Productive Inflation


Back when I was a kid, my after school evenings used to consist of back to back episodes of a Japanese manga called Shinchan that aired almost everyday. It was about the daily antics of a naughty and funny 5 year old Japanese schoolboy named but of course, Shinchan!

His naughty shenanigans were an inspiration for me then. And similarly enjoyable was the Schadenfreude whenever he got caught.

I know what you’re thinking. But no, this is still all on topic.

A particular episode I remember was about Shinchan accompanying his mother to buy an AC at the nearest departmental store during a particularly brutal heatwave.

They end up looking at 10s of different AC’s and finally a couple hours of intense pro-con analysis later they end up finalizing one.

On reaching the billing counter, his mother realizes that AC prices have been consistently going down over the years. And she starts wondering if it would make more sense to wait a couple months and get it cheaper.

This was due to a combination of factors.

Firstly Japan is a deflation prone country ever since the Great Japanese Recession of 1990 so cash actually provides non negative returns.

Secondly AC’s are relatively new technology and have considerable scope for technology & efficiency improvements as well as cost reduction measures.

Thirdly for relatively new products, maximum economies of scale haven’t been fully achieved.

Guess what Shinchan’s mom ended up doing?

She deferred her purchase.

Although all this seems quite inane, this ground my 10 year old self’s gears real hard. And I had my first real world foray of many into Economics.

What I realized was simple.

In a deflationary environment, it is insanely difficult to break the feedback mechanisms of self-defeating deflation.

Allow me to simplify.

Deflation is basically prices of goods decreasing year-over-year.

Hence, people and companies tend to under-spend, under-invest and hoard cash because it is a safer, more attractive investment compared to the alternatives.

This gives rise to further deflation as demand decreases and thus the cycle of doom continues.

People like Shinchan’s mom unwittingly end up contributing to the cycle and also end up becoming victims of the same.

Deflation is thus a curse. And I’m more than pleased to report that this isn’t breaking news.

All (yes, ALL) central banks in the world pursue an inflationary environment.

Mathematicians and economists have calculated that the ideal amount of inflation for an economy is slightly below 2%.

More than that and we head into excess, needless and non productive inflation which opens up its own set of Pandora’s boxes.

While the solution to this problem sounds very simple, it is all but a nightmare to achieve in reality.

For those of you who pay attention to equity/bond markets and economic news in general you probably know that inflation has been muted ever since the great financial crisis of 2008/9.

We have spent more than a decade in a sub-par inflationary state at best and downright deflation at the worst.

Each weapon in the grand arsenal of central banks failed one after another to generate that magic number of around 2% no matter how hard they tried.

Some in more developed nations even resorted to outright money printing (in lieu of decreasing govt bond yields) using mechanisms with increasingly obscure names than the next.

It started with the Fed going all out with Quantitative Easing.

The ECB followed next with its Outright Monetary Transactions.

While poor deflationary Japan which was already doing some form of QE since 2001 went into overdrive with random asset purchases including literally pumping money into the Nikkei. (Something funnily the Swiss Central Bank would follow starting in 2016)

Even the central banks of the UK, Sweden, Australia, Canada and NZ jumped into the fray with varying degrees of measures. And at one point during the peak of the pandemic we even had China and India anxiously put a toe in.

But nothing seemed to work.

Inflation was persistently undershooting and even after years of the metaphorical money printers going brrr there was no end or solution in sight.

More acronym’s were created. TLTRO’s, PEPP, ZIRP, LSAP’s to name a few.

Then came 2020.

While mostly remembered for “the thing that need not be named”, it was a very notable year in terms of economic innovation and experimentation.

Everything but time ground to a halt.

People got desperate. The governments even more so.

And thus began an era of what I like to call Neo-Economics.

Chiefly among it was a renewed focus on targeted QE coupled with straight up instances of Helicopter Money!

Developed nations were handing out stimulus cash to every man, woman and child like there was no tomorrow.

While initially expected to cause little effect in the grander scheme of things, this initial spark of no holds barred stimulus lit the flame for an eventual inflationary feedback cycle.

Initially it turned out quite rosy.

People were happy because they got free money. Politicians were happy because they would get re-elected. And companies were happy because they saw an light at the end of the doom gloom tunnel.

Eventually though as the great bane of “the thing that need not be named” started waning people all around the world simultaneously began spending their excess reserves at a time when the supply side had barely recovered.

This led to spectacular well documented shortfalls of everything from computer chips to simple screws. Unfinished cars were stuck on assembly lines. Transport ships and trucks were stranded due to lack of spares. Even talent was difficult to find as people had migrated elsewhere or didn’t want to go back to their old low paying jobs.

A simple demand-supply mis-calibration akin to the one in deflationary cycles but in the opposite direction. Think rising CPI, labour market tightening and increasing pressure on profit margins.

And thus the present day specter of uncontrolled inflation was born.

Fast forward to mid-year 2022 and the butterfly effects are all but obvious.

We have developing nations nearing double digit inflation numbers which are being regularly revised upwards!

Slightly below 2% is still a far fetched dream.

You can’t find a news source that doesn’t have an article on inflation or stagflation on its front page headlines.

All this is unprecedented in recent history and the last time something similar to this happened was way back in the 1980s.

And don’t even get me started on increasing Geo-political tensions, wars and military build-ups contributing to the chaos.

What does all this mean I hear you ask.

Quite simply, nothing. Or maybe everything. It depends on your perspective.

Humans are complex social creatures and prone to error, mis-judgement and repeating previous mistakes courtesy of our hubris prone minds and persistent rear-view myopia.

Realizing this is the key to understanding and being able to live with cycles of inflationary and deflationary environments and truth be told life in general.

While reality and time are constants that can’t be tampered with and pay heed to none, what we can do is learn to live with it and exploit it the best we can.

Volatility is key to achieving investment Alpha. Without it, it’s all but a Greek Alphabet.

Disclaimer: These are merely glimpses of my casual everyday thoughts, opinions and observations; not to be conflated with absolute truth or gospel. Writing is just an outlet hobby I enjoy in my leisure time. Also, I can only express so much in a page or two. Please forgive minor inconsistencies or errors and feel free to harangue me for major ones. I welcome both constructive and critical feedback :)