Dylan Howse, Director of Finance
Everyone knows that as we begin 2021, we are still in a global recession. The World Bank projected that 2020 shrank the global economy by 5.2%, the deepest recession since the Second World War, with the largest fraction of economies experiencing declines in per capita output since 1870.
What everyone doesn’t know is that as we make plans towards a brighter future, we aren’t necessarily out of the woods just yet.
Fundamental economic theory states that the expansion/recovery phase of a nation’s economic cycle (the one that follows a recession) is dominated by a strong demand for goods and services, which has the inevitable effect of driving up prices. The by-product of this is inflation.
Under normal circumstances, inflation is neither a good or bad thing if it’s treated correctly. The keyword there being normal.
The threat of a drastic increase in inflation has been a hot topic of conversation for economists and legislatures alike, especially in the U.S where unprecedented amounts of stimulus from both the central bank and Congress might spark future inflationary pressure. In other words, wanting to grow too quickly out of this pandemic might cause us to take two steps backward instead.
Many advocates of this concern are citing the 10-year Treasury yield, which is now back above 1%; its highest level since March. Or that Oil prices are up 10% in the past month as well, both signs that investors are predicting more inflation sooner rather than later.
“There is this tug of war around inflation,” said Todd Lowenstein, equity strategy executive of The Private Bank at Union Bank. “Could inflation become entrenched? The Fed doesn’t want to fight it right now, but historically the issue is that inflation is like toothpaste in a tube. It’s impossible to put back“.
Yet, U.S Federal Reserve chair Jerome Powell and his predecessor Janet Yellen, now the first woman to serve as Treasury secretary, are more optimistic.
Powell said that there could be “quite exuberant spending” in the next few months due to vaccine rollout and stimulus checks. Yellen argued that even though prices could increase, they could be transitory, meaning that they won’t be a problem in the long-term.
On the same note, as Yellen stated in her Senate confirmation hearing last week, that now is the time to take advantage of interest rates practically being zero and spend more on stimulus packages.
So, which one is it? Do you spend unprecedented amounts of money on stimulus to rejuvenate a struggling economy and risk the clear possibility of drastic inflation? Or do you sit back and do nothing in terms of stimulus, let the economy tank, and risk people’s livelihood?
A true “pick your poison” scenario.
Currently, there are only small instances of inflation, 3.9% in food for example. Even if the Biden stimulus package gets approved, we won’t see anything immediately change, maybe not even for months. Yet it’s the long-term effect of continuous stimulus that is scary in its uncertainty.
“Longer-term, the risks of inflation cannot be overstated. The market is expecting incredible levels of Fed stimulus for an extended period of time,” said Craig Fehr, investment strategist at Edward Jones, “If you ask me what usually keeps me up at night, it’s inflation.”