Inflation - What's Different this Time. Part 2

In Part 1 we discussed the collapse of the global supply chain accompanied by normal demand as a primary cause of this era's high inflation. The normal demand was continued due primarily to fiscal and monetary stimulus by most countries. Supply driven inflation is difficult to control since monetary and fiscal policy affect demand, not supply. But keeping demand up by basically giving people money to spend when they couldn't work, did drive inflation. But it wasn't just a local country problem. This time it was global.

The Global Inflation Era

The world has experienced many periods of high inflation, but they're usually in the developing world and do come from too much debt. In the 20th century there's the famous example of the Weimar Republic of Germany in the 1920s. In order to pay massive reparations to the Allied countries as compensation for losing World War I, the German government began printing money causing hyper-inflation.

The developed world experienced high inflation as a group in the late 1970s. It started with the OPEC oil embargo of 1974 sent the price of oil soaring. The world was very dependent on oil at the time so the inflation spike in energy costs spilled over into other products. There was monetary stimulus at the time to combat the recessions caused by the energy spike which led to more inflation and the rise of the Monetarist definition of inflation.

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The Weimar episode was local. The OPEC embargo was global. The 2022 Pandemic era inflation was also global. That should give pause to the idea that excessive government spending sparked the inflation. While most countries did execute some form of monetary and/or fiscal stimulus as governments shut down economies to combat the virus, there appeared to be little relationship between the magnitude of inflation and the size of the stimulus. Like the 1970s, inflation was caused by supply shortages, not government spending.

Below is a chart of developed market inflation from 2009 - 2023. The level of correlation is pretty obvious. The US experience is almost identical to the other countries.

It's instructive that Japan, which has the highest level of government spending relative to GDP, also has the lowest inflation. And also after years of fiscal and monetary stimulus, it took the collapse of the global supply chain to finally give them inflation.

Since 2022, inflation has fallen back. In 2024 it has fallen further though at a much slower rate. The disinflation of 2023 was generally caused by the repair of the global supply chain in the wake of the end of the Pandemic. But, like the 1970s inflation, the rise in prices has become embedded in other parts of the economy, particularly in services where inflation does not fall as rapidly. So the move back to that artificial target of 2% is following a more non-linear, slower path than expected.

How a generation of inexperienced economists and money managers have misinterpreted the cause and effect of inflation will be the subject of the next installment.

The Outlook

The markets continue to power ahead, hitting new highs. They've also ignored the Fed's dot chart which dropped potential cuts to the number one. But all the fundamental sentiment indicators continue to be positive, so I remain cautiously optimistic. The threat of an exogenous shock continues to lurk in the background, but it's being treated like static and ignored by the markets.

Please comment on this post if you're so inclined. And feel free to forward this post to anyone you think would find it interesting. Thanks for reading!

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