As we enter the mark the end of April and the tenth week of life with COVID-19, we hope you and yours are experiencing good health and continued safety. For many of us, this period has given us a renewed focus and prioritization on what matters the most in life. While the realities of this horrible pandemic have presented challenges to us all, we are encouraged by the humanity we have seen in virtually all aspects of life. Though uncertainty remains, we are confident that we will all emerge from this challenging period with new perspective and renewed strength.
As the market has provided us with the opportunity, the team at Greenwood Gearhart has been hard at work reviewing portfolio holdings, strategically shifting capital, and overall upgrading the portfolio at better prices. We have favored holdings with higher quality balance sheets in sectors with fewer capital needs, higher intellectual property, and capacity to serve their customers in an increasingly digital economy. We believe these companies will emerge stronger and are confident the purchases we are making today will prove fruitful over the long haul. We are actively working to increase the likelihood of success in your (and our) portfolios in a post-COVID-19 world.
Over the past few weeks, we have received several questions from clients about the inflationary impact of the stimulus measures undertaken by the United States and governments around the world. Will this massive stimulus and “money printing” cause runaway inflation? For interested readers, Director of Research Johann Komander shares the firm’s thoughts on this important topic for the economy and investment environment.
Printing Money and the Impact on Inflation
The primary determinant of inflation is the balance between money supply and the equilibrium of supply and demand of goods and services in the economy. Demand for goods and services has dropped due to the virus and, even under optimistic scenarios, is projected to be lackluster for some time. Even before COVID-19 made matters worse, the trade war and increasingly protectionist policies globally were creating economic frictions. On the other side of the equation, the supply of goods and services has structurally increased largely due to technological change, the proliferation of e-commerce, and resulting efficiency gains in worker productivity, manufacturing processes, and transportation. As the economy shut down, a supply glut of goods and services ensued, most prevalently in the oil markets which was then exacerbated by the Saudi/Russia conflict. These factors are creating disinflationary pressure in the opposite direction as the potential inflationary impact of printing money. This dynamic has been dominating the economic landscape for years and is a source of frustration for the Federal Reserve, who has been stubbornly trying to spur limited inflation for a decade.
The scenario where inflation may rear its ugly head is if the pendulum swings the other way. In this scenario, the global economy bounces significantly, consumes the excess capacity currently overhanging the market, and then starts to run hot all while the economy is flush with too much cash. Even if this occurs, however, there are still several other factors pushing the other way:
- Most of the developed world is in economic stagnation or contraction, with interest rates at zero or negative in many countries.
- Because of this, interest rates in the US will likely struggle to rise significantly and may remain negative elsewhere. If we do see higher US rates, we may also see increased dollar inflows thereby appreciating the US Dollar (USD), and bringing down the cost of imported goods (yet another source of disinflationary pressure). This 'quicksand' effect is part of what has been driving rates lower even before the virus started.
- We are also seeing a structural shortage of US dollars globally as non-US corporations have issued USD debt only to then see their home currencies depreciate.
- From a labor perspective, wages are likely to remain low given the massive population entering the middle class in China and India. This trend means more workers available to create goods and services cheaper than in developed economies. Despite protectionism, the global economy is interconnected and co-dependent and these factors will continue to impact labor costs at home.
- Additionally, the impact of technological innovation on production processes and thus, costs, may mean many jobs will disappear, another factor contributing to low wages.
Because of these factors “pushing against inflation”, we believe consumer price inflation is low on the list of short-term concerns. The most likely scenario is that we continue to see asset inflation in places like real estate, farmland, and perhaps the equity markets where excess cash has been flowing of late (hence the rapid recovery we’ve seen over the last month). This type of inflation feels good in the short-run but provides for other risks we are closely monitoring in the long-run.
The Bottom Line
While we are, in many ways, in unchartered territory, printing money certainly may pose a long-term inflationary risk. However, in our opinion some of the nearer term factors are likely to continue to keep it tepid for some time. Practically, if deficit spending simply replaces wages that would have been generated and paid by business, then there is no doubling up – it is replacement income and thus, should not pressure inflation. But if government, business, and consumers are all spending at once, thus doubling or tripling “normal” spending, then perhaps inflation is the result. How the money is spent, is a major factor in determining the inflation risk.
The Lesser of Two Evils
Finally, it’s important to consider the consequences of not acting in the way the Fed and Treasury has. In some ways, these consequences of spending represent the lesser of two evils. In our opinion, if the US government had not intervened, we could have seen credit seize up as in 2008-09. This time, they avoided this catastrophe (albeit narrowly). Against a backdrop of a shut-down economy – and the resulting supply and demand glut, business failures, and high unemployment – spending our way through this challenging period may be our best approach with highest probability of success.
Director of Research