Taking shelter from the stagflationary storm

Even as it announces a rather mild tapering of asset purchases (strangely resulting in a slight decrease in the US 10 year rate and the stock market rising), and as unemployment in the US appears stubborn, it seems plausible that the US Federal Reserve could delay interest rate increases later into at least the fourth quarter of 2022 and (more likely) into 2023. 

It therefore seems that stagflation is in our future as persistent supply shocks coexist with a very sluggish labor market. How then to structure an investment portfolio?

People in America and elsewhere have been answering this question with their investment and consumer behavior.  For example, bitcoin moving from $10,000 pre-pandemic to roughly $61,000 today is evidence of people happily crowding into digital insurance against currency devaluation.

Similarly, housing in America has found itself driven by investors anticipating inflation driving rental prices and property values upward. Institutional investors and individuals are acting in concert as the Existing Single Family Home Sales statistic in America rose from 4.74 million in 2018 to 4.765 million in 2019 and eventually to 5.06 million in 2020. The 2021 seasonally adjusted annual rate peaked at 5.91 million in January before settling at 5.6 million. 

Similarly, consumers are also increasing present consumption in order to avoid price increases later. For example, while automobile purchases in the US dipped a bit in 2020 to roughly 14.5 million, during other recessions the same statistic dipped much more, to about 10.4 million in 2009, 12.3 million in 1991, and 10.3 million in 1982. In 2020, US consumers purchased 11.57 million vehicles produced in North America, thus exceeding specific US production by 31 percent. This is not exactly what one might expect during a deep recession.  The average excess consumption between 2010 and 2015 was only 14 percent, and did not dramatically spike with the pandemic but slowly rose from 16 percent in 2014 to 25 percent in 2019. This also pushed the average value of used cars in the US up by nearly 7 percent between 2018 and 2020.

American consumption has also proven generally more robust in the sphere of durable goods. Between February 2020 and April 2021, the total US consumption expenditures on durable goods rose 38 percent. This is unique as, while there have historically been rapid recession-induced decreases in these expenditures (most notably in 2008 and 2009), upward trends going back to the 1960s were exclusively long and steady.

Consumers have anticipated what the Fed has yet to admit: Inflation is coming, and will be persistent rather than “transitory.”

John W. Salevurakis

To more specifically and dramatically illustrate what is happening in America, consider that in October of 2016 the Indian government tried to stifle “black money,” via the scheduled demonetization of 500 and 1,000 rupee notes, and placed restrictions upon the degree to which a single depositor could exchange these notes for new ones.

The result, quite naturally, was an immediate rush to pay “money mules” to stand in line to make exchanges on behalf of those with too many bills. There was also a rush toward gold, the payment of worker salaries up to 8 months in advance, the employment of cash based real estate transactions, and also a rush into durable luxury goods. High premiums were paid for gold (often 50+ percent over the spot price) and Rolex watch dealers were cleaned out of their inventory. There was an acute desire to spend the bills in question while they still had value.  

Consider now that the manufacturer suggested the retail price of a steel Rolex Submariner wristwatch is just over $8,500 today. Currently, the generally observable grey market price for the exact same item in America is $16,500. Similarly, the retail price of a Patek Philippe Model 5711 is roughly $35,000. Its grey market price is hovering between $120,000 and $140,000. Why the outrageous premiums on new items that compete with so many closely substitutable products?  For the precise reason Indians once paid a 50 percent premium for gold.

Consumers are now viewing bitcoin, apartment buildings, single family homes, exotic cars, durable household goods, and luxury watches (all surprisingly liquid) as de facto currencies and hedges against inflation.  

Consumers have anticipated what the Fed has yet to admit: Inflation is coming, and will be persistent rather than “transitory.” As West Texas Intermediate crude has regularly exceeded $81 over the last month, a price not seen since 2014, I have to wonder if those seeking shelter in Rolex and real estate are again discovering oil as a suitable form of insurance. Should the Fed, for any reason, delay future tapers or raise rates slower than the market expects or if broad supply shocks continue, might we revisit Q2 of 2008 in petroleum markets?

• John W. Salevurakis is an associate professor of economics at the American University in Cairo and an author.