What If High Inflation Doesn't End? How To Invest If High Inflation Stays
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 400. 400 episodes. The title is, What If High Inflation Persists for Years?

I've been doing the Money for the Rest of Us podcast for over eight years. I obviously, when I started, didn't anticipate doing it for eight years. But here we are at episode 400, numbered episode 400. If we include the premium Money for the Rest of Us Plus episodes, I've done close to 800 episodes.

Thanks for listening to the podcast. Thank you for sharing our work with others, for your feedback that you provide, including leaving reviews on the podcast. We considered doing a special episode for the 400th episode. My son Brett suggested we should do something special for episode 401 in honor of the 401k, the primary employer-sponsored retirement plan in the U.S.,

We decided, though, that we would hold off doing a special episode today. Hold it off for a couple years. We'll wait until we celebrate our 10th anniversary and our 500th episode. So again, thanks for everything you do to share the show, listening to the show, engaging with the show, and all the other content we provide at Money for the Rest of Us. But let's get to this week's topic.

Last week, Federal Reserve Chair Jerome Powell gave a keynote speech at the Kansas City Federal Reserve Bank's Economic Policy Symposium in Jackson Hole, Wyoming.

This is one of the longest running and one of the largest central bank conferences in the world. It's been going on since 1978. They've held it in Jackson Hole since 1982, every August. I think they should change when they hold it because every August in Jackson Hole, and I know this because it's not that far from our cabin in Idaho, it gets smoky with wildfires. You have all these central bankers coming and going.

It's smoky out. They should hold the conference in June. Jerome Powell's speech was very short, less than 10 minutes. In the speech, he drew on three lessons from the 1970s and 1980s that argued for maintaining a more restrictive monetary policy in the face of high inflation. And by restrictive monetary policy, we're talking about much higher inflation

short-term policy rates or short-term interest rates, which then lead to higher, longer-term interest rates. The first lesson, Powell said, was the Federal Reserve and other central bankers can and should take responsibility for delivering low inflation.

He said, "...our responsibility to deliver price stability is unconditional. It is true that current high inflation is a global phenomenon and that many economies around the world face inflation as high or higher than we see here in the United States. It's also true, in my view, that the current high inflation in the United States is the product of strong demand and constrained supply and that the Fed's tools work principally on aggregate demand."

We'll circle back to that comment here in a few minutes because it's pretty critical in a discussion on whether high inflation will persist, the difference between demand and supply. First, let's go over the second two lessons he shared.

The second lesson is what the public thinks about future inflation can impact what inflation will be over time. Powell says, today, by many measures, longer-term inflation expectations appear to remain well anchored. That is broadly true of surveys of households, businesses, and forecasters, and of market-based measures as well.

But that is not grounds for complacency, with inflation having run well above our goal for some time. He continues, if the public expects that inflation will remain low and stable over time, then absent major shocks, it likely will. This is a concept we've discussed in the past. Inflation Anchoring

If households and businesses start to act like inflation will remain high, then they change their behavior. They demand higher wages for their jobs. They change what they purchase and they start to act. Maybe they hoard expecting that prices will continue. As Powell points out, when inflation is persistently high, then households and businesses pay close attention

to what inflation is. You start to notice prices. I certainly do, and I'm sure you do also. I'm much more aware of what I'm paying for gasoline right now or what it costs to eat out because you get some sticker shock when you see this rise in prices, and that can change behavior. And we'll look at behavior changes because those changes in behavior can also be the cure for higher inflation.

The third lesson that Powell shares is central bankers have to keep at a focus on inflation until their job is done. That the cost of bringing down inflation increases when there's a delay, as high inflation becomes more entrenched in wages and prices.

Earlier in the speech, Powell said restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. And with those words, the U.S. stock market fell 3% because the expectation appeared to be that the Federal Reserve would stop raising interest rates perhaps later this year or earlier.

or early next year. It may be even begin to cut interest rates. Chair Powell is saying, not necessarily. They don't know exactly when, but they want to be well assured that inflation is lower and that low inflation expectations are anchored. Minneapolis Federal Reserve Bank President Neil Kashkari said, I was actually happy to see how Chair Powell's Jackson Hole speech was received. Received?

received in terms of the stock market selling off. People now understand the seriousness of our commitment to getting inflation back down to 2%. The Federal Reserve's chair and the members of the Open Market Committee, the other central bankers involved in keeping inflation low and unemployment high, their reputations are at risk.

And they will do what it takes to make sure that their reputations and the reputation of the Federal Reserve isn't harmed. The Federal Reserve has built up credibility over the past 40 years of keeping inflation low and under control. And they don't want to lose that sterling reputation.

What caused the current inflation? Powell said that it was a product of strong demand and constrained supply.

He didn't mention that much of that demand was from money creation, stimulus by the federal government combined with quantitative easing programs that significantly increased the money supply. That was part of it, but it wasn't the only thing. Not every country had that level of stimulus, but we still have high inflation around the world. But coming out of the pandemic, demand increased.

increased and the mix of what households and businesses wanted. That changed. The Federal Reserve can impact demand by adjusting its policy rate, influencing longer-term interest rates, which can impact the willingness of households and businesses to borrow and what they're willing to buy. But the Federal Reserve doesn't control demand.

