A spill-out of lurking inflation shouldn’t be a surprise

All this was prior to the Ukraine invasion and war. And then oil spiked to almost $140 per barrel. Steel and other commodities went up sharply. So now inflation in the US has within a whisker of 8%, significantly higher even than in India. American inflation expectations for next year are running at 5.3%, as measured by the trading values of inflation-protected US Treasury securities. Even longer-term inflation expectations over the next five years and beyond are closer to 3%, which is unusual for the US. It has taken full two years, and as Federal Reserve Chair Jerome Powell called it, the “game changer" event of Ukraine, for the US central bank to grudgingly switch from a language of “temporary" or “transient" to “permanent" or “durable" inflation. The Fed mandarins, barring small dissenting voices, were simply unwilling to accept that inflation is a likely major problem this decade, and it will certainly manifest in wage hikes and a higher cost of living. How the Fed will meet its objective of keeping inflation expectations anchored at 2% is yet to be seen.

That the inflation expectation genie is out of the bottle should not surprise us. The real surprise is that it took so long. Since 2010, the US economy is about 60% bigger, but the Fed’s balance sheet is 300% larger. Money supply is growing five times faster than the stock of goods and services. Even an elementary school kid knows that if there is too much money chasing too few goods, it must lead to inflation. How come inflation was so low for so long? Remember, just two years ago, the Fed was trying to bump “up" the inflation rate (not down). Where was inflation hiding? This is an easy question and the Fed knows the answer. Here’s a clue. The Dow Jones Industrial Average was at 8,000 in January 2009 and is now at 34,000. That’s up fourfold. Now look at one more data point. The All Transactions House Price Index compiled by the St. Louis Fed has gone from 313 in 2011 to 560 at present, a rise of 80%. Housing prices have risen faster than US gross domestic product (GDP) in this long decade. And that’s just the country-wide average. If you take regional or city-wise data, the rise is steeper. Stocks and homes were where inflation was hidden in plain view. Add to that some froth in commodity and gold prices too. And now crypto.

Jumping to another continent, where the sun has always shone on its economy, let’s look at Australia. It has the distinction of never having had a recession in 30 years, except a few months of the pandemic in 2020. Here too, we have the same story: money supply growing much faster than income but not producing conventional inflation. In 2021, housing values grew by 22%, but wages rose only 2.8%. It is clear where surplus money creation has been going. Actually, money supply is all about credit creation, not just printing currency. In Australia, home loan rates are very low and housing debt has been galloping. Its household debt-to-GDP ratio is now 120%, the second highest in the world, and consists largely of mortgages. Sydney and Melbourne are among the least affordable cities to live in from a housing cost point of view. Rental yields are higher than interest costs and rents are raging up after a pandemic-mandated moratorium. This housing inflation (both rentals and capital appreciation) is seen across many Organisation for Economic Co-operation and Development (OECD) countries, across London, Paris, Toronto and Hong Kong, and India is not immune. Sydney is a place where a great majority cannot afford to buy the house that they live in. In Australia, there are over 100,000 homeless people and also more than twice as many vacant houses.

The asset inflation in stocks and housing helps mainly those in the upper-income bracket. Thus, monetary policy of the past decade, made ultra-loose by the pandemic, has worsened inequality, both in wealth and income. This is an inadvertent but harmful side-effect, and fiscal policy will have to make amends. The rather late but eventual manifestation of high inflation, along with slowing economies, has led to global talk of stagflation. Governments are now under pressure to undo the damage caused by loose money on inequality. The welfarism of India was much discussed during recent state elections, but it is a template in other parts of the world too, even as unicorns rise and housing prices bubble.

As for controlling the house-price mania, Australia already has an extra tax on vacant houses. That is on top of property tax. Canada is thinking of a two-year ban on foreigners buying real estate. Meanwhile, every country is struggling to provide affordable housing. In India, the government gives land parcels to builders to build large townships of low-cost housing. But the tsunami of asset inflation continues. And some of it will leak out as generalized inflation this decade.

Ajit Ranade is a Pune-based economist