One of the most frequently used words of 2020 was COVID-19. This year, it is inflation. Unsurprisingly, as a lot of headlines and essays are discussing this topic, it is important we revisit it.
Last time we analyzed future trends, such as the aging population, resumed globalization and technology innovation, which are deflationary and more than likely to outlast the current inflation pressure. In this post, we’ll be discussing inflation in a historical framework. Inflation is not only an economic problem, but also a political concern.
Historically, war has been the top instigator of hyper-inflation. Deficit financing for war campaigns and wartime supplies disruption causes inflation to skyrocket, as witnessed in many countries in WWII and postwar world. Inflation was also caused by some outside shocks, which might be correlated with wars or natural disasters, such as the oil crisis of 1973 and 1979, incited by Arab countries to assert their power over the United States and its allies. This could be further worsened by embedded structural problems in the system, such as unionized workers demanding wage increases to keep up with inflation, which happened in the 1980s. This chain reaction will explode into a wildfire. Politically inflation often gave rise to extreme political parties and affected the stability and cohesion of a society.
While the government’s measures to counter COVID-19 bear resemblance to a large-scale war in magnitude, the timespan and complexities involved are incomparable. We could rule out a hyperinflation scenario if not for extreme cases.
A more recent and comparable case is the 08-09 financial crisis. Stimulus in the 2007-09 recession cost roughly $1.8 trillion, or 2.4% of GDP between 2008 and 2012. In comparison, Congress’s fiscal response to the COVID-19 pandemic will amount to $5.1 trillion, or 4.4% of gross domestic product, through 2024. The numbers seem daunting this time, but the FED has an important role to play. Up until 2015, the FED had been keeping its interest effectively zero for seven years. If inflation is estimated to accelerate and a near full employment rate is achieved, it is likely that the FED will increase the interest rate much sooner than last time.
Nevertheless, the government has the incentive to keep interest rates low to finance major initiatives. Also, moderate inflation would assist in absolving the massive debt accumulated from COVID-19. However, the government understands the importance of social stability. The FED, aimed at full employment and low inflation control, usually acts independently. As I said in my previous post, the FED has the tools to curb inflation, even if it is not transient in nature.
Inflation isn’t what worries most investors, as we know the FED has the ability to curb it. However, historically, the FED’s actions, such as paper tapering and rate increase, have caused market volatility and popped asset bubbles. We expect some volatility from the FED changing courses in the future. A gradual method has been widely expected than a sharp divert.
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