February 04 2022

Stop Looking at the Central Banks for Answers About Inflation

It is as tragic as sipping a cocktail in an empty tiki-bar to think that Central Banks can single-handedly tame the currently rampant inflation.

Raising rates is useful to slow down credit, if you assume that credit was the source of over-heated demand. Actually, credit expansion nearly doubled over the past 14 years in the US. As a consequence of the Great Financial Crisis, banks pumped their books from $9TN to $17BN from Oct08 to Jan22. However, inflation remained subdued tracking below 2% over the period. Inflation only picked up meaningfully after February 2021. It was not due to credit expansion, and raising rates can therefore do very little. Quite the contrary, they would inflict consumers a double-whammy, by increasing their interest bills on top of more expensive consumer goods.

How to jugulate inflation then? As eloquently expressed by one of my partners, Roland Hinterkoerner in a recent post, inflation is best fought by addressing the following points. First, logistics is still impaired by the consequences of the pandemic. So, fighting the virus intelligently and diligently remains key. Second, energy prices need to come down by increasing oil input from oil producing countries – it is a managed market after all. Third, commerce wars and their related tariffs have side effects on supply chains and goods. Lastly, restoring investments in productive assets, and infrastructure in developed countries, the US notably, should restore the imbalances that have been going on for years.

Easier said than done, you would say. But all the ingredients are here, there is just not enough political consensus at the moment. The covid policies are ill-suited, zero-covid policies are a nightmare, and those who refuse vaccination make things worse for others. Investments in infrastructure and logistics are still pending implementation, and some entrepreneurs need to pick up the slack.

The current energy crisis is a particularly tough geopolitical issue, where zero-emission hopes and sovereignty dreams confront each other every day. Here again, you find the sempiternal debate between developed countries who love taking the superior moral ground, and preach ESG and a clean planet future, and the developed world who dearly need to develop its industry further, and affirm its economic independence. This situation is explosive, with obvious tension signs at the border of Ukraine, Taiwan, or North Korea…wherever the two blocks meet.

If you step aside the naked ambitions of each block, whether you have enough or too much of inflation is chicken-or-egg question. In fact, inflation is running at 7% in the US, which is bang on the 7% growth in 4Q21. The first thing we need is to direct this growth properly, not in vain quick fixes but in long-term productive assets. On the latter, stop asking the Fed. They have no control on it.

360 Advisory – Markets