Those of us who were economically active in the 1970s remember the difficulty of controlling inflation. (Of course, OPEC, etc.)
It wasn’t until Paul Volcker at the Fed raised the fed funds rate and induced the fierce 1980-82 recession that inflation subsided. And stayed down. Until 2022.
The Macro trend of low inflation underlaid the economic (and stock market) growth from 1982 (the market bottom) until 2020. In fact, the Fed talked about how difficult it was to maintain inflation at their preferred 2% level and avoid deflation.
Inflation was kept low by three Macro trends which have been disrupted recently.
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Globalization. Manufacturers moved production to low-wage countries with few regulations. Covid supply chain disruptions are causing manufacturers to bring production back to the U.S. with higher labor costs and regulations – inflationary.
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Labor markets. Entry of large baby boom generation in the U.S., access to gigantic foreign low-wage labor markets. The Macro trend has shifted. The baby boomers are retiring, labor force participation of prime-age workers is lower, long Covid may reduce the workforce even more, and immigration has been restricted. Labor productivity has been falling.
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Energy and commodity prices. Energy producers invested in production (especially in the new fracking technology which has turned the U.S. into a net exporter) that kept oil prices low (especially after the “Peak Oil” 2007 bubble burst). During the past 10 years, oil producers have invested less in production due to low energy prices and environmentalist pressure to reduce use of carbon-based fuels.
These Macro trends suddenly reversed during and just before the Covid pandemic. They will have long-term inflationary impacts.
https://www.wsj.com/articles/inflation-jackson-hole-fed-powe…
**Jerome Powell’s Dilemma: What If the Drivers of Inflation Are Here to Stay?**
**Policy makers gathering this week in Jackson Hole are worrying about the emergence of a more volatile world with higher interest rates**
**By Nick Timiraos, The Wall Street Journal, Aug. 24, 2022**
**Central bankers worry that the recent surge in inflation may represent not a temporary phenomenon but a transition to a new, lasting reality.**
**To counter the impact of a decline in global commerce and persistent shortages of labor, commodities and energy, central bankers might lift interest rates higher and for longer than in recent decades — which could result in weaker economic growth, higher unemployment and more frequent recessions....**
**“The global economy is undergoing a series of major transitions,” said Mark Carney, former Bank of Canada and Bank of England governor, in a speech at an economics conference in March. “The long era of low inflation, suppressed volatility and easy financial conditions is ending.”...**
[Pollyanna Scenario] **The Fed could still succeed at curbing inflation by raising interest rates. Postpandemic headwinds might abate or fail to materialize if protectionism and geopolitical risks recede, labor productivity improves, a slowdown in China’s economy reduces demand for global commodities, or new technologies reduce the costs of developing new energy sources....**
**Several former Fed officials who have worked closely with Mr. Powell say he is likely to err on the side of raising rates too much, rather than too little, because tolerating excessive inflation would represent a much greater institutional failure for the central bank....** [end quote]
Raising rates causes falling stock and bond prices.
What’s the chance that the Pollyanna Scenario will fall into place soon?
A Macro trend change to lasting inflation – and/ or the high interest rates needed to quash it – is already leading to drops in all asset price valuations. But they are still wildly over-valued on a historical basis.
Look out below.
Wendy