Finance Monthly - January 2022

he threat is becoming increasingly clear. It’s a massive threat to markets, society and economic growth. Expect to read a lot about it. The big news in December is Jerome Powell, Fed Chair, finally admitting the post-COVID inflation we’ve seen building over the past 18 months is anything but “transitory”. It’s here to stay. That’s come as something of a surprise to many analysts who went with the central bankers dismissing inflation as a likely short-lived issue, a mere post-pandemic hurdle that would swiftly be passed by. Over the comingweeks, sentiment is likely to shift towards new long-term inflation scenarios as the inflation numbers remain stubbornly high. It’s difficult to imagine an inflationary scenario that’s positive. Inflation is currently running a shocking 5-6% across the Western Economies – for howmuch longer, or how much higher is a “how long is a piece of string question.” We don’t know. Inflation is now in a spiral of supply chain hick-ups, wages, earnings and contradictory expectations. Inflation may ease tomorrow. It may not. Be a boy scout… Prepare for a rough ride. Unexpected consequences include fears that inflation will boost rising pandemic populism, leading to protectionism and the end of globalisation – a less connected global economy is likely to prove inflationary, especially in terms of increased tariffs. What is, perhaps,most frightening, is how little financial professionals – from central bankers, investors and traders – really understand what inflation is and how it emerges. It is overly simplistic to state inflation is “everywhere a monetary phenomenon” as the uber-monetarists proclaim. That fundamental ignorance could create massive policy mistakes and market uncertainty. The next time some “expert” tells you inflation is all the fault of Governments borrowing too much, ask them to explain how and why. What a vast number of market participants don’t get is inflation doesn’t follow rules – it follows sentiment. Governments and central banks have been stuffing the global economy with liquidity for the last decade, but it’s only in the last few months the pandemic shock has crystalised real inflation. Why… Because suddenly people fear inflation. Let me coin a new mantra on inflation: “Inflation is everywhere what people fear it might become…” Conventional wisdom assumes inflation can be mitigated by cutting liquidity; central banks raising interest rates (tightening), while governments can raise taxes and cut spending programmes (austerity). These monetary arguments are logical but also highly simplistic and create largely erroneous hopes and expectations. Hope should never be a strategy. Conventional wisdom is cheap. The confusing reality of the system of multiple demand and supply transactions we call the global economy is it’s anything but a series of binary questions. It’s unfeasibly complex. If you raise interest rates that may cause a rise in the relative value of the currency, thus reducing inflation from imported goods, but it will equally create a series of shocks through the economy in terms of more expensive loans, impacts on retail jobs and services and rebalance the whole demand/ supply equation as a trillion new decisions will be made by economic participants. Financial markets work because participants are constantly evaluating every nuance of information to determine future prices. Prices are a reflection of the market putting together everyone’s perception like some enormous voting machine. Inflation is just a particularly important part of the economic picture influencing the market vote at present. Should we let it panic us? Maybe not - we’ve just undergone a period of unmatched and sustained global monetary creation through the past 12 years – since 2009. Stock prices have tripled – posting massively higher gains than the relatively lacklustre economic growth we saw over the same period. It’s financial asset inflation, pure and simple. It’s happened because stocks look relatively cheap to ultra-low interest rates, and central banks have been pumping liquidity into the financial system (in the hope of creating economic activity) via QE. The result is massive financial asset inflation on a cause and effect basis: make money cheap Bus i ne s s & Economy 32 Finance Monthly.