SIMON BROWN: I’m chatting with Mohammed Nalla of Moe-Knows.com. Mohammed, I really appreciate your time today. I’m going to talk about inflation – and not what’s driving it right now. I want to kind of take that step back to the big picture. And in fact, you go back to the seventies, when there was double-digit inflation, particularly in the US; structural inflation they called it. Correct me if I’m wrong about structured inflation. Say inflation is 15% and I go to my boss, and I want a 15% salary increase. He or she gives it to me. They of course then just increase the price of the service or the widget by 15% and inflation kind of becomes baked into the system.
MOHAMMED NALLA: Yes. Thanks, Simon. Thanks for having me on the show. It’s not often someone asks you to go and look at inflation over the much longer term. I quite like that, because we need to view current circumstances in the context of history. You know, they say history doesn’t repeat itself, but it rhymes, and a lot of people seem to have forgotten that.
Let’s go even further back. If you go back into the sixties – and we talk US inflation specifically here – you had inflation nicely within kind of the single digits, 1% or 1.5%. And then slowly it started to unravel. Then we had 1971 happen, and the gold standard disintegrated at that stage and we had inflation rocketing up. In the US in 1970, I believe it was ’74, you had inflation rise into the double-digits for the first time in a very long time – and we are talking post World War II. It tamed and then ratcheted up even further to levels of around the mid-teens in the 1980s. Now there was a gentleman called Volcker, who was Fed chair at the time, who fought inflation very hard in a period of much, much higher interest rates in the US; he really tried to battle inflation.
Going back to your original question, how does structural inflation become baked into the system? It’s exactly as you’ve indicated; it’s essentially the wage-price spiral as it’s called in economic terms. That’s because as inflation ratchets up, labour demands much higher wages and they may get wage settlements in excess of inflation sometimes, and they think they’re better off. But that is a transient and short-term benefit that labour tends to gain because, again, the capital then looks at this and says, we’ve got to bake this into the price of goods and it gets worked into the price of goods. Over the longer term, empirical studies have actually proved that inflation tends to hurt the poorest of the poor a lot harder. That’s why I’m certainly a supporter of an inflation-targeting type of framework that really has been, I guess, the global standard over the course of the last several decades.
SIMON BROWN: Certainly that inflation-targeting [is] everywhere. The US has 2%. Ours is in a 3% to 6% range.
And then we chatted about modern monetary theory (MMT) a few weeks back, and how they would look to use tax to bring inflation down. The current mechanism is those central banks use interest rates, and that’s what Paul Volcker did in the eighties. He raised rates to extremes. Frankly, it worked, it brought inflation back under control. Are interest rates the best of the blunt instruments?
MOHAMMED NALLA: The jury is still out on the whole MMT discussion, and that’s one that we had not too long ago. At the end of the day, I think the reason why a discussion like that comes to the fore is because in more recent times we haven’t seen central banks operate with their usual [monetary policy] reaction function. We’ve had massive stimulus come through from global central banks post the global financial crisis. We’ve had record low-interest rates, where you even got negative interest rates in some jurisdictions globally. That’s something that I guess the economic fraternity is still struggling with.
Now, remember that the other angle of this is that post the global financial crisis, not only did you have this massive monetary stimulus that came into the system, and the reason it didn’t manifest in terms of much higher inflation is that there’s this transmission mechanism that looks at something called the velocity of money. Now, to simplify that, it’s just when you get the stimulus coming into your pocket, do you save that money and it doesn’t go onto your balance sheet, or do you actually go out there and spend the money and does that money move around the economy? That’s the velocity concept.
In order to get inflation running, you’ve got to have both money supply ratcheting up as well as the velocity of money either staying constant or increasing. And what’s happened more recently is that you had money supply increasing, but the velocity of money has actually declined in order to offset that. And that’s why inflation hasn’t been a problem thus far.
But more recently, certainly in an era of ‘stimi’ as they call it in the US, those cheques that come out from the US Treasury are actually going into consumers’ pockets and more recent retail sales data suggest that they are actually spending that money. And so if the velocity of money starts to tick up, there is a risk that we will see some near-term inflation start to manifest.
SIMON BROWN: Those stimulus cheques, as you say, are being spent. I mean, Americans are having money going directly into their hands. If we go back to the 2008/09 crisis, the bailouts then – quantitative easing one, two and three – that was different because the money went to the banks and it didn’t find its into the main street so much. It stayed in Wall Street. Hence we didn’t see inflation on the ground. We saw some inflation in assets, such as equities.
