History is always written by the victors. Biologically, the victors are we who breathe oxygen and sing the praises of the verdant forests that produce it. Gaia appears to us alive and wonderful. For the vanquished, Gaia was beautiful up to two and a half billion years ago. The vanquished had populated the planet for a billion and a half years and led their peaceful lives metabolizing energy through fermentation, in turn made possible by carbon monoxide, sulphates, mercury, nitrates.
For the vanquished, oxygen was highly toxic. Unfortunately for them at the dawn of the Proterozoic this terrible gas began to spread. The Great Oxidation, as remembered today, is the greatest catastrophe recorded in the history of life. The few anaerobic survivors of that massacre have recently been discovered at the bottom of the oceans, refugees in abyssal depths in volcanic areas. For them, Gaia has become hell. Until 2008, inflation was a poisonous gas for most forms of economic life. In unaltered natural conditions, the historic price trend has been one of slow decline.
Inflation has typically occurred only in times of war when states, in addition to taxing and incurring debts, have paid for arms and soldiers with currency with a higher nominal value than its intrinsic value. There have been two exceptions to this rule. The first occurred when sudden discoveries of gold, as in the second half of the sixteenth century in America and in the last decade of the nineteenth century in the Transvaal, caused a rise in prices. The second when states, even in peacetime, have seen fit to finance fiscal deficits through the printing of paper money. The most relevant recent examples are Zimbabwe and Argentina, but the practice dates back to the mists of time.
Since 2008, the toxic gas has been transformed into beneficial oxygen. Not for the easy-going consumers and savers who still think old-fashioned and hate inflation, but for central banks, governments, academia. In a world deeply indebted, inflation of two percent or more accompanied by negative real rates transfers wealth from creditors to debtors and keeps the latter alive even if they are inefficient. Equities and bonds don't like inflation per se. The experience of the XNUMXs is there to remind us that bonds suffer untold pains and equity barely floats in real terms when price growth exceeds a certain level.
What bonds and equity love today is a very particular condition in which inflation is not too low (it would be a sign of economic weakness) but remains below the two per cent target. In this way, central banks are induced to keep real rates negative and nominal rates low, allowing bonds and stocks to flourish. To ensure survival at these high levels, therefore, bonds and equities need an absolutely stable microclimate, as close as possible to 1.5 percent inflation. Any other level is risky. From two on, central banks have to raise nominal rates, putting pressure on equity multiples and long bonds.
From one onwards means that the economy is unresponsive to stimuli and is therefore out of control. Even more than growth, welcome but not essential, it is inflation that must be examined under the microscope. Is it really 1.5 percent? Which direction is it going? Will the central banks be able to raise it with low rates? Under the microscope, inflation is seen to be different than it appears to the naked eye. It is not Amazon, 3D printers, robots and all the technological science fiction that keeps prices low that makes us dream of a world of abundance in which machines will provide us with everything for free and in addition will be taxed to give us a basic salary.
Goldman Sachs, in painstaking work, calculated that e-commerce lowered inflation by just 0.1 percent this decade, half as much as it did in the decade before the rise of Walmart hypermarkets. On the other hand, it was Obamacare that brought down health inflation for reasons that are not at all futuristic and glittering and are, on closer inspection, trivial and even sad. Until 2010, health inflation had always been much higher than general inflation. The population is getting older, it was said, and moreover it is increasingly wealthy. Logical that he spends more on health and understandable that this creates a secular pressure on prices in the sector.
Secular? Today, health care inflation in America is lower than general inflation. Obamacare administratively imposed lower prices on hospitals and doubled the cost of health insurance policies. The prices of the hospitals are calculated in the PCE, the index watched by the Fed, while those of the policies are not included. In the new post-Obamacare policies, the deductible then exploded (the first 10-20 thousand dollars of expenses are not reimbursed) and this has caused the demand for treatment and medical checks to decrease, causing the price to fall.
Without this effect, American inflation would today be 0.4 percent higher (1.8 instead of 1.4 for the Pce Deflator and 2.6 instead of 2.2 for the Cpi). As for the trend, State Street, which calculates e-commerce inflation across all industries, sees a surge over the past three months. Online inflation is a leading indicator. This is where companies experiment with markups and discounts that, if successful, will be adopted on a wider scale. For his part, GaveKal, with equal precision, went to look under the surface of the official Japanese data and noticed, in addition to the poor quality of the data collection method (a questionnaire sent to a group of senior civil servants who have the time and the desire to compile it), a significant and growing underestimation of inflation.
With this we do not want to affirm that the data on which the market feeds (and on which it philosophises) are profoundly wrong or the result of manipulation. We simply mean that they are less solid and unambiguous than they appear. In normal times that wouldn't be a big deal. Inflation is always one, none and one hundred thousand and there are as many inflations as there are baskets of each of us. In times when valuations are high, however, even small cracks need to be watched. As for the effectiveness of the method followed so far by central banks to drive up inflation (keep interest rates exceptionally low), the debate is heated. Avoiding zombie default is positive in the acute phase of a crisis, when a domino effect would occur that would also involve healthy subjects.
However, keeping the zombies alive after the crisis causes a suboptimal allocation of resources, lowers system productivity and actually keeps inflation low, because zombies, which produce at a loss, take away the pricing power from the healthy. It cannot be excluded that a Fed possibly led by Taylor will try to abandon the path of low rates at any cost. For the 26th we bet on a more dovish ECB than expected, thanks to a Catalan crisis that promises to be long and difficult. If the ECB is really soft, the euro will weaken (or in any case will have less room to strengthen in the coming months) and the stock markets will rise. On that rise we are ready to lighten.
