Future inflation ≠ past inflation

Recent inflation data is generally weakening.
But the pandemic and various degrees of lockdowns make CPI data meaningless
Business and consumer surveys are beginning to hint at coming price rises

The end of the month is usually when countries publish updated inflation numbers. Latest data show price pressures in the largest economies remaining weak and even weakening further. US headline inflation eased to 1.2% in October from 1.4% in September and the more important core PCE deflator was 1.4% after a six-month high of 1.6% the previous month. Euro area data is published 1st December, but, judging by available German and Italian numbers, deflation almost certainly deepened slightly in the month. UK core inflation was unchanged at 1.3% for a fourth consecutive month, but eased on a monthly basis. In east Asia, the fall in Japanese consumer prices accelerated in both October (-04% from a year earlier) and in November (-0.7% judging by Tokyo data); and 12-month Chinese inflation dropped to an 11-year low of 0.5%.

So why worry about inflation? For three reasons. First and perhaps most obvious, future inflation is not necessarily the same as past inflation. Current inflation data shows what happened in the period since October or November 2019, not what will happen in the year to November 2021.

Second, as everyone is well aware, this is not a normal period by any stretch of imagination. This matters, because as I have pointed out in the past, consumer price indices are a measure of spending in normal circumstances, which means that they are fairly meaningless in the current situation.

And third, because of continued strong money numbers. Broad money growth eased slightly in most major economies over the summer and early autumn (the exception is Japan, where M3 growth continued to accelerate), but has recently begun to pick up again. In the US, broad money (similar to the old M3 measure) has been in the double digits for 11 months, with the latest number 15.9% in October, down slightly from a peak of 17.6% in June. EA M3 growth accelerated to a 12-year high of 10.5% in October, while UK M4x was 13.1%, the highest number since the series began in 2007. (UK M4, which includes financial institutions’ holdings, was 12.9%, below June and July numbers but a slight uptick from August and September.) In China, M2 growth has continued to ease, but at 10.4%, it remains considerably stronger than what is consistent with current weak GDP growth. Japanese M3 growth has been in the low double digits for the past four months; the last time this happened was in early 1990.

For the time being, strong broad money growth has primarily manifested itself in buoyant asset prices. This is partly (and intentionally) due to a combination of lockdowns and low interest rates. However, both household and corporate balance sheets are swelling with cash. This will eventually find an outlet in spending.

And there is another reason to be wary of inflation. Business and consumer surveys generally include a question about price trends. Looking solely at the US and the EA, we find that these are now creeping up. The US ISM manufacturing price index series reached 65.5 in October, the highest since October2018 and up from a low of 35.3 in April 2020; while the non-manufacturing price index has been above 60 three times in the past five months after a long stretch in the 50s. In the Euro Area, selling price expectations in business are edging up, as are consumer inflation expectations.

At the moment, neither series is at levels that should give cause for alarm. But what is important is that the trends have clearly changed. Assuming, as seems likely, that by the spring we will see a number of vaccines against COVID-19 being rolled out in mass vaccination programs, we can expect economic activity to accelerate rapidly. That should further spur, not just inflation expectations, but most likely actual inflation as well, with numbers in the second half of 2021 and into 2022 likely to be considerably higher than we have grown used to in recent years.

On a somewhat different but related issue, much is currently being made by commentators about how governments should take advantage (as they are) of ultra-low interest rates and borrow ‘for investment’. Leaving aside what governments are capable of (the British government, for instance, talks grandly, but is incapable of replacing a vital Thames crossing, Hammersmith Bridge which has been closed for 18 months for traffic and for four months to pedestrians; latest estimates are a seven-year period to repair the bridge, which took three years to erect 140 years ago), it is clear that once interest rates begin to rise, as one day they will (although see my views on financial repression), government finances will rapidly deteriorate. And so the question arises, why are governments not issuing consols — that is to say, non-redeemable debt? Issue a massive non-redeemable ‘COVID-19 bond’ at 1% (or so) and ignore future interest rate increases. This would also spread the cost of the pandemic to future generations, who, after all, would not be alive if we didn’t survive the virus. Am I missing something here?

Gabriel Stein
gabriel@gabrielstein.com