Inflation hasn't died out, it's just temporarily dormant

The Zhitong Finance App notes that in developed countries, inflation is returning to the low level of 2% set by many central banks, however. However, the British financial historian Edward Chancellor believes that the market should not rush to open champagne to celebrate.

Chancellor said that for a long time, monetary policy makers celebrated the end of inflation too early, but as a result, they were caught off guard by a sudden rise in inflation. Perhaps the best example comes from the early 1970s.

In the late 1960s, after the Vietnam War and President Johnson's spending on social projects, US inflation began to rise. In response, the Federal Reserve raised interest rates to close to 10% in 1969. A brief recession and stock market crash followed. The rate of inflation fell, falling to 2.7% in 1971, close to the current level. By the end of the year, the Federal Reserve's official policy rate had returned to 3%. Large-cap stocks soared. Then everything messed up. In 1974, the inflation rate reached 10%, interest rates peaked at more than 13%, and stocks plummeted, followed by a severe economic recession.

Several factors help explain the sharp rise in inflation. In 1971, President Nixon closed the so-called “gold window”, ending the convertibility of the US dollar with precious metals, and the dollar lost its currency anchor. Meanwhile, during his successful re-election campaign in 1972, Nixon pressured Federal Reserve Chairman Burns to boost the US economy. Both Nixon and Burns placed low unemployment over price stability. The following year, OPEC imposed an embargo on oil importers that supported Israel during the Yom Kippur War, when oil prices tripled.

The Federal Reserve initially responded to the energy crisis by lowering interest rates. The economist Milton Friedman and others later criticized the action. However, if the Bank of America blocks other price increases, the entire economy could collapse. Furthermore, a recent study by the International Monetary Fund found that historically “unresolved” inflation has often been linked to energy shocks.

“Is Inflation Over: Are You Ready?” published in 1983 In the book, A. Gary Shilling and Kiril Sokoloff point out a number of factors driving up prices. These factors include support programs for agricultural and dairy products, as well as tariffs on sugar and Japanese steel. Complex regulations have increased business costs. In 1971, Nixon introduced price and revenue controls, but these measures predictably failed to stem the tide of inflation. Cost of living adjustments to Social Security benefits and minimum wage have spared many Americans from being damaged by inflation. The workers went on strike to maintain their wage gap. Productivity growth has been cut in half. The weak dollar boosted import prices. Most of these inflationary forces are self-reinforcing.

Shilling and Sokoloff described the historical link between the government's rising share of the economic cake and the price spiral, which reached about 40% of US GDP in 1980. The Federal Reserve played a supporting role. After leaving office in 1978, Burns lamented that “the Federal Reserve itself is also involved in philosophical and political trends that are changing American life and culture.” At that point, however, Americans were more concerned about inflation than about unemployment. Under Chairman Volcker's leadership, the Federal Reserve was authorized to squeeze inflation, an achievement achieved through surprisingly high interest rates, two severe recessions, and soaring unemployment.

Today is not a repeat of 1973. Still, there are some interesting similarities. There are more and more government regulations. China and other developing country members are planning to break the dollar's dominance in the international monetary system. Wage increases to fight inflation continue to make headlines. Earlier this month, American dockworkers ended their strike after receiving a 62% increase in wages. Boeing employees declined a 30% pay increase offered by the company. Vice President Harris promised that if she wins next month's presidential election, it will hit the company's exorbitant price demands. This sounds suspiciously like the re-implementation of price controls. Republican presidential candidate Trump wants high tariffs on imported goods.

Meanwhile, another war is raging in the Middle East. Even if it doesn't immediately cut off the Gulf's oil supply, the sustainability of the medium term oil supply remains questionable. ExxonMobil warns there could be an oil shortage by 2030 due to insufficient new investments — although the International Energy Agency does not agree. The shift to renewable energy has helped drive electricity costs in the EU by 45% since 2020, according to Eurostat. Just like in the 1970s, higher energy costs are making much of Europe's manufacturing base tough. According to MacroStrategy Partnership's Andy Lees, since peaking in 2017, industrial production in Germany has fallen 14%.

The public debt is much larger than it was 50 years ago. The IMF expects total global government debt to reach 100 trillion US dollars by the end of this year. Last year, America's fiscal deficit reached $1.6 trillion, or 6.3% of GDP. John Cochran of Stanford University proposed the “fiscal theory,” which argues that there is a link between excessive government spending and inflation. He believes that a return to inflation is not a question of whether, but rather a matter of time.

Sokoloff, founder and chairman of investment advisory firm 13D Research & Strategy, has successfully predicted a turning point in inflation for 40 years. Today, however, he's not that optimistic. He believes that what the market is currently seeing is a cyclical downturn. Significant long-term factors driving up prices remain. De-globalization, rearming, de-dollarization, an aging population, climate change, and the energy transition will continue to drive up inflation for years to come. Just like in the early 1970s, there was no political will to implement high real interest rates to control prices, nor to implement austerity policies to control government finances.

Sokoloff said that gold has always been a reliable barometer of inflation and deflation. Since the beginning of the year, the price of gold has risen by nearly 30%. The senior analyst said that it tells us that 40 years of de-inflation have come to an end, and the bond market is now in a long-term bear market. Inflation has not died out; it is only temporarily dormant.