Anyone who follows the capital markets can’t have helped but notice rising jitters about inflation, triggered by multiple bouts of monetary and fiscal stimulus by global governments and central banks with the goal of offsetting the worst economic impacts of the coronavirus pandemic.
In the US, for example, concern about President Joe Biden’s $1.9 trillion Covid relief package and proposed $2 trillion infrastructure bill contributed to the 10-year breakeven rate, a widely used proxy for inflation expectations, exceeding the Federal Reserve’s 2% inflation target by about 30 basis points.
Short-term shifts in inflation tend to be a product of scarcity – a semiconductor shortage causes the price of graphic processor units to surge — but over a longer horizon there’s a push and pull between the upward pressure from rising populations and debt, and downward pressure exerted by efficiency gains that allow us to produce more for less.
However, even as total debt continues to expand – by $24 trillion to a record $281 trillion last year, according to the Institute of International Finance – the global population growth rate has almost halved to a little over 1% over the past 60 years, while the US population would be shrinking without immigration.
At the same time, the pace of technological progress has accelerated exponentially, which has a multiplier effect on productivity. A single $100,000 Nvidia A100 system has the potential to produce a breakthrough that creates many times its cost in additional value every day. Now apply that across the entire cloud.
So while near-zero rates and asset purchases by central banks place us in a period of significant debt expansion (US investment-grade bond issuance reached a record $1.687 trillion last year, a 60% rise over 2019, according to S&P), we are in a much more significant phase of ever-accelerating technological advancement.
Which makes you wonder why markets are so convinced we’re going to see a surge in inflation, especially when you consider that most of the stimulus didn’t create new growth, but replaced economic activity that ceased during the worst of the pandemic.
Does it not seem logical that inflationary pressure created by more borrowing is countered, or even canceled out, by deflationary potential from slowing population growth and accelerating technological progress, the latter of which is only likely to further increase in pace as we enter the era of artificial intelligence?
The best answer I can provide is possibly, possibly not, because countless other variables impact this extraordinarily complex system that endlessly adapts to every tiny change and input. Such sensitivity means it’s asking a lot to narrowly predict where inflation will land with any degree of certainty.
The only remotely accurate forecast we can make is that from time to time there will be periods of short-term inflationary shock. When, how high and for how long are questions that are open to much wider ranges of possibilities.
Which brings to mind the age-old adage “say what will happen, or when it will happen, but never both.” By thinking more along the lines of how a range of predictions can play out in a complex adaptive system such as the global economy, we can position ourselves better to benefit from growth and to avoid the worst of the inevitable downturns.
We have a tendency as a species to be optimistic, which is great, but it also means we underestimate risk and the likelihood that fat-tail events will upend our plans. These so-called black swans are much more common than we realize.
So by constructing portfolios with a base of larger positions in resilient companies that are well-placed to adapt to and weather disruption, and by balancing that with a long tail of smaller stakes in companies that may one day turn out to be those resilient disruptors, overall risk is mitigated and opportunity optimized.
The digital transformation of the global economy is accelerating, and one key to benefiting from that is to avoid trapping yourself in 20th century, industrial era thinking and practices, like fretting about the absolute level of a metric such as inflation, and instead focus on taking long-term views on adaptable companies with resilient or disruptive traits that stand to benefit from such fluctuations.
Brad Slingerlend is an Investor at NZS Capital, which he co-founded with Brinton Johns in 2019. NZS Capital has a strategic partnership with Jupiter Asset Management.
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