Alberto Matellán, chief economist of MAPFRE Inversión.
Price is the most important variable for any economic decision. We make economic decisions in many different contexts, from professional asset management to a visit to the supermarket. Yet this information becomes useless if it is no longer reliable. If prices cease to be comparable over time, economic and financial decisions will become distorted. This may in turn lead to inefficiencies, a decline in well-being, inequality and other social problems. That is what happens when inflation is not moderate and stable, or so the doctrines of modern central banking say. In fact, inflation is key for investors because it largely determines the prices of financial assets and income growth from many real assets. However, this has not prevented it from becoming an overlooked variable in recent years, when it has been assumed that it is non-existent or very weak and will remain so for a long time.
One problem with the above reasoning lies in the meaning of inflation. Normally, when we talk about inflation, we are referring to the change in consumer prices, as recorded by the CPI. This is, in fact, a concern for central banks and economic authorities. But that is not the only meaning of inflation. Asset inflation occurs when the price of financial or real assets increases. Inflation can also refer to an increase in the amount of money, which may be the origin of the above meanings. In fact, the original concept of inflation is closely related to a disproportionate increase in money supply. According to some old-fashioned economists, printing money without an actual benchmark is not only a technical issue, but also a social and even moral one. And the fact is that if a lot of new money is created in a short period, the use of currency as a unit of measurement becomes meaningless. Imagine if a meter or a kilogram were suddenly no longer the same as three months ago; this would really complicate matters. That’s what happens with dollars and euros: there are currently almost 50 percent more of them in circulation than at the start of the year.
If we apply this to the stock market, in simplified terms, a share worth one euro six months ago would now be worth 1.5 euros, without anything having changed. What’s more, if this share, due to fundamentals, had fallen by 25 percent, it would still be worth (approximately) 25 percent more in euros than it was at the start of the year. This is asset inflation. This doesn’t transfer as easily to consumer prices where there are more intermediate steps and other factors that also have an influence, such as competition between companies or buyer confidence. Therefore, the classic monetary equation, which establishes a direct relationship between the amount of money and CPI inflation, has been ignored for a long time. But this shouldn’t prevent us from applying common sense: if large amounts of currency are printed, any price measured in that currency will go up, whether it’s the price of assets, consumer goods or other currencies.
The practical effect of the above is highly variable. It will be advantageous for those that are able to grow their income and wealth at the same level as the currency, but disadvantageous for those unable to do this. The fact that this concept is more transferable to asset inflation than to CPI is still— paradoxically—an element of stability in the short-term. Any related worsening is barely perceived by those most affected, since they have no basis for comparison; they have no assets to lose. On the contrary, if it translates into an increase in the CPI or even changes in relative consumer prices (for example, increases in food prices), then it can create social instability. Historically, the most significant destabilizing factor in a society is when households are unable to make a living, which worsens with CPI increases, but not necessarily with increased asset prices.
Investors often ask me if the current large-scale money printing will result in inflation. I respond by asking what type of inflation? If we are talking about an increase in the amount of money or the price of assets, well this is already happening. If we are talking about CPI, the answer isn’t as straightforward. The increase in the monetary base is contrasted with high unemployment, low consumer confidence and a zero-rate policy that is deflationary in terms of consumption. This interplay of forces may change in the future, but for now that’s how it is.
This doesn’t mean we are grasping in the dark; indeed there are certain things we are sure about. The upside CPI inflation risk is higher than the price position in the financial markets. But in any case, the threat exists in both directions. Forces are gathering strength both upside and downside and when either side wins, the change may be very sharp, especially in stocks and fixed income. Moreover, many managers and decision-makers in the market at the moment are not old enough to have worked and lived in an environment of very high inflation, so they may not be prepared for it. Furthermore, this is the first time in history that the phenomenon of massive monetary increase is occurring on a global scale; it’s like an experiment with unknown consequences. The point at which problems associated with the excessive printing of currency will develop is much further into the future than the decision-making time frame of the authorities and fund managers. Therefore, it makes sense that this is overlooked, and all the more so when it seems to be the only solution to certain short-term problems.
For all these reasons, inflationary changes in the future will not depend on the amount of money printed, but on how this money is allocated. It is, therefore, a psychological and social phenomenon rather than a technical one. And that means it can change very quickly. In any case, investors should monitor inflation in order to protect their assets instead of just assuming that it will remain very low.