The Inflation Vampire: they said it was dead, but now even a stake in the heart won’t kill it.
Vampires, those creatures from "folklore that “subsist by feeding on the vital essence of the living,” have a few well-known qualities:
Blood drinking
Immortality
Avoiding sunlight
Heightened senses
Morphing shapeshifters
Obsessive-compulsive about counting
Like a vampire, inflation comes quietly and stealthily in the night. It creates pain and drinks the lifeblood out of the economy. Inflation avoids sunlight, as in central bankers like to keep their methodologies and their numbers as much in the dark as possible. The obfuscation of inflation is a sport amongst economic policymakers. Inflation heightens your senses because it makes you hungry. It makes you feel uneasy. It makes you mad. It means you can’t afford heating so you feel cold. Inflation is a morphing shapeshifter. It hits different prices in different countries. Some price changes are more important than others. Energy inflation morphs into higher fertilizer prices and therefore food inflation. Once inflation is present, everyone starts obsessing about how to count it. What counts? Your rent may be rising but that’s not necessarily included in the CPI. Your food costs start rising but central bankers use hedonics to tell you the quality enhancements on your new phone or laptop are so huge that you did not actually pay more given what you got. The sticker prices might be higher than before but the value proposition negates the price hike. Inflation always asks “what counts.”
Inflation is a Vampire.
I began warning about inflation risks back in 2012. Many will say I was wrong. But, inflation began to creep up slowly and persistently after the massive financial crisis bailout in 2009. Of course, the whole point of the bailout and the free money and the record low-interest rates was to create a little inflation. Central bankers wanted asset prices to rise. They did, slowly but surely. First, we saw early-stage inflation. People began to notice that the size of products started to shrink even though the price per weight remained the same. Candy bars got smaller. There were fewer potato chips and a whole lot more air in the bag. Toilet roll squares shrank. The General Mills box of cereal decreased from 19.3 ounces to 18.1 ounces – a drop of nearly 10%. Airline seats got physically smaller and closer together. Tiny apartments started being described as “micro-apartments.” By 2017, The Telegraph reported that over 2500 products had undergone some version of shrinkflation, which is always a precursor to inflation.
Eventually, you can’t take any more chocolates out of the box or chips out of the bag and you have to just raise prices. That’s when real inflation starts. Retailers tried hard to obfuscate their efforts to raise prices. British pubs started selling 2/3 of a pint which made it harder to tell that the price of a whole pint had gone up. Many retailers tried zigzagging, which is when they raise the price and then offer it at “half off” to, essentially, trick consumers into not noticing that they were already paying up.
Then, many things happened nearly all at once. Chinese workers were no longer willing to work for absolutely nothing in the hope that they might become rich later. That meant that the downward pressure from cheap wages stopped. Then the trade wars began, which added to costs. COVID accelerated the inflation trend further. Walmart and Costco started to say “we can’t find ever-cheaper suppliers.” Government debt blew out to such levels that governments had to announce tax hikes, which are inflationary. By November 2021, The Dollar Store hiked prices by 25% and announced that many goods would be sold for $1.25. Prices really started rising.
Inflation in the US went from almost zero to 4% in a decade. That may sound small. It’s massive. This jump pushes poor people into cheaper calories, which are emptier calories, and unleashes a healthcare time bomb. This kind of inflation shift sets alight all sorts of social grievances which then explode into social unrest. This kind of inflation causes voters to move to the extremes. This kind of inflation foments the frustration with the center that causes voters to back separatist movements like Brexit and outsider politicians like Trump.
The Vampire of Inflation turns normal kind folk into raving mad monsters. Even normally sound Central Bankers start doing strange things like moving the goalposts and raising the inflation targets. Instead of 2.5% inflation, maybe 3% or even 4% would be okay, they said, abandoning their long-held semi-religious goal of “price stability.” Inflation is labeled “temporary” to further justify the lack of inaction. Similarly, instead of dealing with the debt ceiling, they abandon it altogether. At least the problem of a debt ceiling would go away even if inflation would not.
What works with vampires? Apotropaics. A stake through the heart, though wood prices are soaring. Garlic, though the price of Chinese garlic is up 30% since last year in European markets. Mirrors? Now that’s a real possibility. Policymakers could look in the mirror and see that they have deliberately fomented this inflation. Then they’d have to acknowledge that they might not be able to get the creature back into a cage.
Note that the Chinese believe that a sack of rice will stop a vampire because they are so obsessed with counting. Remember the monocle-wearing, caped vampire on Sesame Street? Count von Count (Dracula) had to count absolutely everything. Well, if you start counting grains of rice you will soon understand the law of compound interest, which Einstein called the “8th Wonder of the World.” Inflation is the reverse of compounding. Just remember what Einstein also said about compounding: “He who understands it, earns it, and he who doesn’t, pays it.”
Now the data on inflation is rolling in ever faster. In the EU inflation has risen to its highest level since the Euro was introduced - almost 5%. Central bankers are now conceding that the new mutation of COVID will be inflationary as well. Food prices are at a fresh 10 year high after having risen 30% last year.
But, some will say “Look, TIPS aren’t moving”. Treasury Inflation-Protected Securities and bonds generally are not signaling a problem. Why? In short, because institutional investors are now required to hold more liquid security for macro-prudential reasons. That means these security prices no longer reflect inflation expectations the way they used to. They’ve become like a damaged antenna that no longer conveys a meaningful signal. These days Grandma probably knows more about what’s happening to prices than anybody on a trading floor. I think her expectations are much more important than those of the Treasury market. But, the Fed has just released a paper by Jeremy Rudd that says the opposite. He says we keep thinking that
“expected inflation is a key determinant of actual inflation” but this may be totally wrong. In fact, maybe we need not bother with managing inflation expectations at all. “inflation expectations to explain observed inflation dynamics is unnecessary and unsound: unnecessary because an alternative explanation exists that is equally if not more plausible, and unsound because invoking an expectations channel has no compelling theoretical or empirical basis and could potentially result in serious policy errors.”
So, we can stop worrying about Grandma’s views or the view of the TIPS market or the Treasury market. That’s one solution - just say inflation expectations don’t matter. Let’s retire the term “transitory” says, Chairman Powell, not because he concedes that inflation is not going away but because it’s not important. Plus, you might even like a little inflation! “It lessens the real value of debt”! says The Intercept. That publication, which is known for writing against the power of government, writes, “Inflation over the past year has effectively transferred $850 billion in wealth from creditors to debtors. That’s a lot of money”. If the inflation vampire can seduce and convert staff at The Intercept and at the Fed alike, what chance do the rest of us have?
Try to be on the right side of the inflation trade. Inflation is like the monster you spot in that rearview mirror that says “Objects are closer than they appear,” except remember, you can’t see a vampire in a mirror.
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As usual, this is thought provoking and entertaining reading. Now, I am wondering if Jay Powell is the equivalent of poor Renfield, inviting in Dracula, opening the door to the severest of danger, ultimately to be crushed by the monster.
So...what to do about ? Real Estate ? Energy Commodities ? Precious Metals ? BITCOIN ?