We believe inflation is still, and always will be, a monetary phenomenon. It is defined as "too much money chasing too few goods and services" – but that doesn't mean every period of higher inflation is going to look exactly the same.
Today's case for higher inflation is easy to understand. The M2 measure of the money supply is up about 25% from a year ago, the fastest year-to-year growth in the post-World War II era. And while measures of overall economic activity such as real GDP and industrial production are still down from a year ago (pre-COVID), Americans' disposable incomes are substantially higher, boosted by massive payments from the federal government with more "stimulus" on the way.
Right now, the consumer price index is up only 1.7% from a year ago. But, this year-ago comparison is set to soar to 2.5%, or higher, as we drop off the big declines in prices we saw during February - April 2020. The extent of this increase will likely be held back by the government's measure of housing inflation (which only focuses on rental values, not home prices). Excluding rents, inflation will be more like 3.0% this year, and will likely move up by about another percentage point in 2022.
Producer prices are already up 2.8% from a year ago, with much faster growth in prices further up the production pipeline.
Does this mean we are heading back to double-digit inflation, bell-bottoms, disco balls, and the return of Jimmy Carter-style stagflation?
We think we are a long way from that. As Mark Twain once said, "History doesn't repeat, but it often rhymes." In the 1970s, if the Fed would have fought inflation harder early on, we would have never seen it hit double-digits. As a result, for now, we are thinking more of the late 1980s, not the 1970s.
Consumer prices rose only 1.1% in 1986 as oil prices collapsed, but then it revived in 1987, rising above 4.0% by late Summer. To fight this rise in inflation, the Fed raised short-term interest rates by about 140 basis points, to about 7.3% from 5.9% towards the end of 1986.