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Ongoing Inflation

August 20, 2021

Inflation continues to be top of mind for most businesses. Is it a transitory concern that will subside soon, or a system issue? Catch our newest TrendsTalk episode with ITR CEO Brian Beaulieu for an update on inflation trends.



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The below transcript is a literal translation of the podcast audio that has been machine generated by Rev.

Hello. Thank you for joining us for this edition of ITR TrendsTalk. I'm Brian Beaulieu, CEO and Chief Economist of ITR Economics. Let's talk a little bit about inflation. It continues to be an ongoing issue in a lot of people's minds. And some people are, I think getting a little too hung up on whether it's transitory, whether it's systemic, whether it's enduring. It really depends on how you want to look at it. The Federal Reserve is thinking that it's transitory in the near term because so much of the inflation that we're seeing is driven by the congestion, driven by North American demand being stimulated and supply not being able to keep up. And then we just have congestion, bottlenecks all over, up and down the system. We have some ongoing concerns with COVID in China. All of that is leading to ongoing angst in will this inflation continue.

We think it's going to subside. This round of inflation is going to subside as the economy slows and supply chains normalize. Over the course of 2022, that seems to be the most probable occurrence, but we're going to only subside to a higher trough than we've seen before. And we're going to start off the next round of inflation from a whole new level. So in effect, this is the beginning of the systemic inflation, but don't think that 5% is going to endure, which is the more recent CPI number. It is not likely to. We're likely to see it subside to two, 2.2% inflation before we really see it subside.

When you are looking at that longer term inflation, there's really four factors that have to be considered. One is monetary driven inflation, monetized inflation, and that's the Federal Reserve. That isn't that much of a threat at the moment, despite all the money that's been created because the velocity of money remains low. Yes, we've seen a cyclical reversal in the velocity of money in association with this increase, this recent spike. We're about to see some more of that in the future with the next cycle, but it's not yet changed the secular trend that's been prevailing since the great recession really, and even slightly before that.

And that gets into why is the velocity of money going down? First, the velocity of money is inherently difficult to measure accurately. It's a great theory. It explains a lot. And our analysis and others suggest that the velocity of money really went down when tax laws were changed to favor net savers over net spenders, those with a marginal propensity to save being highest were the primary beneficiaries of any tax law changes over the last 20 years, really. Even longer if you want to look at all the data. So that had a lot to do with why we've seen the velocity of money to go down. It's just being taken out of circulation. In a sense, it's going through an intermediary before it gets put back into the economic cycle. So I don't think that's our major concern.

I think we're going to see more inflation logs put on the fire via ongoing labor shortages. Folks, we had a labor shortage pre pandemic. Why does anybody think we're not going to have an ongoing labor shortage after the pandemic? Particularly since some perspectives about working have changed, some attitudes, empowerment shifts have taken place. Labor is going to cost more. I mean, it is not going to be abundant in supply, and demand is going to grow as the economy grows. Supply isn't necessarily going to keep base. And as I mentioned, empowerment has shifted. So you're going to see persistent labor price inflation going forward that you have to build into your thinking, through productivity improvements, through automation needs, solutions, through being able to pass price increases through to the consumer, your consumer.

Other sorts of inflation will be commodity prices or other input prices. For instance, oil. Oil is going up in the future, as we showed during our July webinar that Alan and I did. That has to do with the price of the US dollar, the trade weighted exchange rate value of the US dollar. Other commodity prices are going to be going up also. Price escalators need to be part of your own survival kit to protect your bottom line, but at the same time, those very price escalators feed into this cycle of inflation. Okay, you've got one, so I'm going to need one because I'm your customer, et cetera. And eventually it feeds more rapidly through to the consumer price index.

And finally, there's fiscal policy that drives inflation. Fiscal policy drives inflation when there's significant deficit spending, and people define significant in different ways, but I'm talking about what began really in the 1980s as significant deficit spending. In particular, when we tripped over 80% of our GDP equal to our national debt, we passed a tipping point at that juncture. And it has had a demonstrable impact on the economy slowing down our growth. Productivity improvements have not been occurring like they did prior to the great recession, or particularly since before 2009. We're not seeing the capitalization of our businesses. Capital intensity just isn't there anymore, the building up of capital intensity. All of which means that inefficiencies are more and more embedded into our system. You combine that with nationalism and deficit spending and a Federal Reserve that accommodates that deficit spending, and that's the damnable part of all this, the Federal Reserve accommodates the deficit spending, and you're going to have a weaker and weaker US dollar, which gets you higher and higher inflation.

Go back to oil prices. We showed you with the oil prices. There's at least three primary inflation logs being placed onto this smoldering inflation issue right now. Perhaps a fourth, depending on what the Federal Reserve does with additional monetary policy. Now, the more logs you put on a fire, the brighter it blazes. The three logs that I just said that we know are happening today are significant enough to tell you that there is going to be more and more systemic inflation hitting through the rest of this decade. It is imperative upon business leaders to figure out how to cope with those relentless cost increases. Again, it's productivity, it's automation, it's passing through your cost structure to your customer, to the extent that you can. It's gaining efficiencies wherever you can.

That's our job. It's not going to go away just because the $300 stipend is going away on the unemployment compensation. It's not going to go away just because schools are opening up and some employees are going to be able to return to work. If we had a loose labor market prior to the COVID pandemic, you'd have an argument, but we didn't. We're at virtual full employment. You should assume that the rest of this decade, what we're going to be looking at is structural full employment. We've got to come up with effective business strategies to deal with that. Retaining your employees is probably the first step, making sure you can hold on to your employees, because training, replacing, recruiting is very expensive, but I'd rather do the training than the recruiting and the retraining of people over and over again. Train them once, pay them right, and do your best to hold on to them.

This has been Trends Talk. I'm Brian Beaulieu, CEO and Chief Economist of ITR Economics. Thank you.


Since 1948, we have provided business leaders with economic information, insight, analysis, and strategy. ITR Economics is the oldest privately held, continuously operating economic research and consulting firm in the US. With a knowledge base that spans six decades, we have an uncommon understanding of long-term economic trends as well as best practices ahead of changing market conditions. Our reputation is built on accurate, independent, and objective analysis.