In this episode of On the Margin, Brent Johnson of Santiago Capital discusses his views on whether or not CPI inflation is transitory or here to stay. We cover Brent’s view on the most recent CPI and PCE prints, why consumer prices are ticking up, and whether or not he thinks we are headed for inflation or deflation. We also did a review of Brent’s famous “dollar milkshake theory,” the impact of fiscal and monetary stimulus on the dollar, and why he believes a strong dollar is dangerous for global markets.
00:00 ・ Introductions
02:28 ・ Are we heading into deflation or inflation?
08:30 ・ How does QE play into the mix?
16:07 ・ How does supply/demand play into the mix?
25:20 ・ How do you predict inflation?
30:14 ・ Why is the strong dollar a problem for the world?
45:28 ・ What does a strong dollar do for stocks / US equities?
53:31 ・ The dollar’s international significance
58:52 ・ How to plan for a debt crisis
Will There be Hyperinflation or Deflation?
KIRIL SOKOLOFF: Well, coming back to David Hume’s famous paper, and you’ve referred to me a number of times. His conclusion was that governments should essentially run surpluses because there’s always a crisis or problematic. If you look at corporations coming into this with the worst balance sheets in history, with profits having been flat since 2012, 40% of Americans barely able to get $500 in an emergency, it seems to me that as we come out of this, one of the implications is going to be we need to be better prepared for the future. Do you think that that’s the way we’re going to go, that we will be, look, we got a real wakeup call here, we need to have money for a rainy day?
LACY HUNT: I think that’s the case for the private sector, but I don’t feel that that’s the case for the government sector. Remember, net national saving has the private sector and the private sector saving was fine. 8.50%, not bad. The problem was that we had a 6.50% government dissaving and so we only ended up with two. The real problem is that you have to have a net saving from the private, the government, the net foreign sector, and if the government, even though maybe well-intended, maybe the actions are very popular.
All of these measures that were taken to deal with the pandemic, they were very popular. The measures– and they were essential. They were humane, they had to be done. It would have been far better if we’ve been following Hume’s advice, which is you run surpluses so when you have an emergency, you have– and by the way, Adam Smith in the Wealth of Nations followed Hume, made the same recommendation. Of course, no one remembers that anymore. No one reads Hume and Smith.
KIRIL SOKOLOFF: To get to a positive net national savings, presumably that’s– I’m not saying it’s a governmental objective, but it should be a national objective in some form based on your point that in order to have money to invest, you’ve got to be able to save out of income. If government is going to keep on running deficits, at pick the number, 15 plus percent GDP, in order to have a positive net savings rate, that implies very significant private savings rate.
LACY HUNT: Unachievable, and let’s say that we bring back a lot of our operations, in other words. If that happens, then the current account deficit will start to shrink, but the current account deficit is always the opposite of the capital account. When you have a current account deficit, you have a capital account surplus, but the capital account surplus is net foreign saving. This is one of the problems. If you repatriate businesses, and you shrink the current account deficit, then you’re going to shrink net foreign saving. It’s quite possible that we will have two of saving movements. One for the increased level of government dissaving and also less positive foreign saving. We import a lot of saving from the rest of the world.
KIRIL SOKOLOFF: Given the output cap, not having the savings to invest, is that better than it might otherwise have been? Because we got five, six, seven years to fill that output gap, or is the transformative event that is the easiest way out, if that’s the right word. Is that dependent on having the capital and savings to invest? Does that mean that in order to have that transformative, new economy, we’re going to have to have a net national savings? Am I taking that–
LACY HUNT: The thing about those transformative events is that they often create a surge in income, and thus in saving that they finance themselves, but that’s why I use the term transformative. It cannot be evolutionary. Let’s think about the situation that we were in the late 1920s, early 1930s. We take on a great deal of debt in the ’20s and ’30s. We struggle throughout the 1930s. When Germany invades Poland, we still have an unemployment rate of 17% or 18%. We’ve come off the peak levels, but we still have a very high unemployment rate and we have a substantial number of people underemployed.
In other words, we really made very little progress to turning the economy. We stabilized things, and we ended the worst aspects of the Great Depression. Then World War II comes along. A lot of folks including the great JM Keynes believe that it was the deficit spending of World War II that shored the problems of the Great Depression. That’s not my reading. It is true that on a national income accounts basis, we ran deficits of 14%, 15% which is what we’re now running again by my calculation, national product account basis.
However, we had two other events that occurred simultaneously. Number one,
- we had a surge in our exports, and
- we had mandatory rationing.
If you wanted to buy 10 pounds of sugar, you couldn’t. You could buy one maybe, you had a ration, and so people were paid to produce exports and to produce military goods. The private saving rate went up to 25% of net national income. We were able to cover the federal budget dissaving and we paid off the debts of the 1920s and 1930s. When World War II ended, Keynes suggested if we didn’t continue running the budget deficits of World War II, we would go back into the Great Depression, but that didn’t happen.
