This special QuickHit Cage Match edition is joined by opposing sides of inflation versus deflation with Steven van Metre and Peter Boockvar. Why one thinks we’re having deflation and the other believes in inflation? How soon will this happen and to which commodities and industries?
This is the first part of the discussion.
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Steven van Metre is a money manager who have invented a strategy called Portfolio Shield. He also has a YouTube show that discusses economic data and the news three days a week.
Peter Boockvar is the Chief Investment Officer and portfolio manager at Bleakley Advisory Group. He has a daily macromarket economic newsletter called The Boock Report.
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This QuickHit episode was recorded on October 14, 2021.
The views and opinions expressed in this Quick Hit Cage Match: Van Metre vs Boockvar on Inflation episode are those of the guest and do not necessarily reflect the official policy or position of Complete Intelligence. Any contents provided by our guest are of their opinion and are not intended to malign any political party, religion, ethnic group, club, organization, company, individual or anyone or anything.
TS: I kind of want to start broadly here. So if you could give me your two minute elevator pitch on your view on whether you’re an inflationist or deflationist, even though we already know who is who. And how fluid is your view?
PB: So if we just break down, inflation is just the simple, too much money chasing too few goods. We certainly have too few goods with supply challenges around the world and too much money with a lot of fiscal spending over the past 18 months financed by the Federal Reserve buying most of that debt that the treasury issued to finance a lot of this fiscal spending. So it’s combining with inflation situation where it’s really just a good side. That is the part of the debate.
Services inflation is rather persistent. For the past 20 years leading into Covid, services inflation XNERGY is averaged almost 3%, but goods have been basically zero. And it’s always that trade off that has resulted in an inflation rate of 1% to 2% over the last couple of decades. But now you are back on trend with services inflation, and I’ll argue that will accelerate from here because of rents. And now you combine that with a period of goods inflation. Now, goods inflation is typically cyclical, if history is any guide. But how long of a cyclical rise we have really is the question. And I just think it’s not going to be so short term that it could last a couple of years.
SVM: Yeah. So I think that the inflation story is going to be more, at least the former Fed’s view of being on the transitory side, and I take that view strictly from my understanding of how the monetary system works, looking at the velocity of money, the fiscal stimulus cliff going away.
While I do agree that Peter will be right and that we will likely see higher inflation, and I agree in where he thinks it’s coming from in terms of the supply chain. I completely agree with that. But I do think ultimately those higher prices will get rejected without a sustained amount of new money coming in from fiscal or other means or from lending growth. And so even though we’ll see rising prices and they will probably go up a bit more, ultimately, I think the consumer will reject them just like we saw during the great financial crisis and that we are more likely to see inflation turn down pretty hard and perhaps even into the deflation.
TS: Either one of you can jump in here. Where do you see inflation, deflation hitting the soonest and the hardest? We’re looking at commodities that are still running very hot, supply chains that are very stressed. At what point do you think we see demand destruction? And how long do you think that we’re going to see these extremes in the destruction and supply chains that are causing much of this current inflation?
PB: Well, we’re already seeing some demand responses. We are seeing a slowdown in economic growth. Part of that is a pushback against these price increases. If you look at the housing market, there’s particularly the first time home buyer that has sticker shock and doesn’t want to pay for a home that’s priced 20% more than it was a year ago. And they’re saying, okay, let me take a pause here.
So there is some of that. But then, of course, there’s also some forced demand destruction because enough product can’t be delivered and that an auto plan has to shut down an assembly line because they can’t get enough parts, and they’re not sure when they’re going to be able to get enough. Or it’s Nike that can’t deliver enough store product to foot locker because it’s going to take 80 days to get it from their factory in Vietnam rather than 40 days.
Now, at some point, goods, inflation is going to be temporary. The question is, how long does it take to resolve itself? And one of the things that I think will unfold here is that let’s just take transportation costs, because that is a main factor in the rise in inflation, because every single thing that’s made in this world ends up on a plane, a ship, a truck or a railroad to get it from point A to point B.
So let’s just say I’m a toy manufacturer, and my transportation costs are now 35% year of year on top of the cost of my wholesale cost to actually get the product, and my cost of labor is up 5% to 7% year over year. Well, I’m not going to recoup that all in one shot by raising prices to Walmart by 10%. It could take me a couple of years to recoup that. But I promise you, I’m going to do my best to do so, and I’m going to space that out. I’m going to try my best to cushion the blow to that end, buyer who’s buying for their kids for Christmas by spacing out that price increase. But I know I’m going to have visibility because everyone else is going to be doing the same thing for the next three years in raising prices so I can recapture, I may not be able to regain completely, but recapture some of my lost profit margin. So that’s one of the reasons why I think this is going to be sticky.
And to Steve’s point, yes, there’s going to be a fiscal fall up next year to some extent. We’ll see how much of the lost transferred payments are going to be offset by both the child tax money, plus people going back to work. We saw jobs claim have a two handle today for the first time since pre-Covid and to what extent wage increases can offset the rise in the cost of living? And yeah, we’ll have to see that. But the question is, how much do prices come back in?
