Inflation Update: Not Transitory Yet!
You can listen to a professional narration of this article below:
Inflation is a very interesting, important, and constantly evolving topic. I wrote several articles on inflation this year. This article is an update to previous articles I have written on this topic; the framework I described in the original articles is still intact. However, as time passed and we got more data, I’ve had new thoughts, which I’ll share with you first. If you have not read those articles, I suggest you read them first and then come back to this update (links at the bottom of this update).
Updated Thoughts, October 2021
Here are somewhat random thoughts on inflation.
Today we are experiencing a perfect storm of inflation. A perfect storm is formed by seemingly small factors. Each one on its own may not be particularly significant, but once combined they result in an event that significantly exceeds the sum of all parts.
Inflations are always caused by too much money chasing too few goods.
Let’s explore both sides, starting with “too much money.”
In the eye of the pandemic, during mandated shutdowns, the government dropped money from helicopters, trillions of dollars, to anyone who could fog a mirror. This happened while (and because) big parts of the economy that are normally large cost items in consumers’ budgets – travel, entertainment, restaurants – were shut down. When your income doesn’t change or arguably increases and your expenses decline, your pile of savings grows. Thus, despite a global pandemic, consumers’ pockets were stuffed with cash, resulting in very healthy demand as the economy reopened. Consumer savings were also helped by the freeze on student loan payments and the eviction moratorium.
Most of the action today is happening on the “too few goods” side.
The global economy is an incredibly complex machine that needs to be in a state of constant flow. Once you stop parts of it and interrupt the flow, it takes time and a lot of effort to get it humming again.
Here is one example that highlights what happens when the normal flow of the economy gets interrupted.
Shipping containers: They are one of the most important technological inventions of the 20th century. They are the molecules in the blood vessels of the global economy. Their standardized size allows goods to move effortlessly on different modes of transportation (trucks, trains, ships) across the world. (I highly recommend you read the book The Box.)
There is a container shortage in the US today. Why?
There are many reasons: As the US production shut down during the pandemic and the Chinese economy was humming, we were consuming goods and not sending anything back to China. Containers got stuck in the US ports. But that was just the beginning. Today, containers are stuck at the end destinations and not brought back to shipping hubs due to the shortage of truck drivers. Ports are slow to unload ships due to labor shortages, work disruption due to Covid, and equipment shortages. Therefore fleets of ships loaded with containers are waiting to be unloaded, and this leads to even more container shortages, effectively taking supply out of the market. Companies suffering from post-traumatic stress syndrome caused by inventory shortages are in turn hoarding containers in order to store extra inventory in them.
The global supply chain is very complex. Few manufacturers produce every single part that goes into their finished products. They rely on dozens, and often hundreds, of manufacturers, many of whom have parts and raw materials stuck in the container bottleneck. Today your ability to produce goods is as strong as the weakest link in your supply chain.
Containers are just one example of many that illustrate disruptions on the supply side. In many ways and in many places, the result of Covid was effectively a reduction in the supply of … just about everything.
The one disruption that really puzzles me is the labor shortage. There are millions of jobs going unfilled today. I hear stories of Starbucks stores being closed due to a lack of workers. Every service that has a heavy labor component has gotten worse – be it restaurants, ridesharing, or pharmacies.
For a while we had an easy explanation: We were paying people not to work. So, they did what we asked them to do. However, I would have thought that after we stopped paying them to binge on Netflix, they’d come back to work. This has not happened as much as I thought it would, yet.
I have theories on why that is happening. Again, it is likely a sum of many factors, not just one. I can only partially agree with the rhetoric “I decided not to work as I hated my job and my pay,” a litany we often see repeated today in the press. You can only do this for as long as you have savings. Eventually you’ll starve. Before the pandemic, Americans, especially those in low-paying service jobs – the core of labor shortage – did not have big savings. Many lived paycheck to paycheck. The pandemic has helped many to increase their savings, but eventually they will chew through them. Hunger and living out in the cold are great motivators to get a job, which will lead to normalization of the labor market.
This is my main theory explaining the labor shortage today. But there are other theories, too: early retirement by baby boomers, migration of the labor force, newly minted Bitcoin millionaires who don’t want to work, folks who sold houses in states with expensive real estate and moved to cheaper ones and are now sitting on nice nest eggs.
As a side note, all this newfound wealth (savings) has also made its way into … you guessed it, the stock market, cryptos, real estate, NFTs, and anything else that can be bought and sold. As the final elements of the stimulus roll off, people will either need to go back to work, or sell assets to pay for expenses, and speculative markets will run out of greater fools. At that point, the money will return to its rightful owners, and rational thinking and conservatism will be rewarded again.
The bottom line is that we have strong demand and are producing relatively few goods and services, and thus we have inflation on our hands.
As I discuss in the articles below, wages are the largest cost in the global economy, thus as higher wages roll through the economy, they alone will be the highest contributor to rising prices. I just received a note from our payroll administrator: She told me that her software provider raised prices, so she is raising prices for her services by 20%.
I know it doesn’t feel like it, but inflation is both a feature and a bug of the normalizing economy. Higher prices signal to suppliers of goods and labor that we want more of what you’ve got. Higher container leasing prices will make storing inventory in them expensive and also increase production of new containers. Higher wages will bring truck drivers back on the road again.
The next … I don’t know how long (six months?) will be tough. But I am optimistic, because capitalistic impulses are programmed deeply into our human DNA. I know people have been cancelled for less, but I applaud our selfishness. Yes, we are selfish creatures, and this selfishness is what is going to save us. Millions of tiny selfish decisions in the pursuit of personal profit maximization will return things back to … not normal, but a new normal.
This new normal may be different from the pre-pandemic one. In many ways better, in some worse. A lot of “good” and “bad” is really subject to our personal interpretation of what the pandemic really became: an accelerator of the future. We’ll work from home more, go to the office less. We’ll order more things and food online. Our travel for leisure may not change much, but business travel will be competing with Zoom calls. The global economy will continue to go through deglobalization; more manufacturing will move away from China and back to the US, Europe, and what we consider as “friendlier” countries. Inventories will become a bit less “just-in-time.”
Long term, the present labor shortage will likely result in more automation – equipment never sleeps, talks politics in the office, or asks for a raise or healthcare benefits. As an example, as a small business, IMA is investing in more automation and streamlining our internal processes, and we don’t even make widgets. I don’t want to rely on fickle labor markets. I get a feeling we are not unique.
In addition to higher interest rates – a risk I describe in articles linked below – the most immediate economic risk I worry about today is inflation turning into stagflation. Higher prices result in significant reduction in consumption. We have positioned our portfolio accordingly.
Well, I have added a lengthy update to already lengthy articles. Here is my advice to you: Instead of straining your eyes, you can strain your ears and listen to the following articles. I’m providing links to my pieces on the inflation landscape (read, listen) and how we invest in inflation (read, listen).
Bach – Siloti Siciliano
This prelude was originally composed for flute by Bach. Alexander Siloti transcribed it to piano. I’ll share both flute and piano versions with you.
Vitaliy Katsenelson is the CEO at IMA, a value investing firm in Denver. He has written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. Soul in the Game: The Art of a Meaningful Life (Harriman House, 2022) is his first non-investing book. You can get unpublished bonus chapters by forwarding your purchase receipt to bonus@soulinthegame.net.
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