The supply, particularly when much of the goods and services are bought overseas, as different countries import goods and services, run trade deficits, while others are net exporters. On the Money for the Restless Plus member forum, a member shared a piece by Zoltan Pulsar. He's the global head of short-term interest rate strategy at Credit Suisse.

He had an interesting view when we think about whether our current bout of inflation is more structural, whether there's been a significant shift. And his thesis is there has been. He writes, understanding today's inflation as a result of an escalating economic war and a lingering pandemic is important. For if war and zero COVID policies...

Stay, the view that inflation is mostly cyclical, driven by excess stimulus, is wrong. He believes that there has been a structural change, and it has to do with geopolitics. Two great powers, as he points out.

One is Russia, which has been a major supplier of commodities. Now they're not able to supply those commodities to much of the Western world due to sanctions, trade embargoes. That has significantly boosted the price of commodities, particularly natural gas.

The other great power that Pozar points out is China. They have the zero COVID policy, which has disrupted supply chains and contributed to the supply constraints.

It's amazing over the last four decades how China has developed into a major exporter. I remember in the late 80s reading, oftentimes as I took the bus to work, the magazine The World and I. It was published by The Washington Times, and I would see so many articles about China. I think they dedicated whole issues to China and what's going on. Back then when I was reading The World and I,

China's trade deficit with the U.S., the trade deficit being the difference between the goods imported versus those exported, and there were significantly more imports. Even back then, it was $9 billion, but in 2018, it was $419 billion, a trade deficit, $419 billion more goods coming into the U.S. from China than the U.S. was sending China. Last year, it

it was $360 billion. If we look at the overall trade balance, because the U.S. economy is bigger, so we have to look at what is the trade deficit as a percent of gross domestic product, the monetary value of output. And the trade deficit continues to be huge. The overall trade deficit, including China and other countries in the U.S., is $1.5 trillion. It is

5% of GDP. Back in 1990, when I was reading The World and I, it was less than 1%. The biggest trade deficit as a percent of GDP was back in 2006 at around 6% of GDP, but it's still significantly high. With the pandemic, the trade deficit as a percent of GDP shrank to about 2.5%, but now it's widened out again significantly.

Pozar is suggesting that we will have many more economic conflicts. He describes them as war, and it will contribute to higher commodity prices and higher goods prices as countries will have to bring more domestic production home to their own country where costs are higher. Other contributors to more structural inflation could be labor shortages, particularly for services.

There is a huge gap in terms of the number of workers needed in the U.S. versus workers available or willing to work. Partly it's due to early retirements, but it's also due to fewer legal immigrants. There are fewer immigrants coming to the U.S. today legally, and that is contributing to worker shortages. We discussed this globally a few weeks ago when we were talking about population trends.

As populations shrink in developed countries around the world, one way to solve the problem and for it not to be inflationary is to bring in workers. That's not happening. These labor supply shortages could lead to continued high inflation. The other potential driver of persistent high inflation is capacity constraints in the commodity space.

We discussed this in episode 384 on whether we're entering into a commodity super cycle where there's been underinvestment in oil production capacity. There's also constraints in refining oil products. And in episode 384, we discussed whether that underinvestment was due to ESG mandates or other reasons.

One view, and I tend to believe that this is clearly also a contributor, is over time demand for commodities on a per capita basis will shrink due to efficiencies. This is something that BP, the seventh largest oil company in the world, shows in their annual energy outlook that they do.

You can see a chart, and I'll link to it in the show notes, the report, and they have three scenarios, but they say global energy demand peaks in all three scenarios as gains in energy efficiency accelerate.

A major oil company who gets revenue from oil, wants to sell a lot of oil, is forecasting a peak in demand on an absolute basis and certainly on a per capita basis due to energy efficiency.

Energy analyst Gregor MacDonald wrote in a newsletter that I subscribe to, For those who find it challenging to contemplate a plateau of global oil consumption, just remember that the oil industry also sees this end of growth and is similarly challenged to formulate a response.

How does one invest heavily in future supply if a supermajor like BP keeps producing a forecast that no demand growth globally occurs after 2025? McDonald suggests it's not ESG. It's a recognition by the oil supermajors that there will be a drop-off in demand, and that is what led to underinvestment as demanded by shareholders.

Now, this gets to the crux of whether we are entering a super cycle with commodities, that maybe there is an underinvestment and due to also geopolitical conflicts, that there isn't enough capacity in the commodity space and that will continue to drive higher inflation. Before we continue, let me pause and share some words from this week's sponsors.

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That's the thesis, that we'll continue to have labor shortages, that there'll continue to be economic wars, including over technology, and that will constrain supply. And despite what central bankers can do to reduce demand, that when you have a supply problem on the commodity side, on the labor side, on the trade side, in terms of importing cheap goods, that that could lead to a

a lengthy period of high inflation. Now, what are the mitigating factors? It gets back to behavior. Think about it. Has your behavior changed in terms of your day-to-day purchases due to higher inflation?

