Inflation is not dead, it is just dormant

LONDON, Oct 18 (Reuters Breakingviews) – Over the past three years, inflation has gone from “transitory” to “persistent” to, well, boring. In industrialized countries, annual price increases are trending back towards the moderate level of 2% that many central banks are aiming for. Commentators talk about the Goldilocks scenario, in which the economy, like the porridge in a fairy tale, is neither too hot nor too cold.

However, don’t break out the champagne just yet. There is a long history of monetary policymakers prematurely celebrating the end of inflation, only to be surprised by its sudden resurgence. Perhaps the best example comes from the early 1970s.

There are several factors that explain the dramatic rise in inflation. In 1971, the dollar lost its currency anchor after President Richard Nixon closed the so-called gold window, ending the convertibility of the US dollar into the precious metal. At the same time, during his successful re-election campaign in 1972, Nixon put pressure on Fed Chairman Arthur Burns to stimulate the US economy. Both Nixon and Burns prioritized low unemployment over price stability. The following year, OPEC imposed an embargo on oil-importing countries that had supported Israel during the Yom Kippur War. The price of the black stuff tripled.

In their 1983 book “Is Inflation Over: Are You Ready?” A. Gary Shilling and Kiril Sokoloff pointed to several other factors that were driving up prices. These included support programs for agricultural and dairy products as well as tariffs on sugar and Japanese steel. A variety of regulations increased the cost of doing business. In 1971, Nixon introduced price and income controls, which, as expected, failed to stem the tide of inflation. Cost-of-living adjustments to Social Security benefits and the minimum wage protected much of the American population from the devastating effects of inflation. Workers went on strike to maintain their wage differentials. Productivity growth was halved. The weak dollar drove up import prices. Most of these inflationary forces were self-reinforcing.

Sokoloff, the founder and CEO of investment advisor 13D Research & Strategy, successfully turned around inflation forty years ago. He’s not so confident today. In his view, we are seeing a cyclical downturn. Enormous secular drivers for higher prices remain. Deglobalization, rearmament, de-dollarization, population aging, climate change and energy transition will continue to put upward pressure on inflation in the coming years. As in the early 1970s, there is no political desire for high real interest rates to keep prices under control or for austerity to bring government finances under control.

Gold, says Sokoloff, has long been a reliable barometer of both inflation and deflation. Since the beginning of the year, the price of the yellow metal has risen by almost 30%. It shows us, says the veteran analyst, that four decades of disinflation are over and bonds are now in a long-term, secular bear market. Inflation is not dead, it is just dormant.

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