The latest episode of global inflation is impacting peoples’ lives in multiple ways, especially in developed countries where the present generation of citizens has not experienced this kind of rise in the cost of living; borrowing cost and challenges in accessing consumer credit. It is of course a significant challenge for the young investors and professional money managers who have been raised in an environment of profligate fiscal policies; abundance of liquidity; near zero cost of borrowing; persistent struggle to mitigate the deflationary pressures and unchallenged US supremacy over global markets and geopolitics. For them all the assumptions that underlined their investment strategies might be falling apart; just like the Dreamliner Titanic.
This episode of inflation and consequent
monetary tightening would indubitably prove to be an important life lesson for
the young investors and money managers; and go a long way in defining the
future investment strategies and market directions.
Besides, there are some other noticeable side
effects of the inflationary pressures on the global socio-economic milieu. For
example consider the following:
There are several reports indicating that harassed
by the rising cost of living and high rentals, many youngsters may be returning
to live with their parents; several more may have delayed the decision to leave
the parental homes; yet some other who were living alone are moving in with
their partners and friends to save on rental and other costs (for example see
here). It may be too early to conclude anything, but if this trend sustains
we might find it catalyzing some interesting changes in the demographic profiles
of many countries; housing market; immigration policies etc.
There is enough anecdotal evidence available to
indicate that employees demand higher wages to manage the rising cost of
living; but they seldom agree to wage cuts during the deflationary phase. The
businesses therefore usually engage in workforce realignment to optimize their
wage bill. The senior employees whose actual contribution is stagnating but
wages are rising, are invariably replaced by younger employees which cost much
less simply due to their lesser vintage. Inflation thus causes higher
unemployment in middle and upper tier employees, who are either forced out of
the labor market or accept new jobs at much lower wages. The governments
however do not have this luxury of letting senior people go. They usually meet
the goal by imposing a moratorium on fresh hiring and rationalizing non-wage
costs, e.g., travel.
The products’ prices usually do not move in
direct proportion to the raw material prices. During raw material inflation the
margins of most companies shrink, unless they enjoy significant demand
elasticity for their respective products and are able to pass on the entire raw
material inflation on to their customers. However, during the raw material
price deflation phase, a majority of companies do not pass on the benefit to
their customers. This is the phase when most companies, that have survived the
inflationary period, see their margins expanding.
As the rate of inflation declines, the prices
of consumer goods do not necessarily fall. They just stop rising at a faster
rate. Thus, if the wages of households have not risen in line with the rise in
the cost of living, the hit to their consumption and/or savings could become
structural.
Financial repression is one of the worst
impacts of inflation. The savers lose real income while the borrowers get money
at much lower real cost. Post inflation this situation is rarely reversed.
Neutral real rate is usually the best case in a deflationary period. Positive
real rates are not seen to last for any meaningful period.
To control inflation, a variety of fiscal and
monetary policies are used by the governments and central banks. Higher
interest rates, lower liquidity, higher tariffs to curb demand, subsidies to the
poor to augment their income are some of the popular tools used to mitigate
inflation and its impact. However, in case of deflation the use of fiscal
policies is not very popular; even though in some cases incentives are offered
to encourage demand. Withdrawing fiscal subsidies and incentives in the post
inflation period however proves to be a serious political challenge. Thus,
while the monetary expansion could be moderated in a relatively shorter span of
time, the fiscal corrections could take much longer.