Inflation is back and worse than it’s been in decades. Consumer prices rose 0.9% in October and are up 6.2% in the last twelve months. Two more months of moderate increases, and the CPI will be 6.5% in 2021, the highest inflation since 1982.
As a result, after surging in the earliest stages of the pandemic, “real” (inflation-adjusted) average hourly wages have been trending downward since peaking in April 2020 and are down 1.2% in the past year. In fact, real average hourly wages are up only 1.5% since February 2020 (pre-COVID) versus a gain of 2.3% in the twenty months before COVID arrived.
One of the Keynesian justifications for applying a very loose monetary policy was to run the economy “hot,” in order to offset damage from COVID itself and pandemic lockdowns. But this has apparently backfired as inflation accelerated rapidly. It looks like workers are the ones getting burned
The Federal Reserve, however, says inflation is going to drop next year. And we think the Fed is probably right about the direction of inflation; prices should go up next year, but not as fast as this year.
Why? Think of oil, for example, which ended last year at $48 per barrel (for West Texas Intermediate) and closed on Friday at $81. Could oil prices move up again in 2022? Sure. Will they go up almost 70% like they have so far this year? Probably not. Then there are the massive supply-chain issues, particularly with computer chips, that have disrupted the automobile market. Prices for new cars and trucks are up 9.8% from a year ago; prices for used cars and trucks are up 26.4%. Higher semiconductor production should curb price increases next year and prices might even fall modestly in this sector.
The problem is that the most recent forecast from the Federal Reserve (released September 22) suggests its favorite inflation measure will only be 2.2% next year, which translates into an increase of about 2.5% for the Consumer Price Index (CPI). Sorry…put us down supporting the “Over.”
We think the Fed is making the same mistake it made last year. At the end of last year, the Fed projected that its favorite measure of prices would be up 1.8% in 2021, which translates into roughly a 2.0% increase in the Consumer Price Index (CPI). Oops! Not even close.
The M2 measure of the money supply is up almost 40% from where it was in February 2020, substantially faster than the pre-COVID trend. Ultimately, this is the root cause of the inflation we’re seeing. Yes, the extra government spending matters, too. But it matters because the Fed is monetizing the extra debt related to that spending; otherwise, it’d just be transferring demand from one group to another.
We think CPI inflation will run around 4.0% next year and might continue to do so for multiple years until either the extra M2 growth passes through the economy or the Fed somehow drains some of the extra M2 from the monetary system.
The same thing happened in the 1970s, when the Fed believed that rising inflation was transitory, and therefore did not slow growth in the money supply. As long as the Fed thinks inflation is transitory, it will not drain money from the system. Although the Fed is “tapering,” that just means the expansion of its balance sheet will proceed at a slower pace, not that the balance sheet will actually shrink.
Look for housing rents to be a key source of inflation in the years ahead. Housing rents – both for actual tenants as well as the imputed rent of homeowners – were both artificially low last year due to limits on evictions. Now that the limits on evictions are over, the rental value of real estate will rise more quickly, and rents make up more than 30% of the CPI.
The Fed has let inflation take root in the US economy. We don’t expect to be back at the Fed’s 2.0% target anytime soon.
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When Will Supply Chain Disruptions Be Resolved?
During the darkest days of the pandemic, consumers were able to consume goods but not services. This is very different from what is typically observed during periods of economic stress
- nearly all of the reduction in consumer spending during the financial crisis came from a reduction in spending on goods, whereas during COVID, 67% of the reduction in spending came from services. Reopening the economy made it easier to consume services, but consumers continued gobbling up goods at a rapid
As inventories were drawn down it became increasingly difficult to rebuild them. Southeast Asia has seen many governments maintain a zero-COVID policy, leading factories to temporarily shut down whenever a worker tests positive. Furthermore, entire crews are forced to quarantine outside of port if somebody on a shipping vessel tests positive for COVID, and even once cargoes are unloaded it can be difficult to find workers to transport these goods to their final destination. Below are some numbers that help quantify what is happening:
- Freight and cargo costs have jumped more than 50% since the pandemic began
- The ratio of loaded containers to empty containers at the port of Los Angeles stood a 6X in September (its lowest reading in the past 20 years)
- The cost of shipping a 40ft container rose 5% in 3Q20 and 137.9% since the start of the year
- The number of specialized truckers in the United States has fallen by 22,000 since December 2019; the number of long-distance truckers has fallen 14,000 over that same time period
Semiconductors have come into focus as one of the best examples of the supply constraints faced by the global economy. In normal times, manufacturing a simple semiconductor wafer takes an average of twelve weeks. However, this can take up to twenty weeks for more advanced chips. Additionally, once the chips are manufactured, they must then go through a process known as assembly, test, and packaging (ATP) which can take another six weeks.
It is unclear how long it will take for the semiconductor shortage to resolve itself, but it looks set to remain an issue well into next year. Automakers have highlighted that chip shortages weighed on production in the second half of 2021, and companies in the industrial sector acknowledged that while things are improving, semiconductor supplies are still constrained. With semiconductor companies working to increase production and capacity, the consensus view seems to be that chip shortages will persist through the first half of 2022 before beginning to improve during the second half of the year.
Source: JP Morgan Asset Management: When Will Supply Chain Issues Be Resolved by David Lebovitz
Did You Know?
HERE AT HOME
-The US population grew by +7.4% during the decade of the 2010s (2010-2019), our nation’s lowest percentage growth rate in any decade since the 1930s (source: Census Bureau).
DOUBLE IN THIRTY YEARS
– It would take $1,999 in September 2021 to have the same purchasing power as $1,000 in September 1991 (source: CPI Inflation Calculator, Bureau of Labor Statistics).
“A generous person will prosper; whoever refreshes others will be refreshed.” –Proverbs 11:25
“It’s hard to beat a person who never gives up.” – Babe Ruth
The views stated are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.