Most everyone today is expecting continued high inflation for some time to come, and anytime I find myself among the herd I start to get a little anxious and begin reexamining my assumptions.
I do think there’s a real chance of hyperbitcoinization over the next decade or two, which can on the surface look like a hyperinflation event of sorts (though not as painful as traditional hyperinflations), but my best guess is that we are still at least five years away from that really commencing in earnest. And in the meantime, I’m expecting things to look more like the 1940’s (see chart below).
In the 1940s inflation rates were extremely volatile. Inflation went from about negative 1% in 1939 to 11 percent by 1942 to less than 2 percent by 1944 to almost 15 percent by 1946 and back to negative 1% by 1948. What a rollercoaster ride!
My base case is that we’re going to experience something pretty similar over the next five to ten years. The macroeconomic setup for the 1940s was very similar to that of today. As then, we can expect Fed monetary policy to whipsaw back and forth between tight and loose in relatively short periods of time in response to, or with predictable impact on, inflation.
If the Fed gets this tightrope walk just right or close to it, as it did in the 1940s, then it will successfully keep interest rates lower than the average inflation rate for the next decade or so and thereby inflate away the US’s debt burden over time. But if the Fed overshoots one way or the other (too tight or too loose), or if geopolitical factors force its hand, things could easily tip into a hyperinflationary or hyperinflationary environment from which the Fed won’t be able to quickly engineer a recovery.
Many macro trends support the deflationary hypothesis. First is demographics. As the median age increases, consumption (spending) generally eases while productivity (output/savings) generally increases, both having a deflationary impact on the economy. The developed world (with the limited exception of the US) has just passed its peak consumption/spending years and will be accelerating now into its peak production/savings years. This will reduce demand for almost everything, especially commodities. Measured in real terms, the world has already reached, or soon will, peak consumer demand. The trend is generally down from here.
Also, many boomers are simply not prepared for retirement and will consequently continue working well into old age. Because they will have social security to supplement their income, they will be able to work for less than the Millennial Generation competing for their jobs while also being more productive. This too is deflationary.
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The result of the above demographic factors means we’re likely to have a deflationary glut of capital and of labor, the opposite conditions from what we’ve experienced over the last many decades.
Technology will mostly aggravate the situation. Over the next two decades advances in materials science, artificial intelligence, robots, 3D printing, virtual reality, the metaverse, drones and much more will produce more and more outputs with less required inputs, including especially human labor. This will add to the glut of “stuff” (though that stuff will be increasingly digital/virtual) and of labor.
Cryptocurrency may have both an inflationary and deflationary impact. On the deflationary side crypto will at least partially replace the role that bonds serve in our present system. All else being equal this would raise the cost of /borrowing/capital. Also, cryptocurrency will mostly obsolete millions of careers in law, accounting, insurance, money transmitting, clearing houses, and governments (just to name a few), which is also deflationary.
But on the inflationary side, cryptocurrencies promise to free up absolutely insane amounts of presently-trapped liquidity (liquidity trapped in accounts receivable, supply chains, inventory, collectible, durable goods, and much, much more). All else being equal this would have a significant inflationary impact.
De-globalization will also have a mixed impact. On the deflationary side, export-reliant countries (Germany, Russia, Japan, Korea, etc.) will be increasingly unable to export their surplus production. This will be both a function of demographics (fewer and fewer consumers in the developed world year by year from this point forward) and also of a breakdown in the Pax Americana (making shipping long distances dangerous, more expensive and less reliable). Factories will be mothballed. Supply chains will shorten. This is deflationary.
On the inflationary side, the increased wars and piracy that result from de-globalization will cause more frequent supply shocks (sometimes localized and sometimes global) that drive inflation higher, at least temporarily. The degree to which these shocks trigger more permanent rather than temporary inflation will depend largely upon where one lives and whether these shocks trigger recessions (nature’s way of “fixing” high prices), as well as how successfully the Fed prints more money to try to avoid such recessions. Given that the US government currently has about as much debt as after WWII and core federal spending is running at 120% of revenues at a time when tax receipts are at all time highs, a major recession would blow up the treasury market and cause the US to either default or impose severe austerity on its people. Politicians cannot allow the latter and the Fed cannot allow the former, so…more money printing to ward off any real recession is likely. But the timing and amount of those interventions will be critical, and any errors by the Fed could have catastrophic consequences.
The final and perhaps most important inflationary factor is the eventual decline of US Treasuries as the world's primary reserve asset. If/when other countries start selling (or maybe just not buying more) treasuries for an extended period of time, much of those dollars presently held overseas will come rushing home to the US, potentially triggering a severe inflation here.
In short, over the next twenty years we have absolutely huge and competing trends at play. On balance they might largely offset each other. That would be really nice, though it’s probably not the most likely outcome due to the unpredictability/unreliability of the Federal Reserve and the potential decline in US treasuries as a reserve asset.
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