Inflation has not been a persistent and serious threat to the economy since the 1970s and early 1980s.
The Fed knows how to defeat inflation. Raise interest rates to onerous levels and quash demand in the economy via a serious recession. In turn, companies lose the ability to rapidly boost prices, and employees no longer have the leverage to demand outsized wage hikes.
We don’t want to repeat that cycle.
At a minimum, however, we are starting to see upward pressure on prices. How long might this last?
The Consumer Price Index jumped 0.8% in April. Remove food and energy, and so-called core inflation surged 0.9%, the fastest reading in 40 years (U.S. BLS, St. Louis Federal Reserve).
Fed officials continue to insist any increase will be “transitory,” their word of choice in describing what they see as a temporary rise in prices tied to the reopening of the economy.
That may be the case for hotels and airlines that are set to see a jump in summer bookings.
But there are issues that are influencing pricing decisions on the production side of the economy, too.
We have learned that huge cash infusions via government stimulus will boost demand. We are seeing it in record retail sales reported monthly by the U.S. Census Bureau. Yet, production has been slower to rebound.
A May 13th story in the Wall Street Journal, “Empty Lots, Angry Customers: Semiconductor Crisis (Shortages) Throws Wrench Into Car Business,” sums up what’s happening in the auto industry and highlights the problems auto buyers are facing. Or here is another look from a May 11th CNBC feature: “U.S. Faces Major Shortages in Everything From Labor to Semiconductors, Lumber and Packaging Material.”
In April, the National Association of Homebuilders said that lumber shortages are leading to skyrocketing lumber prices, adding an average of $36,000 to the cost of a new home over the last year.
Government spending and a super accommodative Federal Reserve argue for a more permanent and unwanted rise in inflation. However, longer-term disinflationary trends, i.e., demographic trends and globalization, remain in place. Further, labor unions, which helped drive a wage/price spiral in the 1970s, don’t have the power they once had.
So…Where do we stand?
There are reputable economists on both sides of the inflation debate. No one wants to see a return to the double-digit inflation problems of the 1970s, and the Fed is more likely to react than was the case a generation ago.
But we don’t expect the Fed to lift interest rates anytime soon, as central bankers continue to insist their focus is on full employment, and any rise in pricing pressures is temporary. Nonetheless, the best news on inflation is probably behind us. Fortunately, equities have performed well in inflationary times, just as long as it does not get out of control. It is something we are watching closely.
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