Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 411

How long will the bad inflation news last?

Like other central banks, the US Federal Reserve has been complacent about inflation risks. The complacency was challenged by the 12 May announcement that the increase in the consumer price index was 4.2% in the year to April. Will US consumer inflation exceed 5% and, if so, when? And will the inflation increase prove temporary, persistent, or even permanent?

The next CPI release is on 10th June and will relate to May. In May 2020 the CPI fell by 0.1%. So an increase in May 2021 of 0.7% or more would take the annual rate to 5%. The average monthly increase in the CPI so far this year has been just above 0.6%, while business surveys indicate price-raising pressures are at their most intense for over a decade. Evidently, there is a possibility that the annual rate of consumer inflation will soon go above 5%.

As discussed in this video, the increases in the CPI were quite large in mid-2020, but then negligible (with an average monthly increase of half of 0.1%) in the last four months of the year. A good bet is that – if the annual rate does not exceed 5% next month – it will do so before the end of the year. (I discuss these developments in more detail in a recent article in The International Economy magazine).

In these e-mails the emphasis of the inflation discussion in 2020 and early 2021 was on asset price buoyancy and the remarkable surge in commodity prices from April 2020’s trough. But news is now emerging of big wage increases. McDonalds has raised pay by 10%, in order to recruit enough staff to deal with an anticipated boom in demand when lockdowns end. Meanwhile the Bank of America plans to add 25% to its minimum hourly wage between now and 2025. The labour market is tight. As the Covid-19 restrictions are relaxed and more people return to work, it will tighten further. Upward pressures on costs and prices will become even more general.

The Fed chair, Jay Powell, believes that it is his institution’s task to deliver ‘full employment’ and seems concerned that US employment is still several millions lower than in early 2020, ahead of the Covid-19 devastation. No one seems to have told him:

  • first, that the stability of the Great Moderation is often attributed to the argument that no long-run trade-off exists between unemployment and inflation, and,
  • second, that this argument leads to the prescription that central banks should concentrate on price stability.

Further, his research staff have evidently failed to explain to him that a monetary explanation of national income and the price level – in which inflation is determined mostly by the excess of money growth over the increase in real output – has a long and distinguished pedigree in macroeconomics.

Anyhow the answer to the question, “will the US inflation increase prove temporary, persistent or even permanent?”, depends on current and future rates of growth of the quantity of money, broadly defined. To recover the macroeconomic stability and negligible inflation of the 2010s, it is necessary for that rate of growth to be brought down to about 0.3% a month.

Two main difficulties need to be highlighted.

First, US banks are now keen to expand their profitable loan assets and to reduce the excessive ratio of unremunerative cash reserves to total assets. With M3 broad money at about $26,000 billion, increases in banks’ loan portfolios of $100-150 billion a month by themselves add about 0.5% to the quantity of money. (This assumes – perhaps wrongly in current circumstances – that banks finance the new loans by adding the same amount to their deposit liabilities. As just noted, they may reduce the ratio of cash to assets instead.)

Second, the Federal deficit is widely expected to reach $3,000 billion in the 2021 calendar year, or about $250 billion a month. Again, if that is financed to the extent of $100-150 billion a month from the banking system, the quantity of money rises by about 0.5%. On the face of it, US policymakers will not find it easy to restrain money growth to the low figures that are consistent with inflation of under 2%.

While the USA may have trouble over the next few years in dampening money growth and restoring low inflation/price stability, China is veering towards credit restriction. China has become far more authoritarian under Xi Jinping, while his Harvard-educated top economic adviser, Liu He, is reported to dislike excessive debt. In the three months to April, M3 went up by only 1.8% (or at an annualised growth rate of 7.6%). Annual money growth of little more than 5% would be the lowest since China’s opening to the world began after the death of Chairman Mao in 1976.

 

Professor Tim Congdon, CBE, is Chairman of the Institute of International Monetary Research at the University of Buckingham, England.

Professor Congdon is often regarded as the UK’s leading exponent of the quantity theory of money (or ‘monetarism’). He served as an adviser to the Conservative Government between 1992 and 1997 as a member of the Treasury Panel of Independent Forecasters. He has also authored many books and academic articles on monetarism.

 

RELATED ARTICLES

Are concerns about inflation inflated?

Magic money printing and the reality of inflation

Six suspects in the murder of inflation

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.