Thread by @TheLastBearSta1

🚨The Inflation Framework: A Thread👇👇

I don’t know whether we will see high or low inflation going forward – nobody does. Rather, I suggest considering the range of potential outcomes and their implications:

2. Beyond one’s prediction of inflation itself, it’s important to consider the macro assumptions that go along with it. If you expect low inflation because the asset bubble is about to implode, that is very different than expecting low-inflation in a strong growing economy.

3. Therefore, I propose the following matrix. (1) High vs. Low inflation vs. (2) Good and Bad Economy, and analyzing each of these quadrants in terms of their likelihood and implications:

4. First: Good Economy + Low Inflation = “Goldilocks”. Inflation is indeed transitory, and the strong economic growth continues. Supply chain disruptions caused by COVID resolve quickly and wage pressure abates as more employees return to the workforce.

5. Real earning power grows leading to growing consumption and GDP growth over the long term. QE and cheap rates can continue indefinitely and asset prices continue to rise indefinitely.

6. While the market continues to price this outcome - I think this scenario is highly unlikely, because there is no catalyst for an abatement in prices. The increased circulation of the massive increase in money supply will not lead to declining inflation.

7. With rising wealth effect, global growth supporting commodity prices, and consumers willing and able to pay high prices, I don't see prices decelerating. Supply chain easing simply translates into higher margins. However, if this scenario indeed proves true, get long on assets

8. Second: Good Economy + High Inflation = “Stalemate”. Inflation proves stickier than anticipated but the economy continues to improve as virus impact fades and global “normalization” continues. The acute supply chain pressures ease but core prices continue to rise well above 2%

9. This is a stalemate because nominal earning power will compete with higher inflation for real earnings growth. Increases in nominal earnings beget higher inflation, reducing the impact in real terms. Real consumption growth remains muted dampening the recovery.

10. Asset prices will struggle to continue gains as buying power does not increase uniformly, and markets remain fearful of Fed tightening. IMO – this is the most likely outcome if “good economy” is taken as a given.

11. Third: Bad Economy + Low Inflation = “Déjà vu”. In this scenario, a slowdown or outright decline in the economy crushes demand, commodities and asset prices, leading to rapid reduction in inflation back below historical levels.

12. I call it Déjà vu, because this is basically a repeat of recent advanced economy recessions, including the GFC. These arguments are have been well outlined by @coloradotravis, and I’m personally to sympathetic to them.

13. Indeed I’ve argued previously, the macro setup today does appear strikingly similar to 2008 at least at a high level. Fading stimulus, fading pent up demand, stock market collapse all are good arguments against inflation.

https://twitter.com/TheLastBearSta1/status/1407439405913198595?s=20

14. This scenario is “bad” because it assumes a bad economy – but at least its knowably bad and the monetary playbook employed the past decade continues to apply. Low rates, more printing, and eventually we will work our way out.

15. Four: Bad Economy + High Inflation = “Danger Zone”. Supply chain issues persist much longer than expected. Squeezed producers have only begun pushing prices onto consumers which will continue.

16. Wage pressure adds fuel to the fire while also limiting employment gains. Nominal earnings don’t grow, meanwhile inflation crushes real earnings power killing consumption. Limited inventories lead to higher prices even as buying power diminishes

17. Commodities (in particular, oil) are more resilient than 08 since starting from a much more subdued base. Keep in mind oil prices were $140 in 2008 dollars vs. $65 in 2021 dollars today. Core inflation looks worse, and monetary and fiscal stimulus have been much larger

18. Inflation forces a dramatic reversal in 50 years of loosening economic policy of monetary expansion which is devastating for an economy built on the assumption of cheaper and cheaper debt.

19. Asset prices are destroyed by crushed demand, crushed earnings, rising interest rates and monetary tightening. This scenario is unknowably bad. I don’t think it is the most likely – but I do think its possible, and that is pretty scary.

20. Finally - I'm just some dude on the internet. I really enjoy engagement with different perspectives so please add to the conversation!