Expecting Inflation

Today we’ll consider the arguments for higher inflation in the near future. As you will see, they are serious and convincing. But there are equally serious and convincing points on the deflationary side as well. We’ll get to those next week.

Container, Faucet, Port, Maasvlakte


Inflationary Heartbeat

We’ll start with Peter Boockvar. Peter is the CIO at Bleakley Advisory Group and somehow also produces the Boock Report, in which he flash-analyzes the latest economic data in handy bite-size multiple emails per day. In other words, he has as good a finger on the economy’s pulse as anyone I know. And for the last year or so, he’s felt an inflationary heartbeat.

Peter makes an important distinction between goods inflation and services inflation. They have been behaving differently. Looking at services inflation (ex energy) with the Consumer Price Index, he shows it averaged around 2.8% in the 20-year period leading up to the pandemic.

Source: Peter Boockvar

These services are the non-tangible things you can’t put in your pocket but are nonetheless valuable: rent, healthcare, college tuition, insurance, entertainment, etc. Usually we expect their price to rise every year, our only question being how much. Peter’s data says the answer has been around 2.8% a year. Sometimes a bit more or less, but rarely flat and never negative. Take away the Great Recession and the average is much higher. (Of course, your mileage may vary depending where you live.)

“Goods,” on the other hand, are the material objects and substances we buy in stores, or have shipped to us: food, energy, cars, furniture, toys, lawn mowers, and so on. These prices have more variation than we usually see in services, and often even go down. The 20-year, pre-COVID net, looking at the CPI Core Goods component, was no change at all.

Source: Peter Boockvar

If you never expected to see 0% inflation, now you have. But that’s only in goods; inflation in services pulled the full CPI higher.

How do we explain this discrepancy? We discussed two key factors last week: China and globalization. Goods inflation turned into stability, and often deflation, right about the time China joined the World Trade Organization (2001) and began exporting low-priced goods. But it wasn’t just China; globalized goods production really took off at that point.

Reversal of this strong disinflationary influence is one reason Peter expects inflation. It’s not entirely virus-driven; globalization has been slowing for other reasons. But the pandemic stepped on the brakes even harder. In early 2020 when China basically shut down, we saw how vulnerable these ocean-spanning supply chains can be to events on the other side. Meanwhile, staying home renewed our demand for various physical stuff. If you can’t go to concerts anymore, maybe you buy better home electronics—or a bigger home, which means you (or your contractor) buy more construction material, tools, etc.

Now we see shipping rates and container traffic rising sharply. This isn’t coincidence. The global economy was optimized to deliver something else, and now has to suddenly satisfy new consumer preferences. That drives prices up. Throw in the fact that many transportation companies went bankrupt over the past few years, and the supply of transportation companies all along the supply chain was reduced and thus the prices paid to the survivors have increased.

If services inflation simply continues as it has, and goods inflation rises above the 0% level where it’s been for years, we should expect higher total inflation. But there’s reason to think services inflation will accelerate even more. Buying services really means you’re buying some kind of labor. In a restaurant the food itself costs something, as does the building. But a large part of the bill, maybe most of it, is wages/tips for the cooks, bartenders, and waitstaff. In a hair salon or physician’s office you pay mostly for professional time and skill. There is a close connection between services inflation and wage inflation.

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