Deutsche Bank Macro Strategist Oliver Harvey predicts that the combination of unprecedented government stimulus packages, retreating globalisation, the increase in bargaining power of certain sectors of the labour market as well as the need to reduce large debt burdens will bring about the return of inflation.
In his Konzept article, The case for inflation (page 18) he makes the point that while European government attempts to keep household incomes stable with job retention schemes , although they “have the best of intentions”, will simply result in “more money chasing after significantly fewer goods and services”. To put it bluntly, he adds, “The government is handing out US$100 bills when there is nowhere open to spend them”.
The Economist (18 April) concurs: “Worries about soaring prices start with the observation that virus-fighting measures choke off production. Crudely put, inflation is the result of too much money chasing too few goods. At present the amount of goods and services available for purchase is tumbling. Many service industries are shut down. The virus is playing havoc with the supply of some products.”2
The other problem is that a number of industries will be less profitable once some form of ongoing social distancing regulation limits the capacity at which they are allowed to operate. Examples are restaurants and airlines – which given the low-margin nature of their business models – means they rely respectively on high volumes of table bookings and flight turnarounds to be profitable – therefore the prices charged by such entities still in business would most probably rise. “If you assume 80% of restaurants cannot supply at, say, 60% capacity, do you think the price of a restaurant meal will go up or down?” asked Harvey on a recent Podzept podcast.3
As for all those precautionary savings, households’ spending and saving behaviour is – as every economist knows, says Harvey – “about expectations”. He predicts “as soon as households perceive the price of everyday goods and services starting to rise, their rainy day funds will quickly be raided to buy them.”
Another indicator that inflation is on its way back is, he adds, deglobalisation. The effects of globalisation on suppressing inflation were:
- Cross-border immigration and the offshoring of production increased the global labour supply, putting downward pressure on workers’ wages, particularly among the lower-skilled
- Enhanced competition in the manufacturing sector led to a decline in the cost of many consumer products.
The perception that high inflation is just around the corner is out there – a Deutsche Bank Data Innovation group (dbDIG) survey found that a majority of the Bank’s clients expect the pandemic to be ultimately inflationary. However, the drop in aggregate demand, says Torsten Sløk, Chief Economist, Deutsche Bank Securities, suggests that “we will not see inflation anytime soon”.
While this might be a comfort for some investors, what is the prospect of deflation, Japan-style?