MOHAMMED NALLA: I think that’s the missing piece of the puzzle that a lot of people don’t focus on. When you look at your conventional inflation measures, like CPI or PCE in the US – we can get into the detail a little bit later on – but when you look at those measures, they could necessarily capture the inflation that you’re seeing in asset prices. And when I wrote that piece a little while ago on Moe-Knows.com, just looking at asset prices from the 1970s to where we are right now, equity prices, house prices have all risen, but they’ve risen to the extent that the value of the money has declined.
I’m not going to go into that detail right now, but that asset-price inflation right now is quite rampant. If you look at housing markets in the US, here and Canada as well, they are at record highs in Canada, for example and in Australia. Those are two markets that never corrected in the global financial crisis, and they are being fuelled by record-low interest rates.
So the trillion-dollar question really is: can these economies even sustain higher interest rates, or would it just really result in such massive pressure on consumers’ cashflows and balance sheets that policymakers are now stuck in a jam.
And that’s maybe why proponents of MMT are saying we need to consider additional tools like taxation rather than interest rates in order to try and square the circle.
SIMON BROWN: I hadn’t thought of that. In those markets rising rates really would be a problem. What about the idea of technology? As you say, even in South Africa we haven’t had double-digit inflation since the nineties, or in the US since sort of the first half of the eighties under Ronald Reagan. An argument out there says the global supply chains, that just-in-time, the technology on the factory floor, has helped sort of compress pricing and therefore takes inflation out of the system, perhaps permanently as we keep on advancing technology. Is that an argument that makes sense?
MOHAMMED NALLA: I think so. I think it’s actually a very valid argument. There are some concerns for me. So let’s firstly go back to it in terms of, yes, since the early eighties, the mid-eighties in the US, you had inflation come back within double-digits and then just printing it a trend lower. And so now it’s in this nicely managed band. But a lot of that has been a result of the globalisation of the offshoring of global supply chains.
The simple fact of the matter is that the world has taken advantage of cheap Asian, predominantly Chinese, labour in order to produce the widgets, the iPhones that we require every single day. And that has kept prices nicely contained in a world where the geopolitical stance of your major powers, China and the US, remains in flux, and that is at risk.
There is a risk that in the event that relationships between China and the US start to deteriorate, as we’re kind of seeing right now, onshoring of manufacturing may actually result in an increase in prices and a tick-up in terms of inflation. So it’s definitely one of those mega-trends one would need to watch. But it’s probably too early to call right now an outright inflation risk in the near term. I would say medium to longer-term that risk is definitely there.
SIMON BROWN: The last question. You mentioned the PCE price index. When we talk about inflation in the media, we look at a sort of core headline inflation, but the PCE press index is certainly what the Fed cares about.
MOHAMMED NALLA: It’s important to make a distinction between them because a lot of people refer to CPI, the consumer price index – that’s the terminology in South Africa, and even in the US. There are actually two indices in the US that are of importance. One is CPI, and that’s because a lot of your benefits, social security, are tied to the CPI index. But then there are the Personal Consumption Expenditures – that’s what PCE stands for – Index. That’s the one that’s watched by the Fed in terms of setting policy.
Now they are very similar but, when you look at it over a long period of time, like we are looking at it, there is sometimes as much as a divergence of half a percentage point per annum that kind of compounds over the longer term. So that is material. And part of the reason behind it is that CPI looks at what consumers spend their money on, whereas PCE tends to look at what businesses essentially do with the prices of goods that they’re selling. So that’s the slight nuance between the two. PCE tends to run a little cooler than CPI. It’s why, when I see recent prints of US CPI ticking up a lot more, you’ve got to look at the PCE side of the picture.
And then one last point I really want to emphasise is that inflation fears right now are because we’re seeing near-term data tick up. But remember that inflation is a rate of change. And so for your rate of change to be sustained, it means that prices are going to have to continue escalating at the rates that we’re seeing right now in order for inflation to remain sustained. That’s the reason why I’m not in the camp – certainly not yet – of believing that this inflation bump-up is going to be something that is sustained over a longer time. I certainly believe that it could prove transient, mainly because of the type of year that we’ve had over the course of the last 12 to 18 months.
SIMON BROWN: Yes, the April number. We look back to last April when oil went negative, and we’re going to get a giant April inflation number. We’ll leave it there. Mohammed Nalla is from Moe-Knows.com. Mohammed, I always appreciate the time.
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