A Panacea Or A Pandora’s Box – The Inevitability Of Inflation

The acclaimed author Ernest Hemingway once stated that “the first panacea for a mismanaged nation is inflation of the currency; the second is war”. In the twentieth century, during the eras of Franklin D. Roosevelt and Lyndon B. Johnson, the quandary for fiscal authorities was whether to spend more money on “guns or butter.” Both administrations were unique in that they were engaged in historically significant military conflicts, as they embarked on massive social programs such as the New Deal and the Great Society respectively. While the U.S. is currently not as engaged militarily, the Biden era may closely resemble FDR and LBJ as he will likely spend money on gobs of “butter.” 

During these previous periods, the financial economy was sacrificed for the “real economy.” With some recent proposals such as Wall Street paying for student loan forgiveness (via a tax on financial trading), we are reminded of the prior FDR and LBJ periods.  Though the US dollar did not fare well during those times, it proved to be very good for real assets such as gold in the years that followed as inflation ramped up. Today, whether you look at the price of groceries, cotton, or lumber (to name a few), all have moved up significantly and directly impact consumers’ wallets. One of the largest consumer products companies in the world recently announced future price increases in their baby care, feminine care and adult incontinence products. As they are not simply targeting babies, women and the elderly, the company does have to compensate for higher pulp prices — an essential input.  

Though supply constraints have been a contributing factor in areas such as lumber, it’s not just as simple as blaming a pine beetle – overwhelming demand has been another substantial influence. Actual inflation depends in part on what we expect it to be. If consumers expect prices to climb higher, there is a self-fulfilling quality as some may make additional purchases in anticipation. Just as consumers react out of fear of future price hikes, we would expect the labor market to bargain for higher and higher wages. This feedback loop will continue as businesses then increase prices to counteract these rising costs, which pressures inflation even higher. As it was during the New Deal and Great Society, workers (in general) feel empowered at the expense of the almighty US dollar. 

As the word “austerity” has been completely eradicated from the halls of government, we do not expect this upward price pressure to dissipate. This is further complicated by the fact that the Federal Reserve labels these price increases as “transitory,” which suggests that we will continue to see near-zero interest rates regardless of any inflation acceleration. While the Fed has become squarely focused on unemployment, we know that the Fed also sets inflation targets (the current expectation for 2021 is 2.4%). The surprising reality is that no major economy has managed to keep average annual inflation below 2% since 1971, according to data compiled by Deutsche Bank. Out of 87 economies, none have annualized less than 2% while only 28 have managed to keep inflation below 5% over the full period (the US is at 3.8%).   

Similar to the 1970s, we expect to see nominal GDP move higher, but offset by inflation – meaning that “real GDP” is stagnant. Owning real assets and companies with pricing power are essential to any portfolio which would compensate for this trend. Conversely, long-term bonds ultimately suffer as real interest rates remain at zero (or likely lower) in the face of a weaker dollar. Hemingway spoke of the panacea for mismanaged nations being inflation followed by war. He added, “Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”

The Rosenau Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, SIPC & Hightower Advisors, LLC, a SEC registered investment advisor. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower or its affiliates. This is not an offer to buy or sell securities, and Hightower shall not in any way be liable for claims related to this writing, and makes no expressed or implied representations or warranties as to its accuracy or completeness.    

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