The Dividend Cafe - Inflating Clarification on Inflation Part 1

Episode Date: July 22, 2022

It has been a year and a half since I first took up the inflation/deflation debate as a matter of contemporary debate (a part 1 and a part 2). As much as I wished then (and now) that the great economic fight we would have for the next thirty years was inflation, I believed then (and now) that the great economic fight we will have for the next thirty years is better referred to as deflation (a term that itself will require more precise explanation. Some more in-depth updates on the subject have also been produced with a deep desire to really explain and contextualize the state of affairs. Nevertheless, the responsibility of clarity in messaging is with the writer, not the reader, and while there is only so much I can do to make sure those reading it understand it, I have a pretty strong desire to keep doing more. Let me just leave the introduction there and dive into this topic. I suppose I do hope some clarification comes out of this, but truth be told, I am more passionate about just reiterating the great economic message of our time. My agenda is not academic, and it is not political. I am responsible for actual client capital, which is to say, the instrumentation by which actual human goals and needs are met. I take it very, very seriously. And this subject sits at the center of what I believe is a generational economic challenge. Let’s jump into the Dividend Cafe … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe. Actually, the last one I'll be recording here from the East Coast for a few weeks. I've been out in New York for the most part since the beginning of June, kind of back and forth between our house in East Hampton and in the city. And there was one exception where I was out in Grand Rapids, Michigan for that conference. And then last week, I had a 24-hour trip to Vegas, but I haven't been back to California in a while and I'm excited to fly back to California tomorrow. And then I'll be there for a couple of weeks. And so we'll have a little change of scenery for the next Dividend Cafe. And the next Dividend Cafe will actually be a part two to today's Dividend Cafe, which I did not intend to be a two-parter. I started typing at about five o'clock this morning and at eight o'clock Eastern was past the word limit of what I wanted for the week. And

I think maybe I'm halfway done. I don't know. It could be a little less. It might not even be halfway, but bottom line is I have to turn this into two parts. And that's okay, because it's a very important subject. And I want to talk to you guys today and then again next week about this inflation debate. And you go, dear God, David, you've been talking to us about it forever. And that's true. But we are due for a kind of catch up on the subject. There were so many things written in the early stages of this inflation onset, going back to kind of the beginning of the post COVID recovery, early 2021. And as higher price levels began to sink into the economy, there were so many things written, and I, for many, many years, have written so much about this theme of Japanification and my rather intense study of the downward pressure on economic growth that I believe current fiscal and monetary policy represent, present, that the entire subject warrants a revisit from time to time because the entire subject is prone to misunderstanding and a need for ongoing clarification. What I was afraid of

when I began writing this morning is that people would interpret this as some sort of a mea culpa, like, okay, well, I got this inflation thing wrong. I want to talk to you about this or that. And yet, I do not believe I got it wrong. And yet, there is this need for clarification. And so people could say, well, why not? Why fight this? Why not just kind of be transparent around it all? And yet, there is absolutely nothing that I want to fight. And I want full transparency, clarification. That is my responsibility. If there is an ambiguity about what is being said, that is not with the reader, or the listener or the viewer that is with me, the creator of this content, if you will.

So I believe that clarification on the subject of inflation, its ramifications to investors, and what exactly the macroeconomic conditions that have been forecasted by yours truly and are being forecasted are. And I believe that there are plenty of times in my life and career and in the life and career of anybody engaged in economic modeling, forecasting, or opinion making that warrant me a culpas. aculpas. This is just not one of them, but that is not because I would be hesitant to say, oh, I got this wrong. I say it all the time. It's important to me for two reasons. First of all, it's just the right thing to do. When one makes a mistake, correction and confession and transparency, those things I think as a matter of character

are incredibly important. But also because I think when one needs to reverse course on something, it is a part of the humility that comes with being an effective asset allocator. So a kind of aversion to saying one's wrong doesn't go well with being good at what one does. In other words, paradoxically, if you want, good asset allocators admit when they're wrong and you go, well, no, a good asset allocator just won't be wrong. That's adorable. It doesn't work that way. So what I want to say is I think I'm wrong a lot. I think when I'm wrong, I say so. I think that I always should be open to being wrong and really work vigilantly to check myself and find contra opinion to my own opinions. And I think that I should exercise and execute humility and prudence inside of how we go

