SUPPLY CHAINS ARE FIXED. NO MORE INFLATION

D'ya remember back in March, when the ship above was stuck in the Suez Canal?

Literally everyone was talking about it.

The memes were great too.

I think this was perhaps the first time there was mass media attention on shipping; a pretty boring sector of the economy that rarely gets a look in...

Apart from when you're sitting on the toilet and suddenly pondering how the Amazon delivery driver is knocking at your door at 7am with the package you ordered a mere 12 hours ago...

Maybe that's just me...

But seriously, shipping is really boring, yet it's one of the most vital parts of how we consume.

I want to do a bit of a dive into where we've come from since the start of the pandy, and arrive at where we are now...

And we can do that best simply by looking at a chart...

If you've been a long term subscriber, or even followed me on Twitter before subscribing, you'll know that this has been one of the key charts that I've been focusing on...

Purely because I feel that most of the inflation we have and are experiencing can be rooted in the effects of goods transportation costs increasing so, so, so massively, so quickly.

Let's say that the average container price is approximately $1500 for a 40 footer (it's actually probably a bit less)...

Can we now see why I am so forthright in saying that inflation is indeed transitory?

I mean, check this out...

On the right you have US CPI YoY % change...

On the left, World Container Trades Statistics, which is a different measure to the Drewry one above (this contains less route information and is not high frequency), but I think you can see the trend here...

Container rates started shooting higher, which was met with an uptick of inflation.

How can so few people see this dynamic?

Now couple that with the last few weeks of downturns in container freight rates, and we might start painting a more rosy picture...

Again, I'll flash this chart up which I showed a few weeks ago, of LA Port Traffic...

With the cost of containers decreasing, I'd argue that there are two potential and/or outcomes occurring...

1) Demand has subsided.

2) COVID restrictions have subsided meaning there is more slack in the shipping ecosystem.

Personally, I reckon both things are true as it stands, and we can see that in the chart above.

No longer are we seeing the parabolic moves we saw from Q2 - Q4 last year and the same move in the same time period this year, but more of a breakup over the last few months...

In my view, that's pretty telling.

And let's take this data point too...

That is a massive increase in container ship building where over the last decade, there has been a rather large decline.

Now you can perhaps factor in that some ships have been scrapped, however there is still a net positive on ships that will be online.

That is a massive alleviation to the issues faced; issues that I'd say are highly idiosyncratic and have had outsized effects on inflation in the short run.

The problem with short run (and yes, over a year is short run) inflation expectations, particularly from the consumer, is that the consumer tends to be very, very wrong on where inflation is headed, as mentioned a few times before.

This paper is fantastic at exploring why consumers/household inflation expectations aren't a good empirical gauge (or any gauge) for actual, observable inflation.

This excerpt is key.

It should also be pointed out that all of these models give pride of place to short-run expected inflation, in the sense that current inflation is influenced by a one-period-ahead expectation (the main difference across models is whether the short-run expectation is last period’s expectation of the current inflation rate or this period’s expectation of next period’s inflation rate). This fact sits uneasily with the observation that in policy circles—at least in the United States—much more attention is paid to long-run inflation expectations, as it is the “anchoring” of these expectations that is viewed as being the wellspring of desirable economic outcomes and (as an empirical matter) as the source of important changes in U.S. inflation dynamics over the past 50 years. Moreover, while it turns out to be possible to append an adaptive-learning mechanism to several of these models in order to derive an inflation equation where long-run inflation expectations do play a critical role (see section V, below), such a mechanism turns out to carry subtly different policy implications.

Put simply, models are at odds with how policy makers would... policy make... because of what is/was important to them.

The models are at odds with themselves too since they are grounded in theory to prevent a sense of 'theoretical nihilism' (aka. shit, need something that sounds like it fits my worldview for... reasons... even though the world is highly complex), as the author put it

The models focused on the consumer (aka short run), who is pretty crap at predicting inflation.

Now you see a tonne of people on FinTwit talking about run away inflation which I find astounding for some since they are meant to be quite smart...

But they're quite clearly putting themselves in the consumer category (crap inflation predictors) by focusing on the short run and not the long run.

Here's one good reason why we should focus on the long run...

Now, I know the Fed has been buying Treasuries, keeping yields lower...

But if we were truly going to experience crazy sustained inflation, you'd have to surely bet on yields being way higher than what they are right now?

Sure, the short end is up, but that's expected.

If people are harping on about 80s style inflation, then we'd see a similar reaction in the 10 year.

We are not seeing that.

And this is exactly what the author of the paper above alludes to...

