Didier Saint-Georges: «Should Savers Be Worried About Inflation?»

A long deflationary trend cannot be reversed within one day. The deflationary forces of technology, demographics and over-indebtedness continue to operate. But in view of the strong public pressure, it will be difficult for governments to turn things around without strict budgetary policies, writes Didier Saint-Georges in his article for finews.first.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

Almost everything in the investment world today depends on the future of inflation. Interest rates immediately spring to mind, but the same can be said of equity valuations – not to mention the fate of the roughly $18 trillion worth of negative-yielding sovereign bonds. And for the first time in over a decade, the inflation outlook now has investors on edge.

The last time they worried about it was back in 2009, when the leading central banks inaugurated what was then a revolutionary practice known as quantitative easing. To stimulate the economy, not only did central bankers push key interest rates down; they also printed money to buy sovereign bonds from the banks holding them. The resulting colossal expansion of the money supply awakened memories of a warning issued by the great economist Milton Friedman. Printing more money, he contended, leads to a corresponding increase in demand that will eventually drive up consumer prices.

«This trend has heightened inequality between modest wage-earners and large asset holders»

Yet after ten years of QE, not only did inflation show no sign of surging, but it even continued to sag – to the point of raising fears that we might in fact be in for a gradual slide into deflation. Because the money created over the period never really made its way, via the banking system, into the broader economy, it stayed within the financial system (Weakened and subject to strict oversight, banks were in no mood to grant loans, and most of the private sector faced pressure to deleverage rather than to borrow more.)

So the «monetary manna» flowed mainly into financial assets, and their prices did inflate substantially. Over the past decade, that trend has heightened inequality between modest wage-earners and large asset holders. It has consequently fuelled a rising tide of rebellion against an approach that seeks to fix an economic problem through monetary policy alone.

That was how matters stood when the economy swooned in 2020. Once again, central banks have stepped in to prevent the worst from happening. And once again, financial markets are reaping the benefits. The difference this time however is that governments have crossed the Rubicon, and with central bankers’ blessings. Abandoning any pretense of fiscal orthodoxy, they are directly subsidizing a private sector badly battered by lockdown policies – even if that is causing an unprecedented increase in fiscal deficits and national debt.

«This is an entirely realistic scenario»

Though provided as before by central banks, the newly minted money is no longer confined to the financial system but has also started filling the coffers of businesses and savers alike (Given that consumers have little opportunity to spend the income flowing to them, however, diminished it may be, their savings rates have ballooned on average, albeit with an enduringly huge gap between people at opposite ends of the income scale.)

The first one concerns the near term. Once a sufficient percentage of the population has been vaccinated and economies re-open, won’t consumers eager to make up for lost time begin spending enough of their savings to send prices upward, ultimately substantiating Milton Friedman’s claim?

That outcome could prove to be particularly spectacular due to the extremely favorable basis of comparison. Suppose consumer spending picks up as early as in the second quarter of 2021: the year-on-year rate of increase could be staggering. This is an entirely realistic scenario.

«You won’t be getting your hair cut twice as often in the future»

But the bump in spending probably won’t last long. With jobless rates still high and widespread anxiety likely to persist, consumers may not be so keen on depleting their savings. More crucially, the money they have held off on spending would have gone to services (which, by the way, is what sets the current slump so radically apart from textbook recessions). Yet there’s no way of making up for most of that foregone spending on services – you won’t be getting your hair cut twice as often in the future.

The longer-term question is much more daunting. The shift engineered by governments in 2020 could well be interpreted as no less momentous than the regime change that occurred forty years ago when the Reagan-Thatcher era brought about a more limited role for government, tax cuts, less regulation and, most relevantly, low inflation.

«One can’t help wondering whether a form of «revenge on Wall Street» may not be looming»

The change of leadership that has just been officially consummated in Washington makes such an interpretation seem that much more plausible. The Biden administration, particularly with the appointment of Janet Yellen to the critical position of Secretary of the Treasury, has embraced an agenda aimed expressly at reducing inequality by means of taxation and other policies to redistribute wealth to wage- and salary earners.

The administration’s commitment to a greener economy is likewise considerable, and equally justified, but it is also potentially inflationary – not in this case because of rising consumer demand, but because of rising costs. One can’t help wondering whether a form of «revenge on Wall Street» may not be looming.

«Rome, after all, didn’t change regimes immediately after Caesar’s troops crossed the river»

The deflationary trend that has been going on for forty years (or even only ten if we choose to take 2009 as our starting-point) can’t be undone overnight. Technology disruptions, demographic shifts and large debt loads will continue to exert a powerful deflationary influence. Rome, after all, didn’t change regimes immediately after Caesar’s troops crossed the river.

But after throwing fiscal orthodoxy to the wind in 2020, governments will have a hard time unwinding their latest policies in the current climate of mounting popular pressure. Financial markets would therefore do well as of this year to buckle up for a new regime geared to stronger GDP growth but lower profit margins and less leeway for companies, and to higher earnings but more inflation for wage- and salary earners. Not to mention a trickier situation for people with savings.

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