The budget was basically balanced all the way through and to the early 1960s. We ran small deficits, but we ran small surpluses on balance. It was close to balance. We opened up our export market, we opened up markets to the US, we financed the reconstruction in Europe and Japan, we had a tremendous resurgence. If you look at McKinsey’s 24 cases of overindebted economies and how they got out of it by austerity, one of their cases is the US during World War II. They labeled it a fortuitous circumstance. We didn’t go into World War II to get rid of the debt problem of the 1920s and ’30s.
It was something that happened as a result of the policy mixes but the folks in America were okay with the austerity because it was a great national endeavor. I don’t think that they would be willing to do that today. Everyone is relying on more government activity to solve the problem, not realizing that that’s the source of our deteriorating rate of economic performance.
KIRIL SOKOLOFF: Well, on that note, it’s been a really instructive ending [?].
That 1970s Feeling
Policymakers and too many economic commentators fail to grasp how the next global recession may be unlike the last two. In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp drops in production, generalized shortages, and rapidly rising prices.
CAMBRIDGE – It is too soon to predict the long-run arc of the coronavirus outbreak. But it is not too soon to recognize that the next global recession could be around the corner – and that it may look a lot different from those that began in 2001 and 2008.
For starters, the next recession is likely to emanate from China, and indeed may already be underway. China is a highly leveraged economy, it cannot afford a sustained pause today anymore than fast-growing 1980s Japan could. People, businesses, and municipalities need funds to pay back their out-size debts. Sharply adverse demographics, narrowing scope for technological catch-up, and a huge glut of housing from recurrent stimulus programs – not to mention an increasingly centralized decision-making process – already presage significantly slower growth for China in the next decade.
Moreover, unlike the two previous global recessions this century, the new coronavirus, COVID-19, implies a supply shock as well as a demand shock. Indeed, one has to go back to the oil-supply shocks of the mid-1970s to find one as large. Yes, fear of contagion will hit demand for airlines and global tourism, and precautionary savings will rise. But when tens of millions of people can’t go to work (either because of a lockdown or out of fear), global value chains break down, borders are blocked, and world trade shrinks because countries distrust of one another’s health statistics, the supply side suffers at least as much.
Affected countries will, and should, engage in massive deficit spending to shore up their health systems and prop up their economies. The point of saving for a rainy day is to spend when it rains, and preparing for pandemics, wars, climate crises, and other out-of-the-box events is precisely why open-ended deficit spending during booms is dangerous.
But policymakers and altogether too many economic commentators fail to grasp how the supply component may make the next global recession unlike the last two. In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp declines in production and widespread bottlenecks. In that case, generalized shortages – something that some countries have not seen since the gas lines of 1970s – could ultimately push inflation up, not down.
Admittedly, the initial conditions for containing generalized inflation today are extraordinarily favorable. But, given that four decades of globalization has almost certainly been the main factor underlying low inflation, a sustained retreat behind national borders, owing to a COVID-19 pandemic (or even lasting fear of pandemic), on top of rising trade frictions, is a recipe for the return of upward price pressures. In this scenario, rising inflation could prop up interest rates and challenge both monetary and fiscal policymakers.
It is also noteworthy that the COVID-19 crisis is hitting the world economy when growth is already soft and many countries are wildly overleveraged. Global growth in 2019 was only 2.9%, not so far from the 2.5% level that has historically constituted a global recession. Italy’s economy was barely starting to recover before the virus hit. Japan’s was already tipping into recession after an ill-timed hike in the value-added tax, and Germany’s has been teetering amidst political disarray. The United States is in the best shape, but what once seemed like a 15% chance of a recession starting before the presidential and congressional elections in November now seems much higher.
It might seem strange that the new coronavirus could cause so much economic damage even to countries that seemingly have the resources and technology to fight back. A key reason is that earlier generations were much poorer than today, so many more people had to risk going to work. Unlike today, radical economic pullbacks in response to epidemics that did not kill most people were not an option.
What has happened in Wuhan, China, the current outbreak’s epicenter, is extreme but illustrative. The Chinese government has essentially locked down Hubei province, putting its 58 million people under martial law, with ordinary citizens unable to leave their houses except under very specific circumstances. At the same time, the government apparently has been able to deliver food and water to Hubei’s citizens for roughly six weeks now, something a poor country could not imagine doing.
Elsewhere in China, a great many people in major cities such as Shanghai and Beijing have remained indoors most of the time in order to reduce their exposure. Governments in countries such as South Korea and Italy may not be taking the extreme measures that China has, but many people are staying home, implying a significant adverse impact on economic activity.
The odds of a global recession have risen dramatically, much more than conventional forecasts by investors and international institutions care to acknowledge. Policymakers need to recognize that, besides interest rate cuts and fiscal stimulus, the huge shock to global supply chains also needs to be addressed. The most immediate relief could come from the US sharply scaling back its trade-war tariffs, thereby calming markets, exhibiting statesmanship with China, and putting money in the pockets of US consumers. A global recession is a time for cooperation, not isolation.