The stability of inflation’s long-run trend after the mid-1990s—more precisely, the fact that the trend appears almost completely invariant to changes in economic conditions—is perhaps the most remarkable feature of the U.S. inflation process at present; at a minimum, it represents a significant departure from the experience of the 1970s and 1980s (see the dashed line in figure 3, which plots the stochastic trend for price inflation over a longer period).

Getting back to the shipping thingy, the author makes a real important point as well.

Similarly, the idea that sticky prices would necessarily result in a dependence of aggregate inflation on aggregate expectations seems a little unintuitive: Most of the observed variation in prices appears to be idiosyncratic (suggesting that cost increases are as well), and it seems likely that price stickiness itself is endogenous (in that firms that face relatively more stable costs are more likely to enter into “fixprice” arrangements).

Let's take a simple view on this point.

If you reckon rates are going to rise, you probably want to swap a variable rate mortgage for a fixed rate one, right?

Well this is what many firms do.

They use swaps or mechanisms to lock in price if they reckon prices (input costs really) are gonna rise, which tends to actually nullify a longer term price increase...

And what more would firms want coming out of an economic 'crisis' like the pandemic than a certainty of business?

This is another feature of my argument against sustained inflation - many do not go into a more micro view and think, 'what might I do if I have a tonne of input costs with a desire to hedge risk of upside price increases?'

Something else to factor into inflation expectations is the belief in what is high and low inflation.

Pre 2007-08, PCE inflation sustained at around 3%.

Were people more indifferent then?

Why might they have been more indifferent?

Was it because they had a belief in the long run, perhaps?

My view is that workers now are not as sensitive to inflation increases.

The most recent increase in wage bargaining, in my view, is largely psychological with a lil' sprinkle of government welfare.

People have felt secure, but in a pit of despair due to lockdowns and so, they basically said, 'fuck it,' en masse.

Here's the recent labour market quits data from the US.

Now, couple this with the amount of people over the age of 65 who just retired since 2020...

Just for clarity, I'm making the assumption that most of these are retirees because the 54-64 age group had actually decreased (more people of that age group in the labour force (only slightly) vs pre-pandemic.

So we essentially have a melting pot where people have just... left...

Or at least they do not see a net benefit of remaining in work right now.

What does this mean for inflation?

Well, I would argue that inflation is actually far less of a concern to households in the long run than we may think.

And it is largely because post 1990, inflation has been trending down.

Households have had to be less responsive to inflation than in prior decades, and even less so now.

What households ARE more responsive to, however, are house prices as an example, specifically for renters.

When it comes to the wage-price spiral, though, here's what the author says...

One development to watch for would be any evidence that a renewed concern with price inflation was starting to affect wage determination—either in statistical form (for example, if reduced form models of wage growth that assumed a stable long-run trend were to see errors emerge that appeared to be correlated with actual inflation) or in the form of anecdotes. To the extent possible, we might also try to determine whether quit rates were starting to rise in a manner that was less tied to the state of the labor market and more correlated with consumer price developments, or whether wage increases for new hires were starting to rise appreciably relative to wage increases for workers in continuing employment relationships (the argument being that wages for new hires are more flexible and hence more responsive to economic conditions). Unfortunately, these are developments that would probably only become clear over a span of several years, not over a few months or quarters.

The quit rate demonstrated above is largely correlated to a big shift in the structure of the labour market...

Think remote working, people maybe even having struck big in markets or other pandemic related idiosyncrasies like starting a business when they were previously 'employed'.

What is the outcome of this then?

I may be right, or I may be wrong, but I think many commentators are behaving like households as mentioned above.

They are attributing inflation to bogeymen like politicians and their respective central bankers, while really, the answer is staring them in the fucking face.

1) They're too short term in thinking.

2) They think inflation is a purely monetary phenomenon.

3) They're finance people who focus too much on their niche, forget that there's a world outside of finance.

4) Disregard context.

On the last point there, I want to show you the UK's CPI rate and ask you whether we're in a massive inflationary spiral.

Bear in mind the Bank of England's inflation target is set at 2% (+/-1%), which means they're all good up to 3% inflation all the way down to 1% inflation.

Do you recall the Great Inflation Panic in the UK in 2011?

What about the Great Deflation Panic of 2015?

No?

Me neither.

If inflation had increased at the same pace experienced in 2009-2011, we would not be hearing much about it, and the same goes for the downside move on inflation from 2011-2015.

The problem always comes down to anchoring and velocity...

Which is probably why people are dying to sell Tesla so damn hard right now...