, also adds a new narrative explanation and a new entrant in the discussion on how much inflation is due to natural consequences of the pandemic versus specific policies of the administration and power versus corporate greed versus war with Russia. And don't forget that corporate greed narrative as well, which you can see all over the place today in response to these numbers. The New York Times writes, corporations raise prices as consumers spend

Starting point is 00:09:58 quote with a vengeance. Corporate America is lifting prices and bragging about bigger profits as consumers open their wallets and spend heartily. So what are markets making of all of this? Well, stocks are down, led as you would expect by tech and risk stocks. And it seems clear that while initially the war in Ukraine was seen by some market participants as a reason for the Fed to get more doveish, it seems to be coming around to the realization that that just isn't the case, that the Fed has to keep serving its highest master of fighting inflation, and then ultimately fix the consequences of whatever comes from that next. Max Gockman, the chief investment officer for Alpha Tri, says,

Starting point is 00:10:36 the key here is that shelter and food not used cars are driving the print. Combined with declines in real wages, this locks in the Fed's compass. Of course, with the Russian invasion showing no signs of abating, it's unlikely the next headline reading will be below expectations. The market reaction is investors finally pricing in that this war will make the Fed more, not less hawkish. That's not stopping opinion pieces in places like Bloomberg and elsewhere from arguing that the Fed has to reconsider its anti-inflation policies. Just today, a piece titled Fed needs to delay its rate hikes showed up on Bloomberg. The argument is basically that if the Fed hikes, it increases the chances of a recession, and if a recession hits,

Starting point is 00:11:14 it increases the chances that the Fed has to immediately reverse any rate hikes. That seesaw pattern, the article, argues, weakens the overall impact of the Fed's policy, which is, of course, driven so much by signaling. So let's sum up the lay of the political land you're about to hear. You're going to hear some say that this is all Joe Biden's fault, that the specific policies of this administration around COVID caused inflation and the Fed didn't do enough last year to tamp it down. You're going to hear that it's left over COVID supply chain things,

Starting point is 00:11:43 although that's a less popular narrative now, but it's still there. You're going to hear a lot that this is about corporate greed. read. Elizabeth Warren's Twitter timeline is all over this this morning, right? Quote, one of the reasons why prices are rising and consumers are paying more? Large corporations are using inflation as a cover to expand their profits. We need to lower costs for Americans by cracking down on corporate price gouging and creating more competition. Fourth, of course, you'll hear that this is about Putin's war. Biden's account tweeted this morning, today's inflation report is a reminder that Americans' budgets are being stretched by price

Starting point is 00:12:16 increases and families are starting to feel the impacts of Putin's price hike. But I am fighting to bring down the everyday prices that are squeezing Americans. So what to think? Well, in classic American political fashion, these are all accurate in some way at the same time, but the people saying them are mostly picking and choosing based on the political agenda they have. Inflation was jumpstarted by leftover COVID things, but the Fed and administration made the decisions they did or didn't, which impacted how hot inflation ran. Corporations almost certainly are taking benefits from this. situation. But how much that's really causing versus following the core problem of inflation is a pretty important question to ask. And of course, being skeptical of the voices that are desperately

Starting point is 00:12:55 trying to make it about themselves is worth noting. And yes, this war is going to have a huge impact, as we were just discussing, although to blame that entirely is clearly a narrative shift for political purposes. The math of all of this is that the more contentious American politics get, the more you should be skeptical of everyone. So, in that context, who should you listen to? Podcasters? Well, of course, but the honest answer is anyone who is thinking longer term. For one example, go check out the Wall Street Journal today, which featured an article on Charles Goodhart, former UK central banker. In March 2020, he predicted inflation would hit 5 to 10% in 2021 and stay. And basically, his argument was that

Starting point is 00:13:39 we were in the midst of a massive shift in the world economy that the pandemic was just going to speed up. years and years and years of inexpensive labor had kept prices down and wages down. But that Goodhart argued was going to give way to an era of worker shortages, which would lead to higher prices. Effectively, Goodhart argued that the low inflation we had experienced since the 90s wasn't really about smart central bank policies, but instead was about the simple fact of adding hundreds of millions of inexpensive workers from China, from Eastern Europe, to this new globalized economy. a, quote, demographic dividend that pushed down wages and the prices of products they exported to rich countries. Together with new female workers and a large baby boomer generation,

Starting point is 00:14:22 the labor force supplying advanced economies more than doubled between 91 and 2018, end quote. Now populations are aging out, birth rates are declining, and labor is becoming more scarce. In the context of labor becoming more scarce, workers are going to push for higher wages, which will in turn drive up prices. On top of that, businesses will start to, manufacture and invest more locally in order to offset those labor shortages, which will in turn increase the cost of production and the bargaining power held by those local workers. Goodhart said the coronavirus pandemic will mark the dividing line between the deflationary forces of the last 30 to 40 years and the resurgent inflation of the next two decades.

Starting point is 00:15:01 His sum prediction is that inflation in advanced economies will settle between 3 and 4% and stay there for decades compared with the 1.5% for the last decade. Now, Goodhart may be right, he may be wrong. I don't really know. What I do know is that he's 85 and he's not fighting the same political fights that everyone else is hearing. It's hard, but if you can find voices like that who have a different incentive structure, you might be able to piece together something closer to a truthful view of the world. For now, I want to say thanks again to my sponsors, nexo.io, Arculus, and FTX.

Starting point is 00:15:36 And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Thank you.

The Breakdown - With Inflation at 40-Year Highs, How De-Russianization Has Changed the Narrative

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