In an interview with CNBC, Kyle Bass, founder of hedge fund Hayman Capital, made a blast-from-the-past prediction about 2017.
“You have wages up, you have real estate rent moving up, now you have commodities bouncing. So 2017 is going to be a year of increasing inflation but economic growth lagging,” Bass said during an interview on CNBC’s “Power Lunch.”
“We’re moving into a stagflationary environment in my view.”
What Bass is saying is that the horrific economic conditions of the 1970s — when growth and employment were not keeping pace with the cost of goods and services — are about to return. That will be our punishment for the global, post-financial-crisis experiment that has been quantitative easing, in his view.
He is wrong.
I can’t tell you what’s going to happen, but we can see from the data that the conditions aren’t actually correct for what Bass is predicting.
Under America’s hood
Part of Bass’ argument is rooted in the idea that we’re already seeing inflation creep up in the economy. But according to analysts at Credit Suisse, if you dig deeper into that number, you see that there’s something specific driving that creep — prescription drugs.
From the Credit Suisse report, published earlier this month [emphasis ours]:
“Prescription drugs make up just 3.8% of the core-PCE [Personal Consumption Expenditure] basket, and although they usually grow a bit faster than overall inflation, it is unusual for them to have much impact on headline numbers.
In the past three months though, this component has contributed an average of 4bps to mum core inflation. While this may not seem like much, it is the difference between an annualized run rate of around 1.6% (near current YoY levels) and 1.1% (near 2015 lows). While there is some evidence that drug prices have accelerated in recent years, there is little reason to think they shot even higher in the past few months, and we expect the last few strong prints to ultimately prove anomalous. ”
In short, prescription drug prices have recently been moving up faster than prices in the rest of the economy — fast enough to mask the fact that inflation in the rest of the economy has stayed relatively stable.
If prescription drug price growth returns to normal, the problem that we’ve had since the financial crisis — a lack of inflation — will likely persist into next year, according to projections from the Credit Suisse team.
The election, what else is there?
Now say Credit Suisse is wrong, and that surge in drug prices is not a temporary blip that goes away on its own. Even in that case, we know that Hillary Clinton may very well be our next president. If that happens, she will make a concerted effort to bring down the cost of drugs.
Her plan to do that involves creating a panel to monitor drug price increases and look into alternatives to expensive drugs. It will also attempt to expand access to needed medications, and fine drug companies that jack up the prices of drugs that have been on the market for a long time. She’s also planning to cap monthly and annual out-of-pocket costs for patients with chronic or serious health conditions and implement other cost-curbing measures.
She’s not alone in this either. Politicians on both sides of the aisle have shown support for doing things like speeding up the FDA approval process for generic drugs.
Now, none of this “ex-prescription drugs” talk is to say we don’t or can’t have inflation. Credit Suisse also says it wouldn’t take much more from other sectors to keep inflation moving upward. It’s just that even then, we would barely be grazing the Fed’s target of 2%.
And, let’s remember that the Fed is expected to raise rates in December or early in 2017 (Credit Suisse thinks it’s going to be in the second quarter, for what it’s worth.) That policy would curb the so-so inflation we’re already seeing.
And we should probably talk about China quickly
Bass’ comment about “commodities bouncing” also deserves a quick treatment. Yes, commodity prices have rebounded somewhat from their late 2015 and early 2016 lows. That is, however, in large part because China has yet again restarted its growth machine — its relentless churn of factories that make nothing and buildings that hold no one — in a bid to keep the economy from a more savage downturn.
If Bass is right about another prediction he made on CNBC — that the Chinese banking system will collapse in 2017, all of that will be short-lived. But that’s a post for another time.
If it doesn’t, either way, the Chinese government has started saying that it must pull back or face disaster, so another massive debt-fuelled, commodity gobbling ramp up is likely not an option. Commodities prices will remain “bouncing” at the very best.
It seems like only yesterday, basically
What’s odd about this is that as recently as July, Bass agreed with me about inflation. Back then he told Grant Williams, author of Things that Make You Go Hmm and co-founder of Real Vision TV the following in an interview [emphasis ours]:
“The spreads between U.S. 30 year treasuries and 10 year treasuries, and Japanese 30 years and 10 years, and European 30 years and 10 years, is as wide as it’s ever been. And so what does that mean? That means that I think U.S. rates are coming down, regardless of what kind of inflationary pressures we have, which is something that we’ve never seen before. Again, a new paradigm given the global central banking conundrum. So when you ask me whether stocks have peaked or not in the U.S., look, if China has the comeuppance we think they’re going to have, soon, then that’s not going to be an equity positive environment.”
Of course, July was before we started seeing this weird prescription drug inflation action Credit Suisse pointed out in its report.
The Fed may very well raise interest rates, the economy may continue to grow slowly (despite the efforts of a stimulus-friendly government), and hopefully wages go up too. But that doesn’t mean we’ll have the runaway inflation we saw in the 1970s.
No, this time with the great leap into unknown monetary policy we’ve taken since the financial crisis, we’ve earned ourselves a fresh economic dilemma beyond our current imagining. Lets keep an open mind until it gets here.
This is an editorial. The opinions and conclusions expressed above are those of the author.
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