“Inflation Changes Everything: Implications for the Economy and Financial Markets”
By Retired Men’s Association of Greenwich
At the Retired Men’s Association (RMA) of Greenwich’s meeting on Wednesday, June 8, Bob Phillips introduced speaker of the day, Larry Kantor, an operating partner at Atlas Merchant Capital and former managing director and global head of research at Barclays. Prior to working at Barclays, Dr. Kantor held positions in academia, at the Federal Reserve Board, and at other financial institutions. He received his PhD and MA in economics from Ohio State University. This was Dr. Kantor’s seventh appearance before the RMA. He has been coming each June to share his views on the U.S. and world economy.
Dr. Kantor began his discussion by emphasizing that he would look at the issues from a strictly economic perspective, in contrast to the political lens that is often employed today in discussing economic issues. He then previewed his conclusion that our current inflation problem would be difficult to deal with, likely being abated only by a recession of some degree. He noted that the underlying economic fundamentals were strong – e.g., a historically low unemployment rate and high demand for goods and services. Indeed, it is the strength of those fundamentals that suggests that dealing with inflation will be difficult, because low unemployment tends to push up wages and surging demand will create upward price pressure even if supply dislocations attributable to the Ukraine war and Covid are resolved. Dr. Kantor noted that the largest source of the inflation problem was the Covid relief efforts that pushed an enormous amount of money into the economy in a short period of time. He observed that this did not necessarily mean that it was wrong to inject that amount of Covid relief, as addressing the short-term needs of individuals and businesses may have made it worth paying the price of inflation in the longer-term. But that price is being paid. Economics is called the dismal science in part because of its admonition that “there is no free lunch,” and that principle also applies to Covid relief efforts.
The current Covid relief effort dwarfs the effort to support the economy following the last major financial crisis, the recession of 2008. The infusion of cash following the 2008 recession was about $700 billion compared to the roughly $5 trillion of Covid relief (about $3 trillion during the Trump administration and $2 trillion since Biden took office). To compound the situation, the Covid funds were injected into the economy in a shorter period of time than the recession relief funds. The magnitude and speed of the Covid relief efforts proved to be more than can be readily controlled through ordinary monetary and fiscal policy. On the monetary end, interest rates had already hovered around zero, leaving little opportunity for the Fed to use its traditional inflation-fighting tool of decreasing interest rates. It did, though, employ quantitative easing (QE), which basically involves its buying bonds on the open market. But, because it did not anticipate the severity of inflationary pressures, the Fed has been a bit slow in implementing QE, permitting inflation to build momentum. Dr. Kantor stated it was the enhancement of demand resulting from the cash infusion, rather than problems with the supply chain, that accounted for most of the inflationary pressure. This is evident from the fact that after a sharp but brief decline in output in the first several months of the pandemic, both U.S. production and the amount of goods imported soared well past their pre-pandemic levels.
Even without additional Covid relief, several other factors suggest that the excess demand that is driving up prices will not abate readily. As noted earlier, business fundamentals remain strong. Thus, profits remain high, and spending by businesses will keep demand high. Household wealth, meanwhile, is at record levels, leaving consumers positioned to spend at a high rate. Moreover, it does not appear that debt is overextended, meaning that consumers and businesses will likely not have to cut back spending for fear of being unable to repay debt.
Several factors that have kept prices low over recent decades are reversing themselves or at least abating. The fall of communism created low-cost suppliers to the U.S. like China and Vietnam, and that source of cost reduction has largely run its course. Costs decreased in recent decades because of just-in-time-inventory practices, but companies now appear inclined to maintain higher inventories (thus increasing their carrying costs) for fear of unexpected shortages arising from pandemics, war, or political instability. Similarly, concerns about autocratic or unstable governments may reduce the extent to which U.S. manufacturers will reduce costs by locating plants in low-cost countries. Finally, there has been a movement away from free trade, which had contributed to lower costs.
Dr. Kantor then opined that the solution to the inflation problem would likely require a dampening of the demand created by Covid relief efforts and that such a decline in demand normally meant the economy would fall into a recession. While one hears discussions of achieving a “soft landing” when trying to combat inflation, that goal is more realistic when the aim is simply to curb the acceleration of inflation, rather than decrease the level of inflation which is the objective now given that inflation has already reached a significant level. The market now appears to anticipate that the federal funds rate (basically, the rate that banks charge each other for short-term loans), which had been hovering near zero at the outset of the pandemic and has increased to about 0.75%, will rise to about 2.5% later this year and 3.5% by the middle of next year because of inflation. Dr. Kantor believes that higher interest rates and efforts to combat inflation will lead to a recession, although not necessarily a long-lasting one. Given the strength of underlying business fundamentals, stock prices might rise notwithstanding the slowdown in economic growth, but a decline in stock prices is also plausible if interest rates increase sharply.
A spirited RMA Q&A followed Dr. Kantor’s discussion about inflation changing everything. For those interested in seeing the full presentation, go to the RMA website and click on the video at https://vimeo.com/user9053619/videos.
The RMA’s next presentation will be by Frank McGinnis, a Retired McKinsey consultant and currently a physical trainer at the Greenwich YMCA, and is entitled: “Resistance Training and the Critical Role of Muscle in Aging”. This presentation will occur on June 23 at 11:00 a.m. at the First Presbyterian Church in Greenwich as well as on webinar at: https://bit.ly/30lBj21.
RMA speaker presentations are presented as a community service at no cost to in-person or Zoom attendees. The RMA does request that all eligible individuals consider becoming a member of our great organization, and thereby enjoy all the available fellowship, volunteer and community service opportunities that the RMA offers to its members. For further information, visit www.greenwichrma.org or contact Joe Mancinelli (mailto:jlmanc@optonline.net) or Peter Stern (mailto:members@greenwichrma.org).
RMA speaker presentations are presented as a community service at no cost to in-person or Zoom attendees. The RMA does request that all eligible individuals consider becoming a member of our great organization, and thereby enjoy all the available fellowship, volunteer and community service opportunities that the RMA offers to its members. For further information, visit www.greenwichrma.org or contact Joe Mancinelli (mailto:jlmanc@optonline.net) or Peter Stern (mailto:members@greenwichrma.org).