about investing client capital. And at the same time, in this case, I firmly believe that my long-term views on what is happening in the economy and what represents the real dynamic of inflation, deflation, tug of war, I think that we have been very much right on this issue and unfortunately, unfortunately, we'll be right into the future. This is perhaps one of the biggest misunderstandings about my beliefs that we're in a secular, longer term period of downward pressure on growth and inflation, which are two different things. I am not saying that as a good thing. I am not talking down the long term expectation expectation of inflation because I am giving a rosy economic scenario. I am saying so because I believe we are fighting a different battle and that battle

is going to prove to be a far more formidable one. So in terms of the current state of affairs, along the way of what's taking place over the last 18 months, I have changed my mind on a couple of things. There was a point, I think, in early 21, where someone said the Fed will let the Fed funds rate get up to two and a half or wherever they end up stopping. Let's say it's somewhere in the low threes. Obviously, there's some who believe it's going to be a lot higher. I don't agree with them, but I'm totally ready to be wrong about that. I don't think I will be, but if we get a Fed funds rate of 5%, then I will be wrong because I'm not forecasting that. However, I would have said 1%, 1.5%, at the most 2% a year and a half ago. And there's no question that the facts changed.

And so John Maynard Keynes' line is, in effect, when the facts change, I change. What do you do, sir? That's perfectly fine. I would say too, that the level of supply chain exacerbation and impact into pricing that we've seen did go higher than I would have expected. I'm not remotely surprised that we are experiencing price increases in this time, but the level of them has lasted longer. Now, I think that we are already in the midst of seeing, it's four months in a row now of the level of goods inflation coming down and the overall inflation level has gone up as the services side has continued and the lagging effect of housing prices.

But there's not a ton that is surprising me right now, and yet that may change. Some of the things I now believe are about to happen could end up being a surprise. But all of that is a bit different than the underlying subject of what investment-oriented economic conditions presently call for. This investment orientation is very important because when I talk about economics, I do so as someone responsible for billions of dollars of other people's money. I don't have the luxury of doing it only for a newsletter audience or a podcast. I don't have the luxury of doing it only for a newsletter audience or a podcast. I don't have the luxury of doing it for my own ego. And I don't have the luxury of doing it for a classroom of students or in a faculty lounge.

It's not academic for me. There's investment implications on the line. And one of the reasons that I think people should understand that this debate over the last 6, 12, and 18 months is not something that warrants a mea culpa for us is it isn't exactly like it has hurt us from an investment standpoint. Our dividend growth portfolio, the bulk bread and butter of what we do as investment managers has up substantially in the last 18 months. We've far, far, far outperformed market indices to the extent anyone cares about such things. We've avoided the stuff that has gotten destroyed, your cryptos and shiny objects and high growing tech stuff and all that that is down so much. We very publicly and privately avoided these traps.

There's certain things within the credit market we've done really well. There's certain things within the bond market that have not gone great. But I mean, all in, I'm really pleased with how our investment work has gone. And that's obviously what we care about most. And so to the extent that there would be a mea culpa along this lines, it would be connected to investment implications. That's what we're talking about here. And when I talk about the inflation of the last 18 months, I think the biggest debate is not one that is solvable. It is non-falsifiable when one makes an assertion about the causation of higher prices. And fundamentally, there is a school of thought that has said low interest rates caused disinflation. And all I merely do is say, huh, for 30 years, they didn't. For 30 years,

they haven't in Japan. And yes, they have for housing. In other words, I affirm that the leveraged aspect of housing, which is entirely rate dependent, combined with other preposterous policies that constrict supply, the regulatory environmental apparatus that keeps new housing stock from coming, and various social and cultural realities that continue to serve as sort of a cult of housing. I think that when those things get combined with an artificially and distortive low cost of borrowing. It has absolutely inflated housing. But that should be no surprise that I think that I've talked about that ad nauseum since before the great financial crisis. But do I believe that energy prices are higher because of low interest rates? I mean, it defies the imagination. Interest rates were at

zero for seven years and energy prices came down 70%. No, I do not believe that low interest rates have been the primary causation of the current inflation. I think housing is the unique exception that proves the rule. Now, the more popular belief these days, particularly with a lot of friends of mine on the political right, is that they think the Biden spending bill in the spring of 2021 caused inflation, that we helicopter moneyed a couple trillion dollars into the society. And that is plausible prima facie. But again, the counterfactual is difficult. First of all, to the extent a bunch of people get money and run out and buy things with it, there is no precedent that that is followed up by a velocity of the money, a continued turnover.

that that is followed up by a velocity of the money, a continued turnover. Excess, that money that is helicopter dropped is deficit financed. And excessive indebtedness collapses velocity and the money stops turning over. So even if there is inflation, which sometimes with such events there can be, this is one of them. Other times there has not been but even when there is it's never more than a sugar high okay and then it is stopped in its track by the downward pressure on velocity that we've seen for several decades however I just merely make the anecdotal point that I'm supposed to believe $2 trillion of recent spending caused inflation, but $20 trillion

of excessive spending before that didn't. I mean, you got to admit, it's a little tough to get past that. It doesn't make a lot of sense. And the counterfactual of Japan, which we're going to talk more about next week, a nation with double the debt to GDP we have that continues to spend more than we spend, that helicopter money is a way of life, combined with the financial repression in their monetary policy. We say our rates are too low, which they are. Their rates are lower than ours, which they have been forever, and they have zero inflation. And so I think that there are counterfactuals that would behoove honest critics to kind of contend with. But see, there is a cause for what's made prices go up over the last two years, and it is not worth ignoring. I would just suggest that the

Occam's razor explanation is more likely supply driven, that we have had an unprecedented disruption in our supply chain, an unbelievable complication in getting semiconductors into the country and inadequate domestic manufacturing of such. We have had intermittent lockdowns that have shut down manufacturing activity, both domestically and especially out of China. We had an absolute resurgence of demand and COVID reopening that apparently took people by storm that didn't understand how human beings think and operate. We had a monumental and still suffer from a monumental labor shortage, a lot of which was exacerbated by bad government policy that incentivized people to not work, incentivized people to not return to work via extended

government subsidies and direct government payments. There have been a lot of factors, economic, policy, cultural, that have driven the supply side problems that have exacerbated inflation. You combine that with the temporary effects of helicopter money, and I don't think that there's a huge shock to the fact there's been the price increases. So what exactly is the difference then? So we're just debating about what's caused it, but we all agree inflation is the new normal. sin of housing price inflation, and B, are saying that government spending can go create inflation and ignoring that inflation is also a byproduct of too few goods and services. Too much money chasing too few goods and services means the supply side can be part of the equation. And then C, ultimately failing to understand that inflation is what politicians want to deal with excessive indebtedness. It lets them pay

back a dollar with 70 cents. It's a pretty good deal. And that is not what we want as citizens. And yet what they have created is an environment that puts downward pressure on growth and forces us to live in a low, slow, no growth environment. When I say they, that part did sound like I mean the politicians because it's what I said, but that isn't actually really what I mean. I mean we, because we elect the politicians. And so for the purpose of certain short-term gains, I think that we are taking long-term pain and I don't like it. And I want to talk more about it from an investment standpoint because ultimately if what we were dealing with was simply the fact that there has been a surge of inflation because of a temporary big

spike in spending. And now we don't do the spending spike anymore. And we go tight monetary policy, you would think all that inflation would go away and everything would be back to normal. But then the politicians could go away with that and say, well, now we know what we can do. We can inflate whenever we want with excess spending, and we can take it back by just exacerbating boom-bust cycle. The problem is it isn't that simple because every time they go spend more, they can pull the spending back, which takes away the sugar high, but the debt doesn't come back. The debt's still there. The scar from the spending is still there. And that means future money that has to be allocated to pay back the debt instead of going into goods and services. That's deflationary. That puts downward

pressure on growth. That's not good. That's what I believe our true focus is. So this is, I'm going to leave it there. That's because I'm, otherwise I'm going to start doing part two. Now I want to elaborate more on the truly concerning deflationary and disinflationary pressures I see in the years and decades ahead. Next week, hopefully this week is at least at the table for what the present environment of inflation is, where it's come from, how that fits into my macroeconomic narrative. Thank you for listening to this. Shoot questions at me. I love them all. And even if you disagree, you're not going to phase me. I enjoy true intellectual debate. It's all good. Thanks for listening to and watching the Dividend Cafe. And I will see you back in

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