Shifting Economy, Inflation Déjà Vu

Steve Bokor CFA, and certified financial planner Ian David Clark share some thoughts on how the economy’s resilience continues to defy expectations.

Photo by Kyle Glenn

For those of us old enough to remember the price shocks of the 1970s and interest rates that topped 20 per cent before the 1980 recession, this article may cause our hearts to skip a beat as we speculate a return to those years due to COVID-19.

Some economists would argue that it’s different this time. The stagflation of old was
a result of the falling US dollar as it went off the gold standard. It was also a result of successive OPEC production cuts that started in 1973 when OPEC members tried to penalize Western nations for supporting Israel, a move that sent the price of oil from $3 to $12 per barrel.

To protect their standard of living, labor markets demanded ever higher wages
(wage push inflation) which then caused manufacturers to raise prices to stay profitable (cost push inflation). As a result, inflation skyrocketed.

Today we are experiencing a shock to our economy, unprecedented government instituted shutdowns limit the spread of a devastating virus. Central banks and governments are flooding the system with a tidal wave of cash. All in the belief that the effects of the virus will be short lived and, once vaccines and treatments become readily available, everything will go back to normal. But will it?

In our opinion, maybe not. Inflation is a measure of how fast the price of goods and services increase in value over time. As such the value of one unit of currency today is
worth less than a unit of currency tomorrow or next year. Rising prices occur when costs of production go up, or as a result of more cash in the system at the same level of production. Notice how getting a haircut costs more than it used to. In either case, it has eroded householders the ability to consume the same level of goods over time. Unfortunately, right now we may be experiencing both scenarios at the same time.

How is that happening? For one, governments are handing out monthly cheques to workers sidelined at home, and not receiving as much goods or services in return. The methodology is complex, but in essence, The Government of Canada raises money to give out cheques by issuing new bonds to investors (savers).

The trouble is that savers are not buying the new bonds, given the extremely low rates, but the Bank of Canada is. They do so by effectively turning on the printing press and creating new money out of thin air. In effect, there is now more money circulating in our economy even though there has been a decrease in goods and services produced throughout the recession.

At the same time as the stay at home economy progresses, we see a shift in economic activity. Instead of eating at local restaurants, for example, the local operator is either closed or functioning at significantly reduced levels, leading to consumers eating at home. The grocer makes more sales, but there are fewer restaurant employees earning income. Combine that with social distancing policies throughout the system and it’s easy to imagine a complete revamping of the entire supply chain.

If this scenario plays out over the next few years what are the consequences? It will take some time for inflation to kick in, but with more money in the system, excess cash will be directed towards other asset classes. The most obvious are gold, cyclical stocks and residential real estate.

But there is another concern that centers around the political will to institute a living wage and/or raising the minimum wage, both of which have inflationary consequences.

If you include a fiscal stimulus bill for infrastructure spending then we may start to see longer term inflation impact the economy as it moves to a full recovery – this is of course, conditional on a successful vaccine.

For now there seems to be two active economies; those that can work from home and those that are experiencing massive unemployment and receiving government support. While this widening gulf between the haves and have nots is not inflationary, it is concerning for central banks around the world as their main goals are to keep inflation to a level of around two per cent, and to ensure full employment.

In an attempt to stabilize prices, the Government has thrown everything but the kitchen sink at the problem. This may have unintended consequences, that being inflation. The new normal is low growth, low interest rates and low inflation – for now.


Steve Bokor CFA is a licensed portfolio manager and Ian David Clark is a portfolio manager and certified financial planner with PI Financial Corp, a member of CIPF.