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[TOP INTERVIEW] Sustained higher inflation is unlikely

Old Mutual Wealth investment strategist Izak Odendaal on whether we’ve tamed inflation as a global economy.

SIMON BROWN: [We’re] chatting with Izak Odendaal, he’s an investment strategist at Old Mutual Wealth. Izak morning; I appreciate your time. In 2008. I remember Ben Bernanke launching quantitative easing. I remember him saying then inflation was the risk, but first, he had to save the economy. Here we are 12 years plus later, we haven’t seen inflation, not in developed markets, truthfully, not even in emerging markets. Normally, you would think, you know, massive stimulus. We’ve seen it again this year. What’s happened to inflation and have we managed to tame it as a global economy?

IZAK ODENDAAL: That’s a very, very good question. Of course the big fear around 2009/2010/2011 was that all this money printing would lead to runaway inflation. And in fact, it’s never happened. So obviously there’s something that’s changed in the global economy. I mean there are a lot of theories around secular stagnation that there’s, you know, there’s just too much savings in the world, not enough investment opportunities, that there are ageing demographics putting downward pressure on inflation. I think globalisation has also played a key role: if you just think that any single item that you want to purchase, you can purchase from many countries. And there are people who are willing to produce it cheaper. And I find that a technological change has really accelerated in the last decade: if you just think of what we can do now on our smartphones. And I think that that saves a lot of time, but that also puts downward pressure on prices. It makes price comparisons much easier. So you and I can very quickly see what’s the cheapest item, and  … that kind of competition, places downward pressure on prices from a retail point of view. So I think there’s probably a whole bunch of things that’s contributed to inflation being persistently low. And I don’t think any of those factors have really gone away. And with all the trillions of dollars of stimulus that we’ve seen in the last couple of months, I don’t think that is going to be enough to get us to the kind of sustained higher inflation that a lot of investors are worried about.

SIMON BROWN: And that sustained higher inflation is still … you put out a note and you showed a chart of US inflation and really, we kind of got the fears of those [nineteen] seventies when inflation was crazy. I remember when President Reagan came in 1981, inflation was double-digit in the US, but that really was a time-specific. And, you know, we had the oil price shocks. There were all sorts of other issues going on there, [like] exiting the gold standard at the beginning of the decade, that really has passed us and there really is an opportunity here for just the way it’s been working and the sort of independence of central banks in developed markets, of course, but also rising so in emerging markets to say that perhaps [regarding] inflation, we’re going to have some higher levels, but we’re probably not going back to those 1970s levels ever again.

IZAK ODENDAAL: No, I mean, I think that particular chart of US inflation – if you take the long term – the 1970s does stand out. Obviously they were the two World Wars as well, but I think the 1970s is the outlier. The periods of low inflation in between seem to be quite normal. And I think what made the 1970s an outlier and you mentioned the oil shocks, you mentioned the central bank independence, but I think also you had a very, very rigid economy, so there were automatic wage increases. So if CPI is 5% then wage increases are 6% and you immediately run into a wage-price spiral that was broken by very high-interest rates in the early 1980s, which basically caused massive recession and kind of reset the whole process. But also from that point onwards, you have globalisation, you have China and India ***, so the junior countries enter global labour markets, so suddenly, in developed markets, you know, the unions lost their bargaining power and couldn’t compete on wage basis. That obviously had a whole bunch of other implications, but one of those was that this wage-price spiral was broken for good.

SIMON BROWN: I hadn’t thought of that: the unions losing their power is certainly significant. A quick last question: you mentioned as well that we’ve got JSE dividend yields actually above inflation, this is the first time in a while, and that should be positive for real returns in our market over the next couple of years?

IZAK ODENDAAL: Yes, so … South African inflation is most likely in the process of converging on global low inflation. And then you have an outlook on South African inflation. Look, it’s going to be bumpy up and down, but more or less on a much lower trajectory than in the past. And then you look at some of the real yields that you can get from the equity market and specifically the bond market, and then those are starting to look quite attractive.

So I think there is a prospect here for, for decent, real returns when there has been a tough period the last five years. But I think the outlook is going to be much better.

SIMON BROWN: Yeah. It has been a massively tough period. And particularly in the yields and the bonds, there are some really good rates lurking there. Izak Odendaal, investment strategist at Old Mutual Wealth, appreciate your early morning time.

The question we’re asking you today [is], are you worried about inflation? My sense is that there [are still] a lot of people who have concerns around it, and yet we haven’t seen it. The evidence isn’t there, our local inflation has been at the bottom end of that 3% to 6% range for years and years. And just even with the stimulus, we haven’t seen it. So the question is: are you worried about inflation going forward?

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Maybe consumer inflation appears low right now. Except for the things you actually need and want (like electricity, water, food, education, and medical care). At best this is contrived number and can be manipulated at will.
What about the other types of inflation like asset price and money supply ? These are certainly not under control.
Monetary inflation has so far only led to asset price inflation, but at some stage this will probably affect consumer prices. The analogy of shaking the tomato sauce bottle comes to mind.

End of comments.

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