A Final Wave of Inflation

The past two years have seen a marked increase in inflation, leading many to question the stability of the economy and the efficacy of current monetary policies. However, recent indicators suggest that the elevated inflation rates may finally be subsiding. However, this should not be taken as a guarantee that the trend will continue.

The recent slowdown in consumer price growth is undoubtedly a cause for optimism, but it is essential to remember that inflation is a complex and unpredictable economic phenomenon. While inflation has come down in the past seven months, it is not necessarily a guarantee that the trend will continue. Several factors can impact inflation, including changes in demand and supply, shifts in the labor market, and government policies.

A second wave of inflation can significantly affect consumers and the economy. The historical record of inflation in the U.S. serves as a cautionary tale, highlighting the importance of monitoring economic indicators and being prepared for any shifts in the inflation rate.

The traditional view held by the Federal Reserve is that there is no conflict between its dual mandate of price stability and full employment. The Fed believes that a long expansion is necessary to achieve full employment, and that rampant inflation will force it to take action that could cut short such an expansion. Hence, price stability is seen as a prerequisite for full employment. This perspective is informed by the history ofPaul Volcker's tenure as Fed chair in the 1980s, where he was forced to raise rates to kill inflation but put the US economy into a deep recession. Central bankers since then have recognized the need to avoid such a harsh use of monetary policy.

The current bout of high inflation, have brought these two elements of economic history back to the forefront. The proper lesson to draw is to avoid wage and price controls and to strive to bring resurgent inflation under control using well-calibrated interest rate increases to avoid reversing the growth that the global economy has enjoyed.

In historical terms, the US economy has seen three waves of inflation: after World War I and World War II and in the 1970s and 1980s. Times of recession or depression are typically accompanied by lower inflation rates, while rapid economic growth often brings higher inflation.

In the 1970s through the early 1980s, the U.S. experienced highly elevated inflation in three waves. During this time, inflation appeared to recede on two occasions, only to bounce back even worse before finally subsiding. This experience highlights the unpredictability of inflation and the need for constant vigilance.

The 1970s was a time of high inflation in the U.S. and many other countries worldwide. The inflationary episode of the 1970s was caused by a complex interplay of factors, including:

1. The end of the post-World War II economic boom: The solid economic growth of the post-World War II period started to slow down in the late 1960s and early 1970s, leading to inflation.
2. The oil crisis: The oil crisis of the 1970s, which was caused by a combination of the embargo by the Organization of the Petroleum Exporting Countries (OPEC) and supply disruptions, led to higher energy costs and inflation.
3. Expansionary monetary policy: The Federal Reserve pursued an expansionary monetary policy in the 1970s, which increased the money supply and contributed to inflation.
4. Increased government spending: Increased government spending, including spending on the Vietnam War and social programs, contributed to inflation by increasing the money supply and creating demand for goods and services.
5. Increase in wages: Increased wages, especially for workers in the manufacturing and construction sectors, contributed to inflation by increasing the cost of goods and services.

These factors combined to create a period of high inflation in the 1970s, which came in three waves and appeared to recede on two occasions, only to bounce back stronger before finally subsiding. The inflationary episode of the 1970s serves as a reminder of the complex and unpredictable nature of inflation and the importance of monitoring economic indicators and being prepared for any shifts in the inflation rate.

When looking at the current environment, these factors are reoccurring. For example, the Russian and Ukrainian wars led to an energy and oil crisis. What we have fighting this is the Federal Reserve pursuing a tightening policy. But there is another central bank that could provide the spending worldwide demand.

Everyone is talking about inflation talking, while in reality, they should look for reasons why inflation has bottomed and will return in Q2. Well, I found a reason, China.

China's reopening after a three-year-long coronavirus lockdown is expected to impact the global economy significantly. The revival of the world's second-largest economy, the biggest consumer of commodities, threatens to increase prices for fuel, industrial metals, and food globally. The surge in demand from China has already started to reflect in the prices of copper, aluminum, zinc, and tin, which have recorded their best start to the year in 11 years, with tin experiencing its most significant rise in 32 years. China's reopening has also led to a 14% rise in stocks in MSCI's China index and a 19% rise in Nasdaq's Golden Dragon China Index, tracking Chinese companies listed in the US.

However, despite the surge in commodity prices, metals like copper and aluminum are not a significant part of the overall inflation basket. The real threat of inflation lies in the rising global food and energy prices. China's reopening could increase demand for agricultural goods while the world faces the worst food crisis in modern history, with wheat prices still 58% higher than in mid-2020. China's imports of soybeans, which it uses primarily to feed livestock, rose by 18% in December, indicating an anticipated rebound in demand.

China's reopening is also expected to drive up oil demand, with the International Energy Agency forecasting a global demand surge to an all-time high of 101.7 million barrels per day this year, with China accounting for almost half of that increase. The rise in oil prices could knock on global inflation, just as consumer price rises show signs of moderating.

It is impossible to say whether a second wave of inflation could occur as it did in the 1970s, as inflation is influenced by many factors that change over time. The 1970s was a unique period in economic history. A complex interplay of factors, including the end of the post-World War II economic boom, the oil crisis, expansionary monetary policy, increased government spending, and increased wages, caused the inflationary episode of that decade.

While some of these factors can play a role in any future inflationary episodes, the specifics of the current economic situation are different, and a different set of factors will influence the behavior of inflation. It is impossible to predict how inflation will behave in the future, whether a second wave of inflation will occur, and if so, how it will compare to the 1970s experience.

Join the Flagship community and secure your financial future with the guidance of our Captain Crunch.