Getting the Inflation Genie Back in the Bottle

By Peter Klein on October 10, 2024

We are all familiar with the concept that it is difficult to get the genie back in the bottle—once something is already afoot it is almost impossible to reverse. If you told your spouse, “That outfit looks small on you.” it would be hard to unsay that, and more likely than not you will find yourself in the proverbial doghouse.

When we speak of economics, inflation is the element that is most difficult to walk back—to vanquish inflation an economy often needs tough medicine in the form of higher interest rates and a possible recession (the rare “soft-landing” notwithstanding). Much of the process depends upon the definition of inflation or better yet the cause—be it generated by cyclical or secular factors. If the inflation in question is generated by cyclical forces, then interest rate increases should be able to do the trick. With higher rates and tighter monetary policy, the economy will slow down (and sometimes that slowdown is more pronounced; read: a recession), and that economic slowdown is likely to lower the rate of change of prices on goods (inflation). Mission accomplished! Not so fast…

Side note: inflation is the rate of change from month to month or year over year. “Lower inflation” as a headline might read does not mean lower prices, it means that the prices rose less than they did the prior period—the rate of change was lower. This is called disinflation. Deflation is the economic term that describes a lowering of prices (or expressed quantitatively as negative inflation figures).

Ok, so back to the genie getting back in the bottle—no easy task. Will it be possible for the monetary gurus at the Fed to balance the world’s largest, most intense, and interconnected economy through the levers at their disposal for a soft landing—avoiding the pain of higher rates (inflation) while maintaining employment growth? And oh, by the way, they must do this while trying to avoid an “event” (be it market-related or possibly a major trade gone south, a geopolitical flare-up that disturbs already fragile supply chains, or a company is caught with an upside-down balance sheet now exposed) that often accompanies such changes in the overall economic machinations. This is the nature of cyclical generated inflation and in this domain, the geeky PhD economists from grad school become the Masters of the Universe.

But how about a secular-generated inflation era? Maybe the levers of the macro economy so deftly deployed by said “MOTUs” become numbed, rendered nearly ineffectual, to larger forces in the economy? Forces that cannot be ameliorated so “easily.”

At the current juncture, I see a couple of these “big picture forces” at play that are likely to have a substantive impact on inflation over the next several years:

1. Deglobalization—clearly geopolitics as of this decade have been sort of on the hot, perhaps even very hot (2 wars!) side. It becomes more difficult to arbitrage labor costs and production costs between countries to gain efficiencies and protect profit margins (even at lower prices) when no one is talking nice to each other anymore.

• Decarbonization—the global effort to “bend the curve” and save the earth from heating up too much. This is a large trend that is impacting economies around the world—all noble reasons (who doesn’t want to save the planet?) but the bill will be an expensive one and likely a burden not shared equally. The demand for certain green metals that are crucial in the electrification process (such as copper) will outstrip supply (if it hasn’t already) and hence prices will rise. Increasing supply is not as easy as turning on a switch, it will be roiled in regulations and permitting and powerful unions—all of which are inflationary.

• Deficit spending and the $36 trillion of national debt is also a secular force that can very well maintain the inflation wheel turning fast. Here is how that might play out: DC continues to spend, more deficits, and more national debt until perhaps the Bond Vigilantes awake from their near 30-year hibernation to ask/demand higher returns (read: higher interest rates) for what they see as a broken system and an increasingly poor fiscal situation. It was James Carville who suggested that he would like to be reincarnated as the bond market because you can intimidate everybody.

Other big-picture or secular forces at play could add to the threat of increasing inflation for a time to come. The above are my “Top 3.” I hope that the above provided some context as it relates to the notion of inflation and the chance that future headlines are filled with more uncertainty.

Servicing Our $34 Trillion Debt