Democratic Senator Joe Manchin wants to vote against President Joe Biden’s Build Back Better programme. Since the Democrats only have a narrow majority in the Senate, a majority that they are going to lose at the end of this year, the generosity of the American government will be over.
According to the Republican senators and Manchin, it is no longer about saving the economy, but about fighting rising inflation.
If Build Back Better does not go ahead, it will save about $2 trillion in liquidity. By comparison, that is more than the US central bank is buying in bonds this year and next. The immediate consequence is that growth forecasts for the US economy for next year will be revised downwards.
Soon the European economy will grow stronger than the American economy next year. We have not seen that yet this century. Such an intervention removes the need for the Federal Reserve to apply the brakes sharply. It would be like the Fed selling a quarter of its bond holdings at a stroke, the biggest quantitative tightening ever.
Chips not down
Of course, the chips are not yet down. A politician in Manchin’s position can get a lot done for his voters; he demands lower medicine prices and a fairer tax system, among other things. At the same time, Manchin lashed out at the White House and other Democrats who are trying to bring him into line. November next year is election time in the United States.
The popularity of Joe Biden (photo) is currently lower than just about every president before him. Soon he will even overtake Donald Trump and Gerald Ford. Rising inflation and staff shortages are having a negative impact on consumer confidence. The Republicans are therefore gaining in the opinion polls. As soon as they have the majority in the Senate, the big investment packages are over.
With the politicians doing the dirty work for the central bank, Powell can quite easily temporise the proposed rate hikes in the course of 2022. This may cause the dollar to weaken, taking the pressure off monetary policy outside the United States. China’s central bank has already started to cut interest rates and mandatory reserves and will have even more room once the dollar weakens. The Fed seems to be right after all in saying that inflation is a temporary phenomenon.
Likely to decline
Inflation is likely to decline in the United States in the course of 2022, while at the same time inflation expectations are rising. The recent rise in inflation has been largely caused by the US government’s massive cash injections along with US central bank post-corona. From the start of the corona crisis, the money supply has increased by 32 per cent, but because of corona, people have difficulty spending that money. The only way to do that was to buy stuff, and several chains proved unable to withstand such a demand impulse. This is a temporary phenomenon, and possibly even more temporary if “Build Back Better” does not take place.
It will be replaced by a more structural form of inflation. This is caused by various structural trends that last much longer than one year. For example, we are in the middle of the retirement of the Baby Boom generation (1945 - 1965), all people who will no longer produce, but who will consume. Moreover, it is the first generation that has saved massively for retirement. Furthermore, there is a regionalisation of production as a result of the supply problems and the recent battle between the United States and China.
Instead of producing everything in Asia, part of it must now be produced locally and close by, a counter-movement to the globalisation trend that has gone into overdrive since the fall of the Wall and China’s entry into the World Trade Organisation. The only reason the chains are so long is because of the low cost price. Even after Corona, cost price remains an important factor, so this form of deglobalisation may not be so bad. In addition to globalisation, the IT revolution has also pushed down prices in recent decades. Today, many IT services are “free”. But there is increasing criticism of this model, because when something is free, the customer is usually the product.
Subscription model
Other IT services follow the subscription model from the cloud, the main advantage being that companies can then charge higher prices. This is evidenced by the greatly increased profit margins in the IT sector. Just about every large IT company nowadays has a monopoly position. Thanks to the (mobile) Internet, network effects and the related disruptive innovations are so rapid that a new successful player quickly becomes the global leader. Monopolies have the unpleasant characteristic of maximising profit. They do not cause deflation, but more inflation.
The energy transition will also contribute to inflation in the coming years. Initially, this will be due to the fact that there has been totally inadequate investment in the extraction of fossil fuels, but later it will be due to the fact that there needs to be a great deal of investment in alternative energy. Not only in generation, but also in distribution and use. Furthermore, a larger government will also contribute to structurally higher inflation, and when the millennials form the largest population group in society, the pendulum will swing a little further from capital to labour. A millennial wants to retire at the age of 55 and only wants to work four days a week to do so. Central bankers stand by and watch. They don’t think higher inflation is such a problem, it fits perfectly in the reflation policy, a policy perhaps better known as financial repression.
Structural rise
Demographics, regionalisation, Big Tech monopolies, bigger government, the pendulum of capital-labour and financial repression are the reasons why inflation may rise structurally in the coming years. This will gradually be factored into inflation expectations, just when the “temporary” inflation as an effect of the unprecedentedly large, but nonetheless one-off, cash injections will fade into the background. This means that despite the expected decline in inflation, inflation-linked bonds still have a role to play in the portfolio.
A better inflation hedge remains commodities, especially those that benefit from the trends outlined above. Equities are remarkably resilient to higher prices. It also creates a sharper distinction between winners and losers. Companies that can charge higher prices can also raise wages. This is much more difficult with zombie companies. The more structural, but much more stable inflation also provides peace of mind for central bankers and on the interest rate front. What more could an investor want?
Han Dieperink is an independent investor, consultant and knowledge expert for Fondsnieuws. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. He is currently active as chief commercial officer at Auréus Asset Management.
Dieperink provides his analysis and commentary on the economy and markets. His contributions appear on Fondnieuws in Dutch on Tuesdays and Thursdays and occasionally in English on Investment Officer Luxembourg.