US Growth Has Peaked Inflation Will Persist

Long before supply chain issues and soaring consumer prices made the headlines, I warned readers that massive monetary expansion made persistent inflation inevitable. Last winter we headlined “THE GENIE IS OUT OF THE BOTTLE” in reference to rising inflation. I followed up in spring explaining how massive federal deficits had shortened the normal lag.

“A few years back I suggested that the Feds effort to boost inflation would succeed beyond their wildest dreams. In normal cycles there is a long lag of 12-36 months between the time the Fed expands money growth and consumer prices rise more than they otherwise would. The lags are relatively shorter when the monetary expansion is financing government deficits than when it is fueled by loan growth at banks. The immediate economic boost from big deficits in early 2018 fueled rising inflation late in 2019. It takes ever larger deficits to overcome the drag on growth exerted by rising prices. Last year’s shutdown slowed the price hikes, but prices still rose. This year inflation is once again accelerating faster than the growth in output as it has for the last few years.

You may have seen the headline that economic growth rose to 6.4% in the first quarter. You probably haven't heard that consumer prices rose 7.4% in the same time period. The press reported that consumer prices were up 2.6% at the end of March. That 2.6% number represented price changes over an entire year, whereas the 6.4% number was arrived at by multiplying the 1.6% quarterly gain times four. When you calculate CPI the same way prices rose 7.4%. Since then, growth is slower even as consumer prices are rising faster.

Between March and May "transitory" shortages of almost everything pushed consumer prices up at a 9% annual rate. This a mirror image of the "transitory" price reductions during the shutdown in spring 2020. The shortages will diminish as export-oriented economies reopen, companies slowly ramp up production, and price hikes slow spending. The pace of price hikes will slow, but inflation will remain elevated. The 3.1% rate of price increases since the end of 2019 provides clear evidence of the accelerating price trend net of both "transitory" distortions. That rate is about 65% percent faster than the sub 2% inflation of the prior decade. The seeds of that inflationary trend were planted in 2017 with tariffs, reduced immigration and massive structural deficits financed by the FED monetary expansion. Last year's 25% expansion of M2 is only starting to impact the numbers.

Reported CPI will jump in the next few months as annual change gets measured from the spring 2020 shutdown. This summer that statistical anomaly will pass as Chairman Powell has indicated, but prices will continue to rise. We can take a little solace in the fact that unlike ongoing revenue shortfalls from the 2017 tax cuts, this year’s Recovery Act deficits have expired. Businesses attempting to satisfy rising demand will face ever higher costs in 2022, beginning with payrolls. Last years’ letter introduced a chart displaying how consumer prices were accelerating even as economic growth slowed. Those trends continued, as shown on the next page.

At the time, I forecast that consumer prices would continue to rise at least double the 2% pace expected by the Fed and other forecasters. My relatively pessimistic forecast was instead wildly optimistic. Consumer prices rose about 7% in 2021. Everyone has raised their near-term inflation outlook, but most forecasters still regard recent price hikes as an anomaly that will soon pass. The most vocal proponent of this ‘transitory” view of inflation had been Fed Chairman Powell. Those assurances were bought hook, line and sinker by the vast majority of market participants.