We were back in Idaho and I was having a discussion with a couple of friends and this gentleman drives a very fuel inefficient Ford 350 pickup truck. And he mentioned he's taking fewer trips from Teton Valley into Idaho Falls because it costs $60 or more for the fuel to take that trip. His behavior has changed. I get fewer haircuts now than I used to. I wear my hair longer. Partly it was due to the pandemic, but that's...

That's a small cost, but it isn't necessarily an inflation reason. But it also is because haircuts can be expensive depending on where you go.

When prices are high, people can choose to purchase less or they can purchase lower priced goods. Those behavior changes in terms of what is bought and how frequently things are bought, what people are willing to pay, that can put some downward pressure on prices or at least keep them from rising as much. The other mitigating factor is productivity. In

This can come from technology that allows businesses to produce more with less or produce more services with less. I went to a Walmart a few months ago and there were no individuals checking people out at the cash register. It was all self-checkout, the entire store. You go to McDonald's. Many McDonald's have kiosks now where you order your food. And as you start to use them, you just get more comfortable using

doing that. Those are examples of technology changes that are helping with the labor shortage in the services space. The other thing that could be changed is immigration policies could be changed to allow more workers to come into a given country to help provide the workers needed in agriculture and hospitality services.

Another mitigating factor is slowing population growth, like we talked about a few episodes ago. If there are less people buying things, then that certainly can reduce the inflationary pressures.

Another big behavior change is less to do with higher prices and more to do with just being more environmentally aware and socially aware. I look at my adult children and how they're so deliberate about what they purchase, deciding whether they really need it, whether they want it, but also what's the environmental footprint of buying that.

Now, it varies by each of our children, but I think that's a generational thing. Not everyone, of course, but across the populace globally, if individuals become more aware of the impact of what they're buying and decide to buy less, I just don't want as much stuff. That could impact structural inflation. It would be disinflationary.

So while the argument for higher structural inflation is continued labor shortages, continued high commodity prices due to underinvestment, more economic wars that leads to more supply disruptions, economic turmoil, more production having to be done at home at higher wages, more entrenched inflationary expectations, and then we get a decade or more of high inflation.

That thesis could be mitigated by the ability of households and businesses to substitute what they're willing to buy, behavior changes on what they buy, both from a price standpoint, as well as just more aware and deciding to buy less because of the environmental impact or just they don't want it because they want to do other things. They value experiences more than goods and services. They decide to stay home more. We don't know. But

But if you believe structural inflation is here or you want to protect against it, what do you invest in?

We've discussed many of these before. Land and real estate is a good long-term structural inflation hedge. Now, with these inflation hedges, investments to protect against rising inflation, they will not necessarily outpace inflation every single year. But we're talking a decade or more of higher inflation. And what works in that timescale?

Land and real estate. There's only so much land. And real estate prices tend to track very well with inflation over the long term. Another source to help protect against higher inflation is having a business or a skill or a trade in which you can increase your prices, what you charge for the services you provide as prices increase. That's a powerful inflation hedge.

Commodity futures, such as the Deutsche Bank Commodity Tracking ETF, DBC. Commodity futures are a great investment if inflation comes in higher than expected. If inflation comes in at the rate everyone believes, then commodities won't do very well. The commodity futures are priced in a way that inflation is not.

Inflation has to surprise to the upside for commodities to be a successful investment. And commodities over a longer term period, that particular ETF has only returned 0.8% in the past 15 years. It's had a negative return over the past decade. But over the past five years, it's returned 13% annualized. Over 40% gain in the past year, including 30% year to date. Because commodities have surprised to the upside.

Another way to protect against structural inflation is to own businesses, stocks, that will benefit from higher inflation, but perhaps not require huge investments in capital. One way to participate in that is with the Horizon Kinetics Inflation Beneficiaries ETF, INFL. This ETF is structured for longer-term high-income.

higher structural inflation. It hasn't done so well protecting against inflation in the short term. It's only returned 4% in the past year. It's lagged inflation, but their thesis of Horizon Kinetics is by investing in businesses that will benefit from higher inflation over the long term that the ETF will do well. We'll see.

So those are some things you can invest in, commodity futures, stocks that benefit from higher inflation, land and rental real estate, as well as owning a business or a trade where you have the ability to raise your prices.

I personally think inflation will moderate in the coming years. I believe the disinflationary forces of a population slowdown, greater efficiency and productivity, and behavior changes, less desire for stuff, more aware of environmental and social impacts of our consumption decisions, that will be enough to overcome the supply constraints and inflation will come down.

I don't know. That's why I have land, real estate, investments in businesses that benefit from higher inflation on both the public and private side, because we don't know. And that's why it's important to think about the alternative. Well, what if inflation is here to stay and it's now embedded in the consciousness of households and businesses, that they're anchored based on that?

Hopefully not. We'll see. We can protect against it, but we can also make decisions in our own daily lives to mute the impact of higher inflation by what we buy and how much we buy. That's our discussion of inflation. Thanks again for listening. Many of you have listened to all 400 episodes. For that, I'm incredibly appreciative.

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