Fade out or fake out? While Canadian inflation’s surprise September slowdown sparked some optimism – and fanned Bank of Canada rate pause chatter – many remain skeptical. A similar situation is unfolding in the United States and the euro zone.
Global monthly inflation rates have slowed sharply, yet still-high price levels, reignited oil and gas prices and the spectre of wage-price spirals fan sticky fears. Don’t panic. When it comes to inflation, money supply trumps all. And the recent tightening of that supply by central banks signals future inflation spikes are dead. Let me explain.
In Western economies we never reverse already incurred inflation. But we can slow it down, which is what central banks have been aiming to do.
“Inflation is always and everywhere a monetary phenomenon.” So said legendary economist and Nobel laureate Milton Friedman in the 1960s. He knew inflation stems from too much money chasing too few goods and services. Recent years proved him right again. Central banks stoke lending and spending by increasing the money supply, which eventually juices inflation with unpredictable, variable time lags.
One broad measure of money supply, known as M2++, averaged a middling year-over-year growth of 7.1 per cent in Canada in 2019. The Bank of Canada inexplicably doubled that rate by February, 2021, as part of its response to an economy locked down by the COVID pandemic. That increase paralleled moves by other central banks globally. By mid-2020, the U.S. Federal Reserve was expanding America’s M4, its broadest measure of money supply, by a whopping 30 per cent.
Because lockdowns disrupted product supply, much of that new money couldn’t be spent immediately. But banks, awash in central bank-injected reserves, ramped up their lending. U.S. and euro zone loan growth hit double-digits by 2021. Canadian lending wasn’t quite as hot, but it echoed broader global trends as temporary lockdowns eased. Canada’s 2022 loan growth averaged more than 8 per cent year-over-year, peaking at 10.1 per cent last October. Inflation soared.
Now? Canadian money supply growth has cooled. July’s M2++ growth slowed to 1.9 per cent year-over-year (the latest data available). July and August euro zone M3 growth was negative. In the U.S., M4 has been negative since last December. Hence, inflation slowed. (M2, M3 and M4 are money supply metrics used by central banks.)
Canada’s September headline CPI cooled to a 3.8 per cent year-over-year – well below the high of 8 per cent in June, 2022 – bringing some relief after it ticked up modestly in July and August. Meanwhile, Canadian core inflation (which excludes eight of the most volatile components, such as food, mortgage interest and energy costs) slowed to 2.8 per cent – under half the 6.1.-per-cent rate of June, 2022.
U.S. CPI, meanwhile, dropped to 3.7 per cent year-over-year from a 9.1-per-cent high. Preliminary euro zone readings show inflation at 4.3 per cent – far off the 10.6 per cent of October, 2022.
Yet many gripe that prices remain far above 2019 levels. But it is the current rate of price gains – not current prices – that matters now. Reversing 2021-2022 price increases would take epic deflation. U.S. M4 money supply would have to shrink by 32 per cent to reach 2019 levels – causing Great Depression-like devastation. No one wants that.
Many claim even normal inflation rates aren’t assured, fearing resurgent energy prices and the dreaded wage-price spiral of pay gains forcing price jumps. That won’t happen. U.S. oil production is set for 2024 records, offsetting OPEC+ cuts. Canadian production, too, looks set to break records next year. Moreover, the Israel-Hamas war shouldn’t take a heavy toll on global supply as direct oil industry exposure is minimal. Even if conflict spread to Iran, its oil industry was sanctioned for years and a recovery this year was small. Meanwhile, China, Brazil, Iraq, Libya, Nigeria and Venezuela are all boosting output. Natural gas? Prices are far below 2022 peaks. And in the EU – here Russian gas shortfalls spur repeat supply worries – winter storage filled early.
Wage-price spirals? In the current economic climate, they’re as real as Halloween ghosts. Yes, global wage growth is hot; Canada’s September rate came in at 5 per cent. But as Mr. Friedman showed wage growth always follows inflation – it never causes it. Inflation’s easing as global wage growth accelerates now demonstrates that point perfectly. Still, few acknowledge this, including economists who really should know better.
Remember stranded cargo ships and nosebleed shipping prices? St. Lawrence Seaway strike talk has fanned some fears, but COVID-era supply chain snarls have untangled. Shipping rates have plunged. The rates on Shanghai-to-Rotterdam routes sank 78 per cent year, while rates for Rotterdam to New York fell by a similar amount. Even notoriously backlogged Shanghai-to-Los-Angeles routes fell by 24 per cent. The New York Fed’s global supply chain pressure index has eased to levels unseen since 2015.
Despite all this, rampant inflation fears are still adding bricks to this bull market’s wall of worry. But the market is in for a positive surprise. Expect inflation rates to irregularly keep cooling – and stocks to eventually reignite.
Ken Fisher is founder, executive chairman and co-chief investment officer of Fisher Investments.
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