🔮 Inflation Perspectives

🔮 Inflation Perspectives
Photo by Jason Dent / Unsplash

Evergreened version of inflation perspectives first published in the June 12, 2022 edition of S3T. Click the Subscribe button to sign up and get S3T in your inbox each week, or click Value in the top menu to learn more about S3T (pronounced "set").

A different kind of inflation problem

Raising interest rates is a tool that has been used and honed in scenarios where constricting the money supply would resolve the primary problem of "excess money."  Today's situation however is different due to a set of 3 drivers:

  • The perfect storm of a pandemic, supply chain, and war, culminating in a critical energy shortage.
  • The shift from globalization economic arrangements to regional economic arrangements and supply chains.
  • The shift from centralized tech platforms to decentralized tech platforms.

Given the issues facing us today, the question is whether raising the interest rates will do much good at all. The traditional solution for the rebuilding/remaking situations listed above would be to make money easier to obtain, not harder, and focus it on building more resilient manufacturing and supply chains to meet human needs.

In other words, if this were a "normal" era we'd say its time to invest, not cut. Let's look at the sets of 3 drivers that make this inflation problem different.

⏩ Driver #1: The perfect storm that led to the energy shortage

In this recent interview podcast, Lyn Alden shares a helpful breakdown of the perfect storm of macro factors in play - best segment starts about 11 minutes in:

  • We created an energy glut via shale, alternative fuels.
  • At the same time legitimate ESG concerns put a damper on energy investing outside of green energy. Green energy made great strides but did not attain the ability to take over significant (enough) portions of the world's energy needs.
  • The pandemic shutdown temporarily masked the severity of the situation.
  • Post pandemic reopening, the Ukraine war, the lack of upkeep in trad-fuels, supply chain challenges all combine to create a critical energy shortage. This shortage exacerbates inflation - the inflation driven by the pandemic stimulus, as well as the unacknowledged inflation that existed before the pandemic. (see Flawed Inflation Tracking S3T Feb 27).

⏩ Driver #2: The shift from global to regional economics

The 2nd reason this inflation problem is different is that the supply demand dynamic here is different.

Demand is not exceeding supply because consumers have "excess money" and just want too much stuff. Demand is being driven by non-negotiable needs of consumers. To be more specific:

  • Demand is exceeding supply because the globalized corporations and banks of the world are failing to deliver.
  • The globalized world order that promised to deliver all personal needs at Walmart prices is currently "experiencing service interruptions."

Why is this an important point? Because demand in this case is not simply a factor that "people just have too much money" or "too many frivolous desires." People can't get enough of the basics they need, because the global system that was supposed to deliver their needs is collapsing. A new set of regional alliances are forming but this will take time. Again, as counterintuitive and inconvenient as this may sound its time to invest not cut.

In this context, raising interest rates feels like turning your radio up because your car lost its brakes.

⏩ Driver #3: Centralized tech to decentralized tech

The 3rd reason this inflation problem is different relates to a shift underway in tech. The tech sector is shifting from centralized to decentralized platforms and this shift is underway in part because centralized platform companies descredited themselves: exploiting data and workers while ignoring fundamentals of the companies they were growing.

Tiger, the hedge fund that went all in on leading tech stocks has seen its value cut in half. Some investors say this is a healthy shakeout not a collapse because unlike the dotcom meltdown, today's tech companies have significant customer bases and revenues.

But this more than just a shakeout of a few less healthy companies. This may be more like a reset of the entire playing field (NLW calls it the great repricing).  

Lured by the outside gains of tech unicorns over the past decade, VC‘s wrote large checks for anything that smelled like a unicorn. Fundamentals (like profitability, sustainable business mode, etc) didn't matter because the new dogma was

  • unicorns are just different,
  • there's plenty of capital
  • you don't want to miss out

Amid today's macro conditions, these “fundamentals don’t matter” check-writers are getting burned badly and are in capital preservation mode - for their non-crypto and crypto holdings alike. This of course is impacting prices of everything from tech stocks to bitcoin.

Fundamentals do matter. And something about the way fundamentals work is changing. They'll work differently in the near future.

Many - not all - of the unicorns of the past 10 years used exploitative centralized platforms that are now being questioned. The rise of decentralized web3 technologies is offering an alternative to these centralized exploitative platforms.

Side note: a lot of talent was ingested into the tech sector over the past several years - and crypto in the past year. That is now reversing: a significant amount of talent is being dumped back out on onto the streets. This could depress consumer spending and demand for non-basic goods.

Crypto and web3 companies will struggle - whether they were offering scams or building important new capabilities - they'll both be impacted.

📉 Recession?  

The macro factors in play today frame up what to expect in the kind of recession that could play out over 2022-23:

  • Food and fuel supply will be an issue more acute for some populations than others.
  • Fuel will (continue to) be an inflation factor for any retail foods/goods that require transport.
  • As prices for food, gas and daily needs go noticeably higher, many consumers will reduce their spending and travel.

Prices will stay high until supply increases...but supply can't increase until:

  • larger systemic problems are resolved: war, lockdowns in China based manufacturing hubs, supply chain issues, and changes in the labor pool.
  • key shifts underway in the global economy and the tech sector have progressed to a point where the new is able to compensate for the failings of the old.

These two points give words to the vague fear being felt right now: we may be facing a different kind of inflation problem (that interest rates can't resolve) and it may take time to play out.

Update Nov 2022: Fed Vice Chair Lael Brainard worries we face a future with a "more volatile" kind of inflation.

🔭 What to watch

Look below the noise and watch for signs of the underlying fundamental shifts taking place. Those may be delayed but not ultimately stopped by the current economic churn.

The post-globalized world order made up of regional alliances will continue to evolve. This will likely be a boost for regional manufacturing and the further advancement of 3d printing and micro manufacturing.

The shift toward decentralized tech platforms will continue, albeit at the pace that capital availability and regulatory clarity and engagement allows.

As I've noted before, this is a time for patient investing in and building out the next generation capabilities. Until those better capabilities come on line, it will be tough. This is a time to be alert and ready to adapt.

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