Why are markets worried about inflation?

Inflation is low, so why is everyone worried about it? Basically, inflationary concerns exist because everyone knows it’s coming at some point. You simply can’t print as much money as governments around the world have printed, borrow as much as they have borrowed, all designed to stimulate the economy, and expect there to be no inflationary impact eventually.

This issue really started with the GFC. Presented with the potential for another Great Depression, governments worldwide decided to manage the issue over 20-30 years rather than see a very sharp 3–5-year problem as was seen in the 1930’s. So, to avoid a more damaging catastrophe, governments started quantitative easing programs (a form of printing money) and borrowing money to stimulate their economies. Those that led the way in the crisis, such as US Federal Reserve Chairman Ben Bernanke, were students of the great depression and well positioned to guide the US at that moment. To be fair, a few years of government deficits to smooth out what would otherwise have been a tough landing, is a sound policy in the middle of a once in a generation financial crisis.

However, there are a few problems with this approach in practice. Firstly, governments are terrible at correcting these budget deficits, and once you start, it’s difficult to reign it in. The deficits become entrenched structural deficits. Secondly, governments become reliant on borrowing money to stimulate their economy, not just in times of crisis, but every time there’s the hint of a problem. So, instead of going into deficit for a few years and getting these issues under control, governments constantly run deficits and their debt increases. Thirdly, that extra money is in the system in some way, and more is added to the economy each day. It’s the last point there that causes markets the most concern. Some inflation would be okay. That’s what central banks worldwide are hoping for, enough impact to get the wheels of economic growth turning. But everyone is so impatient these days. If things aren’t moving fast enough, then there’s ever increasing pressure on governments to do more. So, they do more. More stimulus means more borrowing.

What markets really fear is that enough has already been done, but that it takes longer than everyone thought to work its way through the economic system - years instead of months, decades instead of years. If that is the case, the concern is that the global economy has been flooded with money and that prices will increase substantially in the years or decade to come. There’s already a lot of money in the system and that is driving up asset prices across the world, from commodities shares, bonds and property. While this inflation isn’t driven by everyday consumers, they will be the ones who are eventually impacted. So, when markets drop on inflation fears, its not the prospect of inflation itself that is causing the jitters. It’s the fear of an inflationary period that may have been years in the making. The overriding concern being that such an inflationary period could potentially result in a dramatic rise interest rates.

It seems farfetched at the moment as inflation is very low, and interest rates are basically zero. However, the possibility of a high inflationary period is the underlying fear within today’s markets, in my opinion. Its not the signs of inflation per se or even inflation emerging that spark concern. Instead, it’s the fear that the prospect of inflation rearing its head is the start of a new problem that will impact all of us. As always though, those risks will bring with it opportunities.





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