DEFLATION NOT INFLATION WILL BE THE TOPIC WHEN HOUSING, EQUITY BUBBLES POP
Let’s also realize a few things. This supply-side inflation is occurring at a time when there is still ample labour market slack in the U.S. I realize that many pundits point to the 11 million job openings with about eight million officially unemployed as a sign of a super-tight jobs market, but this is a case of looking blindly at the data without doing any real analysis.
The U.S. economy is now the same size now as it was pre-COVID-19 when job openings numbered seven million. Do we really need four million more workers to provide for a GDP that hasn’t budged for a year and a half? Really? If the labour market was truly as tight as they say, we would be experiencing an across-the-board wage boom. Anecdotes aside, that isn’t happening.
We have an inflation situation in the context of lingering high unemployment relative to the economy’s full potential. This is all about supply constraints, and not just materials, but also labour. To some extent, the seeming tightness in the jobs market is the result of the government paying people not to work for nearly 18 months, but that gravy train just came to an end.
Which brings me back to the primary issue here. This is all about the pandemic. The transitory inflation view is hinged on the pandemic ending or shifting towards herd immunity, but the delta variant got in the way. It stands to reason that we will get through this pandemic, even if it lasts longer, and these supply constraints will subside once we do.
Manufacturing capacity in key areas such as semiconductors will come back. At some point, perhaps sooner than expected, the near-record volumes of inbound containers at major U.S. ports will be unloaded and fuel a bulge in imports and inventories. This has yet to happen. Why? The pandemic. The constraints on global supply chains suddenly emerged from what? The pandemic. Whatever decisions workers are making to delay their return to the labour force is due to what? The pandemic. It’s all about the pandemic.
I recall all too well the experience of the mid-2000s. Back then, inflation lasted a lot longer than it has currently, which has been the grand total of three to four months. That period in the mid-2000s was all about the “commodity supercycle” that culminated in oil prices touching US$150 per barrel. That era wasn’t about supply constraints, but about double-digit growth in China at a time when it was consuming half of the world’s basic materials.
The bubble this time around is even more acute, and the reversal in these asset values will hit even harder. The S&P 500’s cyclically adjusted price-to-earnings ratio (CAPE) multiple is 38.3x today and U.S. home prices have soared a record 20 per cent on a year-over-year basis. It now takes a near-unprecedented eight years of wages to buy a new house (the historical norm is closer to five years).
Let’s look at the entire situation from a holistic viewpoint. We know that productivity growth is running at around a year-over-year two-per-cent pace, which, by the way, is a key positive supply-side catalyst and is close to double the trend of the last business cycle. This is because we actually had some capital deepening in 2020, when, in the economy’s worst year since 1946, business volume spending on technology goods and software rose seven per cent.
This leads to a further conclusion that this pandemic-induced supply-chain inflation is, indeed, not at all permanent. Despite all the hype over the “non-transitory” nature of the current inflation backdrop, we have really had only three bad readings in the past 12 months: April, May and June, where core CPI averaged +0.9 per cent month over month. It averaged +0.1 per cent the other nine months.
Like I said, don’t call it transitory. Call it something fancier, perhaps, like ephemeral. It sounds better and more reasonable to me, since I simply refuse to believe that the pandemic will be the one event to trigger a whole new inflationary experience.
What is going to be transitory (did I just utter the “T” word again?) will be this era of fiscal recklessness. As fiscal stimulus turns to withdrawal, demand will slow below supply, and the move to a new and better chapter in this pandemic will create the conditions for all these global production and labour market bottlenecks to thaw.
As for stagflation, the new fear factor term everyone is using today, that was a condition that existed in the 1970s, which in the history of the global economy was a true anomaly. Simply put, there is no such thing as stagflation with productivity running near two per cent at an annualized pace.
One may argue that infrastructure spending is on its way, but it will not be enough to compensate for the expiration of all these other stimulative measures. The thing about infrastructure spending is that it has long gestation periods and has to be capitalized over long time periods. This sort of government expenditure has never affected the contours of the business cycle.
The conversation will quickly turn away from inflation towards deflation when that happens, as it did in 2000-01 and again in 2007-08. Also, expect long-term Treasury yields to beat a path back down towards the lows we saw a little more than a year ago.
That this is not the consensus makes this forecast that much more compelling. When all the experts and forecasts agree, something else is going to happen. Which only means that sustained inflation, a return to stagflation or a durable bear market in Treasuries are not going to happen.
Story by: Financial Post