More inflation on the way
Inflation occurs when too much money tries to buy too few goods. It is as simple as that. Yet in this simplicity lies much complexity. For what is too much and what is too little? Too much money is determined by the supply of money and the demand for money. Too little goods is also determined by the demand for goods and the supply of goods. If all components remain the same, then more supply of money automatically equals more inflation. However, it is rare for everything to remain the same. According to some analysts, sharply rising inflation is unthinkable; it is something from the past. That is a bad argument; the Great Financial Crisis was also seen as unthinkable. Things can change. A little inflation is not seen as a problem; it is even seen as a lubricant for the economy. Deflation is the big problem. That is not because people then postpone purchases, but deflation combined with high debt is a deadly combination. When that happens, debt quickly grows as a percentage of income and creates a debt-deflation spiral. Savings have to be made to pay the debts, which means there is less to spend, resulting in further falling prices.
The definition of inflation
There is no such thing as the ultimate inflation. Inflation varies from country to country and depends on personal expenditure. It is usually calculated for an average person, with an average income and average expenditure. The basket with expenditures is updated with some regularity. Still, mistakes are made. For example, for a long time, kimonos weighed heavily in the Japanese definition of inflation, so the underlying deflation did not appear to be too bad. In the Western world, the reverse is true. Inflation is not allowed to rise too fast, because government benefits and many budget items rise with inflation every year. As a result, some items, such as tobacco and health care premiums, are deliberately not included. A house is seen as an investment and not as consumption. On average, one-third of income goes towards the home, but that is not reflected in the inflation rate. Between 1996 and 2019, house prices in the Netherlands rose by 280 percent, while inflation only rose by 54 percent. Then there are things like a computer or a car that are adjusted for improvements in the product. The price of these products rises but adjusted for better performance, statistically, the prices fall in the inflation basket. It all seems harmless, but it is not without consequences. Those who 30 years ago with an average income could buy a house, have a car parked outside and even buy a PC, can no longer do so today. This causes discontent among large sections of the population. While it seems as if they have hardly been better off all these years, in reality, they have been worse off. Fortunately, there are many things that offer compensation. Holidays with British Airways now become Easyjet, the hotel becomes an AirBnB, and Waitrose becomes Lidl. Yet we are playing with fire. Yellow Jackets, the Arab Spring, and the uprising in Tiananmen Square have one common cause and that is inflation. In the case of the ‘Yellow Jackets’, it was higher energy taxes so that hardly any disposable income remained in the French countryside, the Arab Spring was only possible thanks to sharply rising food prices, and China’s inflation rate prior to the uprising was 20 percent. According to Karl Marx, historical events are shaped by economic forces and inflation is by far the strongest force. It is the underestimation of inflation that causes discontent among the population and is therefore a cause of rising populism.
No hyperinflation, but inflation is on the rise
The good news is that we do not have to fear hyperinflation any time soon. Just look at Zimbabwe, Venezuela, the Weimar Republic, or the Song dynasty. If you demolish the supply side of the economy and keep printing money, you get hyperinflation surprisingly quickly. It will not come to that. Yet there are several arguments that inflation will rise in the coming years. Especially at a time when we are being misled by the inflationary developments after the Great Financial Crisis. Despite massive injections of liquidity, inflation did not rise then; on the contrary, it fell. The money was mainly used to plug the holes in the financial system. All that money had ensured that inflation (in the form of house prices, which are not in the basket in the United States either) had risen sharply before the Great Financial Crisis. The money had already been spent and now deflation meant that the creditors had a problem. They needed money, lots of it. This never reached the real economy, because in reaction to the payment problems the credit tap was turned off. This time it is different. Not by the banks, because they are still part of the problem. This time money, much more money, is going directly to the consumer. An unemployed person in the United States has an income of more than $30,000 over the past 12 months, often better than a paid job. The restrictive measures ensure that not all that money has been spent. It was used to pay off debts, save, or invest in the stock market. But when the economy opens in a few months’ time, many American consumers will simply spend what comes in again. This is a more cyclical form of inflation. Not something for the long term, but when you are in the middle of it, it often feels different.
Tipping point structural factors
In recent decades, we have benefited from several structural factors that have pushed inflation down. Thanks to telecommunications and container transport, globalization brought about constantly falling prices. China in particular has been the great exporter of deflation. Via Alibaba, everything was for sale at a tenth of the price. Technology also makes it possible for products to become cheaper all the time. You name it, there is an app for it. Usually, a free app, where the consumer often does not realize that he himself is the product. The baby boom generation has worked hard in recent decades, but not all hard-earned money has been converted into consumption. People saved for their old age. Producing more and consuming less automatically reduces inflation. Moreover, in the past, there was also a wage-price spiral, but the power of the trade unions has disappeared. In the next ten years, we will have to look at these structural factors differently. Deglobalisation has been going on for some time and has accelerated since the corona crisis. Just-in-time is now becoming just-in-case. The fact that the supply of semiconductors and containers is going wrong at the moment is a temporary phenomenon, but one that ensures that higher stocks are held or that production takes place locally and close by. That does not make products cheaper. China is rebalancing its economy. Less emphasis on the Asian growth model with its cheap exports, but more reliance on the economy’s own strengths. The ongoing feud between the United States and China will only accelerate this process. The Big Tech companies are being challenged on the use of the data they have collected. Suddenly, they have to pay for it. There are also many tech monopolists. They don’t tend to lower prices anyway. The baby-boom generation is retiring. That is the moment when people definitely start producing much less but continue to consume thanks to the money they have saved. This causes more inflation, also because it allows interest rates to rise. After all, we are going from a savings surplus to a savings deficit. The power of trade unions has disappeared, but various protests have shown that workers who organise themselves through social media are more powerful than ever. The pendulum of capital-labour is swinging more and more in the direction of the labour factor. On top of all these factors comes the sustainable trend. This means that external negative effects will soon have to be reflected in the price of the product. At present, it costs nothing to pollute the environment, restore biodiversity, or to dump plastic in the ocean. The moment those costs are included in the price of a product, that too causes inflation. There are many negative externalities, especially in the extraction of raw materials. If they were all included, commodity prices could easily double from their current levels. Commodities mainly offer protection against an inflation shock in the short term and, given the spectacular growth this year, such a shock can by no means be ruled out. In the long term, equities and real estate investments appear to be perfectly capable of withstanding inflation, even if it causes multiple rotations in the stock market.