Kevin R. from Fairfield, CA asks: Hi Mitch, I’m concerned about the October inflation numbers and the pattern of higher prices. The “temporary” inflation argument looks like it’s wrong, and I’m wondering if we should be more worried about this. Thank you.
Mitch’s Response:
Thanks for writing, Kevin. I know your concern is shared among many readers, and it’s probably the most-discussed worry in the financial media – all of which makes me bullish, as I will explain later.
First, let’s frame the inflation issue. In October, the Consumer Price Index (CPI) measure of inflation reached a 30-year high, posting a 6.2% year-over-year increase and following five straight months where inflation has topped 5%.1
An equally important, but far less acknowledged, gauge of inflation is producer prices, as measured by the producer-price index (PPI). A good way to understand the PPI is in relation to the CPI. The CPI measures the change in prices from the consumer’s point of view, while the PPI measures the change in prices from the business’s point of view. In a sign inflation is currently broad-based, the U.S. PPI also soared in October, recording its biggest increase on record at 8.6%.
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Even if we say these inflation readings are high because of the base rate effects, i.e., comparing them to much lower 2020 inflation levels, the month-over-month price increases have also been pretty firm this year. Earlier in the year, we saw month-over-month inflation spikes due to base effects of rising hotel prices, airline tickets, and used cars, and later in the year (currently), the increases have been tied to labor shortages, rising energy prices, and snags in the global supply chain.
Permanent, nefarious inflation happens when there is too much money chasing too few goods, which I’m sure has many readers saying: that’s what we have now! The difference, however, is that the U.S. and global economy have the capacity to build-out supply, it is just currently trailing the demand surge in the economy. In other words, turning consumer demand ‘back on’ can happen instantaneously. Turning supply back on takes a bit more time, as businesses ramp up production and push towards being fully back online. “Too few goods” is fixable, in other words, and I think it will be fixed in a few months’ time.
On the “too much money” side, while it is true that government stimulus created a sizable increase in the M2 money stock, we have not seen a sustained increase in the velocity of M2, which ultimately measures whether the money is transacting in the economy (loans, spending, etc.). We know a good portion of stimulus money was used to pay down debt and to save, and bank lending has not moved considerably higher over the past year. As you can see in the chart below, the “too much money” side of the equation is moderating.
Finally, as I alluded to at the outset of my response, the widespread concern and worry makes me even more bullish. The reason is simple: When everyone is fixated on an issue and it becomes widely discussed, its pricing power concurrently falls. This is how “walls of worry” get built. In other words, while we grow increasingly concerned about inflation, the market has already priced in its actual impact.
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Disclosure
2 ZIM may amend or rescind the guide “Helping You Manage Market Volatility” for any reason and at ZIM’s discretion.
3 Fred Economic Data. October 26, 2021. https://fred.stlouisfed.org/series/WM2NS#0
4 ZIM may amend or rescind the guide “Helping You Manage Market Volatility” for any reason and at ZIM’s discretion.
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