Caiaimage / Paul Bradbury

The wilder the party, the bigger the hangover

The post-Covid recovery is set to roar, but will surely bring inflation in its wake

Tim Congdon

This article is taken from the May 2021 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering five issue for just £10.

Boom times are here again. Nowadays business surveys are followed closely by economists and participants in financial markets, as they are among the most reliable real-time evidence of what is happening. 

The March manufacturing survey from the United States of America’s Institute of Supply and Management was a corker. The Institute’s purchasing managers’ index, which collates information on orders and production, reached the highest level since December 1983. 

To recall, December 1983 was in the early stages of the Reagan boom. The USA’s national output rose by 4.6 per cent in 1983 and by a stonking 7.2 per cent in 1984, while inflation stayed under control. Reagan’s election landslide in November 1984 saw him securing almost 60 per cent of the popular vote and winning 49 of the 50 states.

As the USA remains on most measures the world’s most important economy, its boom is positive for world economic activity. In the UK also the latest purchasing managers’ index for manufacturing is buoyant, with the strongest number for a decade. Particularly remarkable is that in both nations coronavirus-related restrictions are still in force, if expected to be eased in coming weeks.

Money and inflation are related, whatever the qualifications about the “long and variable lags”

The surveys I have just cited refer to manufacturing. But it is clear that — as the restrictions come to an end — the most spectacular gains will be in spending on services. 

The USA and the UK are not the world of course, and conditions vary elsewhere. But nowhere is a major slowdown imminent. Although the Eurozone countries are undoubtedly behind the USA and the UK because of the delays in vaccination programmes, a bounce-back will happen sooner or later. From an economic perspective the rest of 2021 promises to be a big global party, as households spend freely after the clampdown enforced by Covid-19, and companies make up for postponed investment and the deferral of expansion plans. 

But big parties tend to become wild and to be followed by hangovers, while the better and wilder the party, the bigger and more painful the hangover. Timothy Fiore, chair of the US ISM, remarked in the press release accompanying the March survey results that, “companies and suppliers continue to struggle to meet increasing rates of demand due to coronavirus impacts limiting availability of parts and materials”.

Commodity prices plunged in the opening months of 2020 as the coronavirus shock was felt, but in the year from April 2020 — according to the representative S & P GSCI index — they have doubled. Upward pressures on costs are already evident in the major economies, even before the boom has properly begun. Those upward pressures will intensify as the festivities become livelier, and inflation — perhaps much more inflation — will be the result. 

Nearly all forecasters now accept that consumer inflation in the USA and several other countries will move above three per cent this year. The debate is about what is to be expected in 2022 and 2023. A minority of economists — who include the author of this column — have pointed out since last spring that leading central banks are engaged in an extraordinary experiment. 

Annual growth rates of the quantity of money are everywhere in the double digits and in the USA they are even above 20 per cent. Since these numbers are far ahead of the trend growth rate of real output, the implication is that inflation will exceed 5 per cent. Even double-digit numbers are not to be dismissed as inconceivable. Money and inflation are related, whatever the qualifications about the “long and variable lags” — to quote Milton Friedman — that separate them in most business cycles. 

The New Keynesian economists who guide policy thinking pay no attention to money statistics

However, the majority of the economics profession is more complacent. Most forecasters say that this year’s rise in inflation will prove temporary, because persistent slack in labour markets will check wage and price increases in future. Indeed, the New Keynesian economists who guide policy thinking at both the USA’s central bank, the Federal Reserve, and the European Central Bank pay no attention at all to money statistics.

Crucial to the outcome of the debate will be policy decisions in North America and Europe in the next few months. The longest-serving chairman of the USA’s central bank, the Federal Reserve, was William McChesney Martin from 1951 to 1970. 

In a famous speech to New York investment bankers in October 1955 he remarked, “In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects — if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has the punch bowl removed just when the party was really warming up.” 

The current Fed chair, Jay Powell, enjoyed much applause last summer. A magazine image had him holding toy pistols that squirted endless quantities of newly-printed dollar bills at Wall Street and Main Street. No one knows exactly when the hangover will come or how bad it will be, but a hangover of some kind is inevitable.

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