Charts of the Month - December '21

Topic of the Year: Inflation

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Not all inflation is created equal.

We want to set the record straight because even the smart people, the ones we look up to, are conflating terminology and adding to the confusion.

We need to look at inflation as two separate but related phenomena:

1) Consumer Price Inflation (CPI), and

2) Asset Inflation.

Consumer Price Inflation (CPI)

This is the one that generates most of the noise. It simply highlights the changes in prices of a basket of goods and services that are “representative” of a normal consumption profile for the average consumer (though it glaringly excludes booze). This is governed, broadly, by the supply of and demand for those goods and services. Simple.

Let’s look at the demand side first.

Personal Consumption Expenditures (PCE) is a good proxy for the demand for goods and services in an economy. Currently, PCE is significantly above the post-GFC trendline.

The gap on the chart above may not look like much, but it’s ~$1.3 trillion of excess demand above trend or about 4.8% of US GDP.

What’s driving this excess demand?

Depends which tribe you ask:

• Fed haters will say excessive Monetary Policy.
• Government haters will say irresponsible Fiscal Policy.
• Sociologists will say we’re acting like a bunch of caged animals just re-released into the wild and are blowing through our money ‘just to feel something again’.

The correct answer is some combination of all the above, but the definite wrong answer is to simply say that excess demand comes from only one of the above.

As we’ll see below:

1. Loose monetary policy has driven up asset prices, creating more wealth, which increases demand (something economists refer to as the wealth effect – your house or stock portfolio is worth 30% more, and so you feel comfortable buying a new car).
2. Fiscal stimulus in the form of direct payments, unemployment support, and child tax credits has increased the amount of disposable income to the middle class, which also increases demand.
3. The post-lockdown YOLO spending, again, increases demand.

Now on to supply.

This is easier to figure out, and we don’t even need any words to do it (although FRED just released an ‘investigative’ look into semiconductor shortage).

Below is an aerial shot of the LA/Long Beach port, which is the largest in the US.

These bottlenecks are taking place all over the world.

Sorry Jen Psaki, this has nothing to do with the mean meat producers being greedy or the oil conglomerates restricting supply.

The uncomfortable truth (most truths are uncomfortable), is that this post-COVID world is seeing above trend demand at the same time supply of inputs (semiconductors), finished products (Christmas stuff), and labor are all constrained, and the confluence of these forces is what’s driving Consumer Price Inflation to these concerning levels (the last reading was 6.8% annualized rate of change).

Higher demand (temporarily) and lower supply (temporarily). Again, simple.

Asset Price Inflation

This is the broad rise in prices of assets like stocks, bonds, real estate, Bitcoin, and art.

Now, enter the Fed haters.

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This article was originally puplished on The Lykeion. You can subscribe to their newsletter here to access the full article.

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