The guest commentary below was written by Daniel Lacalle.
Central banks have tried to create inflation at any cost under the misguided view that this will boost growth and help reduce the debt burden. Just as a pilot driving a Ferrari with the instructions of a Ford T, central banks are pushing the accelerator looking at the rearview mirror and screaming “go faster, we have not crashed yet!”.
The first problem with governments’ calculation of inflation is that it massively misrepresents some important factors. Housing is not reflecting either real rental prices or actual mortgage payments, healthcare and education weigh only 8.5% and 6.5% respectively on CPI but are two of the largest expenditures of an average family.
It is not a surprise that protests against the rising cost of living are spreading all over the world while central banks say there is no inflation. The recent case in China is also symptomatic. China CPI came at 5.4% but pork prices rose 116% while vegetables soared 17% and transport-related fuel price inflation increased 7.2 percent year on year.
CPI components for Germany and France, where protests have increased in the past two years over rising consumer prices, also show the disparity: In Germany, the food price index rose 40% more than the official CPI, in an economy where GDP narrowly escaped recession. In France, food and services also rose higher than official inflation (between 90% and 30% higher, respectively), also in an economy where growth was weak.
These may seem low figures for central bank officials, but the house price index, rental costs, and food price indicators are rising faster than after-tax real wages and the economy.
Without entering into a debate about the calculation of CPI, these figures can help us understand why consumer habits are changing and why investment and consumption remain weak or negative in many economies. Consumers are more prudent because they perceive higher levels of inflation and cost of living in a weak wage growth environment while companies invest less as growth expectations are revised down and overcapacity is incentivized via low rates and high liquidity.
Protests against the rising cost of living were spreading globally many months before the coronavirus impact on Chinese prices, and even in China pork and food prices were seeing double-digit growths before the lockdowns and outbreaks. From Iran to Chile, Nicaragua to France or Spain, this is not an isolated or temporary issue, and the demonstrations also coincide with the ongoing downward revisions of global and country-specific growth rates with central banks accelerating financial repression and trying to disguise the problem with more liquidity.
Why should investors and economists care about stagflation risks? Because central banks have no tool to combat it, and fiscal policies do not help. One can argue that central banks have no tool to combat economic cycles, but no one can disagree that stagflation cannot be solved with money printing, low rates, and government spending. Those measures exacerbate the issue. For investors, it is a true challenge, as macro and earnings disappoint, but global liquidity continues to disguise problems.
Furthermore, governments tend to implement more interventionist measures when stagflation arrives. Do non-replicable good prices rise? Governments decide to intervene with price controls, which causes less investment, regulatory and legal security risk and, in turn, even lower growth.
No government or central bank will admit that rising inflation in essential goods is a direct consequence of financial and fiscal repression, and economic history always shows us that their reaction to rising discontent will be more financial repression and economic intervention.
We need to monitor these changes in patterns of inflation and growth as it is happening in more economies every year. With the global supply chain significantly impacted by the epidemic in China and the estimates of global growth significantly downgrades, stagflation is a word most economists and policymakers do not want to mention, but one that may become a real risk in very little time.
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap.