By Santiago Hunt
In the last 20 years, Argentina has undergone a cumulative inflation of over 11000%. Yes. Eleven thousand percent. That’s not a typo.
This dubious performance puts Argentina in a “Hall of Fame” of sorts with countries like Zimbabwe and Venezuela. It comes with a massive series of societal and cultural issues. It also grants a unique perspective when looking at global inflation in today’s world.
I want to share 3 unique perspectives on global inflation given my Argentinian lens.
1) Commitment is important. But patience is critical.
After 40 or more years, inflation is back. Why? Several reasons have been articulated: supply chain issues, Covid’s impact on the workforce, the war in Ukraine, the larger energy crisis due to lack of capital investment, green movements pushing for “ESG” policies which heavily backfired, etc.
All of these are true and relevant. We’ll cover them in due time. But there are two fundamental drivers of inflation: Monetary easing coupled with massive fiscal stimuli during Covid:
The above highlights the US expansive stance on monetary and fiscal policy due to the pandemic. But you can copy/paste other countries’ approach and the directional picture will be the same. It can be debated to death if this reaction was the correct one or not. But that’s not the point. The true point is this: Inflation arises when there’s a mismatch between money availability and productivity. In other words, if the pool of goods and services in an economy remains constant, and you increase money availability by 10/20/30%, you will see a dislocation between supply and demand.
How to solve this? Increasing productivity is HARD and takes time. Hence, the only way out in the short run is by tightening monetary conditions – which has already been happening at a record pace during the last year (US). In line with this, economists have predicted (erroneously) and continue to predict (erroneously as well in my view) a sharp drop in inflation.
As we can see, economists keep expecting sharp drop-offs in inflation which fail to happen. As these predictions keep failing, patience vanishes. Financial markets went into hysteria over an August CPI reading that showed…+0.1% inflation month over month. The FED continues to signal (truthfully?) that they will hike rates no matter what the cost until inflation is squashed.
Here’s the first nugget of my Argentinian inflationary worldview: Lowering inflation takes commitment, but also time. Hiking rates month after month will have less of an impact than keeping rates high (but stable) for longer. If one zooms out, it might be that inflation peaked and we’re trending in the right direction. Slowly.
Expect no magical y/y inflation drops. It’ll be a slow grind. The issue with this? The FED might get pressured into hiking too much too soon, breaking something, which in turn makes them pivot too quickly, which then fires inflation back… A reflexive loop hard to shake off.
2) Wars are inflationary. And Covid-19 was a war.
If you think calling Covid-19 a war is crazy, check the numbers. We’re globally tracking close to circa 8M deaths due to the pandemic (6.5M + ~20% excess mortality). While nowhere close to the 40/50M deaths attributable to WW2, it does put us in roughly a similar order of magnitude than WW1 (15M).
Furthermore, wars are painful not only because of death and destruction, but also because of their economic impact. All activities suffer as resources are refocused on essential tasks. In that sense, there’s no question that Covid lockdowns had an impact similar to the world wars of the 20th century.
We highlighted how inflation arises when there’s a mismatch between demand and supply. And Covid hit squarely on the supply side. The challenge here is that war driven inflation takes time to digest. Take a look at the 1940s (an inflationary decade even after WW2):
Lyn Alden has done an excellent job highlighting how our current situation is less comparable to the 1970s, and more so to the 1940s. The 1940s were a decade full of start/stop inflationary jolts, driven in no small part by the supply chain instability caused by WW2.
The current state of supply chain, while normalizing, reminds of me the “Beer game”. The Beer game (link here) is a simple simulation that showcases how fast supply chains can go wonky when there are incomplete, volatile base assumptions. The result of the beer game is that once out sync, normalization is hard and costly.
And here’s where another Argentinian viewpoint kicks in: Once you lose the ability to accurately forecast your production costs, you’re in for one hell of a ride. This situation is particularly acute in the EU. PPIs at ~30%+ are bad not only because of the impact on COGS, but because of the uncertainty they create. This is a key issue behind the UKR war and the energy crisis. It’s not only the cost increase, but the fact that as we speak multiple companies are assessing scenarios to explore if their EU production base is sustainable in the long run. While many are likely overshooting their expectations on EU energy prices, the exercise per se will do a lot of damage. And Germany is the country which will suffer this the most.
3) In a sustained inflationary context, Cash is NOT king.
It’s been very hard to find safe investment havens in the last year.
Be it equities or bonds. Be it US, Developed or Emerging. Gold or Bitcoin…nothing has worked. Cash has outperformed all of these. Even the notable exceptions, Oil and Commodities as a whole, have seen strong drops since their mid-June highs.
The reasons are apparent: When facing looming recession fears, cash means optionality. There’s another more subtle reason: all of these have been priced in US dollars, and the USD is having a stellar performance since the beginning of 2021. This in turn showcases how the USD has become the ultimate safe haven.
What lies ahead is a fork in the road: If inflation normalizes and goes back to its 1-2% target depending on the geography, things will go back to normal, and cash will retain a high optionality value. However, if CBs end up throwing the towel and ease too quickly in the face of too abrupt hikes, and inflation becomes chronically entrenched at 4-5%, then we’re in a very different world.
This latter scenario means a totally different thing for cash. Third and final piece of Argentinian advice: Find the “hard money”. With inflation currently at 8% y/y, cash IS NOT hard money. Many people understood this and bought cars in 2021 at drastically lower prices than today – and cars are not the best form of hard money either.
For us Argentinians, the USD has been the typical form of hard money. But other exist as well. A common piece of wisdom amongst traditional trade retailers was to “save in shaving blades”. Why? Measured in USD prices, shaving blades ended up being a better investment than holding USD cash in the argentinian inflationary context!
It goes without saying that Bitcoiners and crypto-enthusiasts as a whole will say “Bitcoin/Ethereum is hard money”. And yet, they have a heavy proof burden to lift here moving forward. Crypto is down -60% ytd, which proves that up to now it was a “liquidity hedge” rather than an inflation hedge. This might change moving forward, but it remains to be seen.
Regardless of the case, there will be forms of hard money. There are multiple candidates, all with challenges: Physical assets face depreciation, Commodities face boom/bust cycles, Crypto faces speculation. There is one certainty though: Cash is a horrible place to be in long term inflationary cycles.
One final corollary: beware of “nominality” when dealing with inflation. This is obvious, and yet a common mistake. An example: many people believe that at -18%ytd, the S&P 500 still has a long way to fall. Here’s the thing though: the S&P is down -26%ytd. You need to account for inflation in real terms. This doesn’t mean the S&P can’t keep going down. But I’m sure many would reconsider the aggressiveness of their short position if they fully factored in that -26%.
What now?
At the risk of joining the dark side of the Force, I will wager some predictions on what might happen moving forward. Warning: For what it’s worth, I was VERY wrong on my inflation expectations at the end of 2021.
Let’s plot 3 scenarios:
a) Controlled recession. Inflation falls relatively fast. Economic activity starts recovering in Q3/Q4 2023. Back to “normal” (2%ish inflation in 2024 onwards).
b) Inflation falls to 4/5ish, but CBs are forced to relax tigthening given economic damage. Start/stop inflation cycles throughout the decade until a new influx of “cheap energy” comes in. This might be a combo of gas, shale in places where it was banned and nuclear.
c) High inflation: 7-8%+ becomes the norm. Some countries see entrenched double digit inflation. Massive global unrest and geopolitical conflict.
I believe the end result will be a mix of a and b. There are multiple technological tailwinds coupled with secular slowing demographics which are deflationary in nature. The missing pieces in the “low inflation” puzzle are i) severe global energy bottlenecks (which predate the UKR war) ii) EU is in a rock and a hard place where it cannot raise rates to real positive levels given its economic weakness.
What might lead to c? I don’t think the EU situation is enough to cause this scenario. The big risk here is what happens if geopolitical tensions between CN-US rise during this decade. That’s a very different Pandora box. Although I do not believe it would lead to “traditional” war, economic war (Zoltan Pozsar dixit) would be a very real threat, leading to a dramatically different inflation picture.