If we knew the degree to which the higher CPI numbers were embedded in the economy maybe we could all make a 100% accurate call. Not everyone’s sold on the idea inflation is as much of an issue as it’s been made out to be. A number of economists are already predicting a softening this year as the economy continues to expand. Translation: an easing of supply-chain interruptions. It’s transitory more than money supply related.
The higher prices have been caused by temporary breakdowns in supply chains, a temporary burst in consumer spending and the temporary tail on the dog, higher labor costs. Minus Nos. 1 and 2, No. 3 can’t and won’t sustain itself.
Let's rewind the tape a bit because it seems like this is missing something.
The economy was humming along pretty nicely when the pandemic hit. The government wildly overreacted by making it illegal for most people to work for a few weeks followed by a period where the central committee picked which businesses got to succeed and which were screwed. Somewhere around 8 million jobs were eliminated.
To prevent catastrophic impacts to gdp the government passed almost 6 trillion in various stimulus packages (for context we only bring in around 3.5 trillion a year in taxes). The vast majority of the stimulus of course didn't go to the people most impacted by the draconian government overreach, but instead to curry favor from various voting blocks.
On top of that, the Fed jumped in to pump money into the economy going beyond a target rate of zero, adding loads of longer term securities like mortgage backed securities to its balance sheet and artificially reducing the risk premium on those investments. All in the Fed added more than $4 trillion to its balance sheet, figuratively printing money to pay for the massive stimulus packages.
All of that extra money in the economy and historically low interest rates combined with government imposed restrictions on consumption drove up assets like real estate, precious metals and crypto.
Initially the supply side pressure on inflation from the productivity impacts of job losses was balanced by the lack of demand which was both government imposed, but also organic from fear of covid. As people have started to get over their fears and restrictions have loosened, demand has recovered faster than supply and inflation has followed. Not surprising given all of the stimulus and easy money.
The real question of course is what happens next. There are still around 4 million fewer people working than there were in January of 2020. There are still millions of people hiding in their closets with three masks on. As life returns to normal does growth in demand continue to outpace growth in supply?
If I were a betting man (and we've established that I'm not), I would bet that the Fed will have to continue to take action to stave off inflation. I expect rates to go up, especially for mortgages. I expect softening in real estate and pull back in precious metals. Maybe a collapse in crypto. Probably time to sell bonds and buy them back when the Fed finishes tightening. If the Fed doesn't act though, I would guess none of that happens.