Thursday, April 9, 2020

Why I Expect an Acceleration in Price Inflation After the Lockdown is Over



At the post, First Sign of Accelerating Price Inflation: Egg Prices More Than Triple in March, I see a number of comments that don't see the accelerating price inflation that I expect after the lockdown is over and object to my use of the egg price example as a teaser of what is to come.

One commenter writes:
Inflation? Hardly... The price of one product going up is not indicative of other things going up in value. Supply shocks are occurring and for some products more than others...which is indicative of price increases...yes...people buying more eggs probably, but for the underlying reason that people are locked down at home, without work buying only essentials.
LIKE FOOD...of which eggs are a part of. This article is what I like to call a clear example of selective bias. You might as well have pointed to the skyrocketing price for rice for evidence of your inflation that is...IF you can find it
Dominick adds:
Must agree with Anonymous. There has been a run on eggs (just like toilet paper) and some severe supply problems during this shutdown fiasco. That's not a sign of "inflation." (Is the fantastic drop in oil prices a sign of "deflation"? Hardly.) Now whether we will get a general inflation when this nonsense ends depends upon whether supplies can be restored quickly in most markets (doubtful) and/or whether the "money out of thin air" that the Fed generates more than replaces the massive money destruction that has taken place over the last 3 months.
And then  this:
 Exactly, Dominick. Wenzel sees inflation as a certainty...that's where the mistake lies.
Well, guys not exactly.

What I see is a major paradigm shift occurring and that the egg price spike is an example of how that is going to occur because of super immediate demand increases  (Though I do not expect anything close to the 300% price increases that have occurred in egg prices in recent weeks. I am thinking more in the 5% plus range over months).

I am not attempting to prove that price inflation will occur after the lockdown by the egg example but something deeper, that what is going on with egg prices can show us how we should think about prices after the lockdown is over.

What we are experiencing in the lockdown is what the economist G.L.S Shackle, in a slightly different context, called a kaleidoscopic event. "The basic and essential character of the kaleidoscopic phenomenon renders inappropriate the accepted methods of analysis of fully known problems," he wrote.

In this sense, the common business cycle can be considered a known problem---we have a rough idea of how people will act during different phases of the cycle.

Often after the crash phase of the business cycle, people are hesitant to spend cash because they are not sure of what the future will bring. This is not the type of attitude we are facing now.

Rather it is the opposite, people are willing to spend much more on goods they want, including, toilet paper, paper towels, eggs and groceries in general.

This is occurring because people have shifted their purchase patterns and gone from "just-in-time" buying to "I need to stock up" buying even if it costs more.

This is not going to stop after the lockdown ends. But even more than this, pent up demand after months of a lockdown is going to explode. Goods deteriorate, there is no doubt people are out there with broken eyeglasses, holes in their socks, holes in their shoes and a zillion other deteriorations that I can't think of. What was generally replaced on a smooth just-in-time basis on both the side of the consumer and the retailer on a daily basis is going to result in a major demand crush of pent up demand over a very short period. Barbers, hairdressers, dry cleaners and car washes are also going to be booming.

And for the physical products, the manufacturing side will boom. How many people will need summer clothes the day the lockdown is lifted that they would have spread out buying over past many weeks? I expect gas prices within a couple of months to more than double from current levels.

Now, this doesn't mean, as I have pointed out before, that prices will climb for things we don't want.

I don't expect a climb in cruise ship prices. In fact, I expect major discounts to be offered in the cruise industry. And it remains to be seen what happens to airline, hotel and movie theatre demand.  But for things we want, the demand is going to be explosive---and this will occur at a time that the Federal Reserve Board is printing enormous amounts of money.

And this price inflation will occur even if there is high unemployment. To deny accelerating price inflation can occur when unemployment is high, you have to buy into the discredited Phillips curve and also deny that stagflation can occur.

It is not about how many unemployed there are, it is about how much money is out there and how aggressively those holding it will want to spend it.

Further, the unemployment situation will be extremely different this time compared to previous business cycle downturns. As a result of the structure of the unemployment bailout package, many will be receiving more on unemployment than they would have if working.

 Casey B. Mulligan and Brian Blase explain in The Wall Street Journal:
One measure that will soon be famous: the $1,000 weekly payments to the average person receiving unemployment insurance benefits. Congress provided a $600 increase for a four-month period to the nearly $400 average weekly amount that the unemployed receive.
A thousand dollars a week is more than what the majority of full-time workers were getting paid before the virus arrived. The $600 bonus is 24 times the $25 bonus Congress paid during the last recession, when government policies that discouraged work severely harmed the economic recovery.
One measure that will soon be famous: the $1,000 weekly payments to the average person receiving unemployment insurance benefits. Congress provided a $600 increase for a four-month period to the nearly $400 average weekly amount that the unemployed receive.
A thousand dollars a week is more than what the majority of full-time workers were getting paid before the virus arrived. The $600 bonus is 24 times the $25 bonus Congress paid during the last recession, when government policies that discouraged work severely harmed the economic recovery.
There is certainly good reason to think that money is going to be burning a hole in a lot of people's pockets.  To say nothing about the Fed money printing that will have to go on to back up those checks.

No this isn't because I blindly "sees inflation as a certainty." It is because I am doing now what I have always done when thinking about the economy. And that is to think out all the aspects of how things are likely to develop and blocking out the noise of other opinions. And it is my well thought out forecast that price inflation will accelerate, for the reasons listed above, but it is not a certainty.

The eggs example just shows how the "just-in-time" economy price structure breaks down when demand explodes---and, very important, this is demand exploding when there are piles of new money in the system.

-RW


2 comments:

  1. Will there be "super immediate" increases in demand for gasoline and crude oil and will it drive up prices in some sort of paradigm shift? No. Will there be some super immediate increase in demand for new homes and condos and will it drive up prices as a reflection of some paradigm shift? No. What service market prices will explode when the new money goes into peoples wallets? What business investments will ramp up and what input prices are likely to rise double digit? The travel industry (and those products and services that depend on it) is dead (in terms of price inflation) for many years and may never be fully restored. Bob, you can't just argue that the trillion dollar Fed machine will necessarily create a general inflation with the new money "burning a hole in people's pockets" without first demonstrating that this new money IS A NET ADDITION (AND A NET SUBSTANTIAL ADDITION) to current household and business income and wealth. The point is that there is already a "hole in people's pockets" and real money and purchasing power has already leaked out. Incomes and checking account balances have been devastated and the reverse wealth effect makes almost everyone feel poorer. Prices for goods that are hoarded or that are in short supply will increase but the case for any general price inflation is still problematic.

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  2. I'm a EPJ daily subscriber, thank you for the money you have made me in the past few years.

    Can you address the "dollar destruction" and dollar bull wing of the Austrian school. They see the dollar going up in value because of foreign demand for dollars in a credit squeeze. Also, many Austrians have been looking for inflation since the last stimulus, but a lot of the new money was numbers on balance sheets that never circulated. Why is this time different other than demand restoration and pent up demand? What cash flow mechanisms turn these balance sheet transactions into price inflation? How does it go from monetary inflation to price inflation this time?

    I really do appreciate your insights and you have converted me from a perma bear like most Austrians to understanding the cycle better. Can't thank you enough. Just wish I had this knowledge ten years ago.

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