The stock market is never happy unless it has something miserable to complain and worry about. Having moved on incredibly quickly from a worldwide pandemic, the chattering investor classes have retrained their sights on that old 1970s bugaboo, “inflation.”
As you can tell from the cumbersome subtitle, inflation is the most confusing and misunderstood investment concept that we think about. Every policy maker, every economist and every investor has a view on inflation, most of it informed by the skyrocketing interest rates of the 1970s. Calculations of inflation go into every model, every forecast, and every policy decision. The idea of real vs. nominal data is based on inflation, and of course an entire asset class (Treasury Inflation Protected Securities) was created to protect investors against inflation.
The truth is, almost none of the conventional thinking on inflation is truly supported by the actual experience of the past 50 years. For example, classic Keynesian thinking could not at all explain the stagflation of the 1970s, when you had skyrocketing inflation combined with a moribund economy. Fast forward to today, when we have record low interest rates despite multi-trillion-dollar annual government budget deficits. That wasn’t supposed to happen either.
When you dig beneath the surface, very little about inflation adds up to what almost all the investment community thinks. So, we thought we would lay out the issues to see if we could get a better understanding of how to think about this chameleon of an economic concept.
What Is Inflation?
The definition of inflation as price oriented didn’t really take hold until the 1970s, when the dramatic increase in prices and interest rates brought “inflation” into the forefront of the public psyche. Also, the monetarist notion that “inflation” was caused by money supply increases gained a stronger foothold as the previously mentioned “stagflation” was simply not possible under the Keynesian thinking that had dominated in the post war period.
The big problem to consider is this: Which prices are we measuring, how do we actually measure them and how do weight them?
Put simply, everyone has their own personal inflation rate, and they vary dramatically depending on socioeconomic status and your personal consumption basket. “Inflation” is definitely not a simple one-size-fits-all concept.
What Causes Inflation?
Most people would say that when the economy gets too strong and/or the government prints too much money, inflation goes up.
Except that that’s not true either. As noted, it wasn’t true throughout the 1970s. Now think about the 1983-2007 period. This was a remarkable period of consistent economic growth. While punctuated with two small and ultimately inconsequential recessions, the U.S. economy churned forward like an unstoppable force, with globalism and technology creating unimaginable new businesses and opportunities. Interest rates fell persistently for 25 years.
The 2008 to current period is, well, a whole new unexplainable economic period when thinking about inflation and interest rates. As we know, rates have been zero most of the time in the U.S., and negative in much of the rest of the world. Federal deficits are at numbers never even dreamed of. Until 2021, “inflation” continued to be remarkably low. Even after 2021, interest rates are still at historically de minimis levels.