Winter is Coming?… Part II: The case for low inflation
With US inflation running at +6.2% in October, the highest since 1991, the question of the moment for markets is: Will inflation be a persistent problem, or will the current bout of inflation ease?
Last week, we outlined the leading arguments in favour of structurally higher inflation. This week, we make the opposing case for a return to low inflation.
The most convincing arguments for a return to lower inflation are:
- It’s mostly supply chain: The current spike in inflation has, to a large extent, been caused by short-term supply chain issues. These have taken longer to fix than had been expected but will be resolved. Already we are seeing logistics prices come down from recent highs and new supply commitments in areas where shortages are most severe, like semiconductors. Once these one-time issues pass, inflation will come down.
- Technology: New technologies which reduce the cost of goods and services can be powerful at reducing inflation. These hidden cost reductions (think of how much an international call used to cost, now you can Zoom for free) will continue to put a lid on inflation for the foreseeable future as existing technologies are improved and new deflationary technologies are introduced like artificial intelligence, driverless cars, and genetic medicine.
- Globalisation: The shifting of jobs to where labour costs are lowest is far from over. Despite rising geopolitical tensions with China, the world continues to trade with the country. And beyond China lies India, South-East Asia, and Africa, where labour costs remain low and political relations with the developed world are healthy.
- Demographics: As the boomer generation retires in the developed world (and China), working age populations will begin to decline, much as has been seen in Japan, acting as a deflationary force in the economy and limiting inflation.
On point i (inflation is mostly supply chain), we agree, there’s no reason to think the current supply chain issues should persist much beyond next year.
The 1990s through to the 2020 pandemic saw one of the longest periods of low inflation since the industrial revolution. This was undoubtedly a function of new digital technologies and globalisation overlapping to generate productivity and output increases, while also working to reduce price levels across many goods and services.
With respect to points ii, iii and iv (technology, globalisation, and demographics) we agree that these are powerful deflationary forces, they have not gone away, and are likely to reassert themselves in coming years.
Going into 2022, rather than inflation, it could in fact be deflation that investors need to be thinking about.
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