You take lumber, for example, and I’ll give it to Steve right after this, lumber prices in the heart of the housing bubble in the mid 2000s was about $300. Now it went up to $1600 now it’s about 650. The cost of a home, construction wise, and what a builder would charge their customer is not going back to where it was. They are going to use this and fatten their margin as best they can, and it’s going to take years for that buyer to experience what is truly reflected at 650 lumber, but that’s even more than double where it was. So it’s still multiple years of price increases that are going to flew through the chain.
SVM: Yeah. Peter, you bring up some absolutely excellent points about how long this could go. And that’s something I really haven’t considered that it could run a couple of years because I look at this fiscal cliff and to me, you go back to the pandemic and we know all this was driven by fiscal stimulus. And without it, and I know we still have the child tax credit for a bit. I’m just concerned that this drop off comes a lot stronger than most people are expecting. And I do realize a lot of these goods are sitting off ports waiting to get shipped in, waiting for truckers to take them to warehouses and eventually on the stores.
The question I keep asking is when those goods hit the shelves, will consumers be there with money? Do they have the money to spend? Are they going to go back to work fast enough? And even though, as you mentioned, we had a two handle today, we both know that that’s almost 50% higher than normal.
So the question is we still see this huge amount of job openings everywhere. We’re not seeing people go back to work. We saw the jolt state. I know you looked at that recently from the other day where people are quitting their jobs. And so I keep coming back to the same question is will consumers come and spend and keep these prices up? If they don’t, then we get the reversal. But that’s my question. Do they come?
PB: It’s a great question of whether that will be the case. I don’t think the labor market is going back to where it was pre Covid. And all you have to do is look at the participation rate to confirm that, particularly for the age group of 25 to 54 year olds, which is sort of the core wage earning population, and it’s still well below where it was in February 2020. So, yeah, we’re not going back to a 3.5% unemployment rate with the same number of employed people anytime soon.
Now, what is replacing a lot of the lost sort of or not made up fiscal money that has been spent, particularly December 2020 with Trump’s last fiscal package and then repeated just a few months later with Biden, is that eventually we do have that child tax money that’s going out. We do have an increase in food stamps. Basically that reservation wage, which is basically the wage level at which someone has a tough choice of whether do they go take that job or do they collect all the government handout? That continues to go up.
So that person who may not want to go back to work while they’re getting a lot of benefits elsewhere. And while the aggregate, we’re going to probably see some sort of fiscal drop off. The question is, is that enough from the demand side to offset what’s going on in the supply side?
Now, again, supply side is going to normalize at some point. There’s no question about it. Just a matter of when. Taiwan semi is spending billions of dollars that just broke ground in June in Arizona to build a semi plant. Well, it’s not going to be done until 2024.
Now, there could be a lot of double ordering, triple ordering that’s going on in Semis right now. We’re going to have this major inventory hangover. We’re already actually seeing it in DRAM, for example. And that could happen. And there’s going to be a mess at the other end of this. I just think that this drags out and also a key part of this inflation debate, too, is in what context is this coming in?
If we had a Fed funds rate in the US of 3%, if we had a ten year at four to five, if we didn’t have such thing as negative interest rates, I’d say, “you know what the world can handle about of higher inflation because interest rates are higher. If equity valuations weren’t as extreme as they are and they were more in line with history,” I would say, okay, “we can absorb it.” But that’s not the case right now. We have valuations that are excessive in a variety of different things. Obviously, we have zero interest rates, negative interest rates, QE and so on. So even if inflation decelerated to, let’s just say a 3% rate for a year or two. I just don’t think that the world is positioned for that.
SVM: Yeah. I’m not worried about the upper 50%. I’m really curious about the bottom 50%, who is really the big recipients. I know a lot of people got the fiscal checks, but my wife is a fourth grade teacher, and one of the problems they’re having in schools right now, and you’ve probably been hearing about this is a kid or a staff or a teacher gets Covid, and next thing you know, they’re quarantining out segments of the classroom. They’re sending them home. And the parents are really struggling with this because they want to go back to work. But then all of a sudden, their kids back and they can’t.
And so they’re forced to stay at home and they don’t have the family support. Maybe they don’t want to send the kids to grandma and grandpa because they don’t want them to get sick in case their kid has it. And so I keep wondering, without all this fiscal support from the government is the natural expectation, particularly with higher energy prices, as we go into the winter, that these cash-strapped households are going to ultimately make the choice to I’ve got to buy food. We all know that’s gone up. We have to pay for energy. We know that’s gone up. As Peter, as you mentioned earlier, that rents are probably going up. So what does that leave in terms of discretionary income to spend to drive inflation?
And I kind of wonder, without their spending power, how is this going to last? And that’s my big concern is I don’t think it does. I think consumers are going to reject it. I don’t think they have the income. I don’t think the money supply is growing fast enough. And then you start looking at the dollar and interest rates and you would want to see the dollar going down. You want to see interest rates going up and we keep seeing the dollar fighting to go higher.
We keep seeing interest rates trying to press back lower, and it’s telling us that financial conditions are tight. And, of course, the Feds potentially about to taper and start to remove their support of that. And I just keep kind of shaking my head going, like, how are we going to get through the holiday season unless consumers come out and spend a big way? I’m just not convinced.
TS: Well, perfect segue into what I kind of wanted to get into next was talking about the Fed tapering. So first, because everybody’s talking about this. Do you see the Fed tapering? And if they do, how much is this going to affect inflation? And also, I know the market is saying the Fed is going to raise rates in ’22, ’23. But is this a reality at all?