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BFI Bullion
March 2, 2022

The Real Cost of Higher Prices

Much has been said and written over the last year about the state of the global economy and the post-covid recovery, with the focus being increasingly fixed upon inflation. Although this risk was roundly dismissed by policymakers and by political leaders at the beginning of the covid crisis, when countless rational voices warned against the consequences of reckless printing and spending, it is by now obvious that climbing prices are not “transitory”.

Still, when discussing inflation and its impact, most economists, market analysts, investment experts and the financial press at large tend to examine the matter from an academic or technical perspective. Most analyses we see these days are preoccupied with monetary policy implications and whether another higher-than-expected CPI reading will force earlier rate hikes, while others are trying to predict the effect on different asset classes.

While these are all important considerations for investors trying to anticipate how inflation will impact their own portfolios, they must not pull their focus away from the bigger picture.

The working poor

While it is striking to read headlines about CPI in the US hitting a 40-year high, or about wholesale natural gas prices in Europe climbing over 400%, the true impact of these price increases cannot be easily communicated through charts and economic metrics, nor can it be truly fathomed by anyone who is not directly affected by them. Of course, we’ve all been paying more at the gas pump, and we’ve been spending more at the grocery store for months already. But the financial reality for millions of Western households, until recently considered “middle class”, is much more dire.

US Inflation surgeAnnual % change in US CPI

Source: Bloomberg

For example, in the UK, where inflation rose to a 30-year high in January and is expected to keep climbing, there’s a cost-of-living crisis the likes of which most young adults have never encountered before in their lifetimes. Food and heating costs have exploded over the last few months and the squeeze has brought countless households close to breaking point. The nation is set to experience a 30% rise in destitution this year, according to the National Institute of Economic and Social Research, while data from the Food Foundation paints an even bleaker picture: In the world's fifth-largest economy, 4.7 million adults experienced food insecurity in January and 1 million had to go without food for an entire day.

German households are facing similar challenges, with non-profit operations, like Tafel, that are distributing discarded food to those in need, seeing an unprecedented explosion in the number of people who seek their assistance. In France, climbing prices have become a hot-button election issue, while in Lithuania, where inflation hit an incredible 12.2% in January, driving to Poland for basic groceries has become the norm for many.

Across the Atlantic, climbing prices in the US, combined with the expiration of covid-relief measures like the expanded child tax credit, translated to a 41% increase in the nation’s child poverty rate in January, according to the Center on Poverty and Social Policy at Columbia University. Meanwhile, according to data recently released by the Federal Reserve Bank of New York, US household debt increased by $1 trillion last year, the biggest annual jump since 2007. And in Canada, where inflation hit its highest level since 1991, food banks in Montreal reported a surge in demand, while they are also seeing an increasing number of people who used to donate not too long ago now standing in line themselves. Quebec Food Bank, which supplies food to 32 food banks and more than 1,200 community organizations, reported an increase in demand of up to 60% compared to pre-pandemic levels.

Share of US adults experiencing financial hardship due to recent price increases, by household income

Source: Statista, Gallup

Action and reaction

As the headlines about skyrocketing food prices and record-breaking gas bills keeping piling up, we’re also seeing at the same time an unprecedented number of reports about social unrest, demonstrations, and protests from all over the world. And while most mainstream media outlets attempt to explain the latter phenomenon away as isolated manifestations of anti-vaxx sentiment, extreme right-wing propaganda or even foreign interference in national politics, the principle of Occam’s razor remains the best way for any rational observer to understand why millions of people are taking to the streets. The simplest explanation, or the one that requires the fewest assumptions, is usually the right one. And it’s no different in this case.

For instance, let’s look at the trucker protest in Canada, that lasted for nearly a month and made international headlines almost every day. It is true that the “Freedom convoy” was initially triggered by the introduction of a vaccine mandate that many Canadians were opposed to for a variety of reasons. However, what the truckers specifically protested with their original “march” was the financial impact of the new law, a sentiment that became much clearer as the protests spread. Having already suffered during the lockdowns and after seeing their incomes now once again shrink thanks to inflationary pressures, the demonstrators and the millions who supported them around the world refused to live with yet another threat to their livelihoods.

The link between deteriorating living standards and the simultaneous spike in protests and social unrest is even more apparent when we look at other large demonstrations elsewhere in the world. In Spain, for example, another convoy of trailer trucks made its way through Madrid in late December. The protesters’ demands in this case were not open to interpretation: They clearly called for the government to act against surging fuel prices that made it impossible for them to earn a living. In mid-February, demonstrators in the UK were similarly explicit and direct. Thousands of people participated in marches in over 25 towns and cities across the country to express their anger at the cost-of-living crisis. A week later, the same clear message was sent by Greek farmers, who blocked a national highway with hundreds of tractors. Their production costs have risen by over 50% and the pressures keep mounting, pushing many family farms to the brink.

In the developing world, the situation is infinitely worse. In Morocco, Nigeria, Kenya, India, Cuba, and elsewhere, desperate citizens have been demonstrating for months, demanding meaningful action and support from their governments and the international community. In those less privileged parts of the world, inflationary pressures have already triggered full blown humanitarian crises and exacerbated preexisting ones.

“The way democracies die”

This is how legendary investor Charlie Munger described in a recent interview what might lie ahead should we continue to go down this inflationary path. The vice-chairman of Berkshire Hathaway, now 98-years old, cited historical examples of the sociopolitical implications of runaway inflation, from the Roman Republic to Latin America, and warned that this “is the biggest long-range danger we have, apart from nuclear war”.

To some, this might sound hyperbolic. Indeed, at first glance, it is hard to see how a 7% increase in consumer prices can turn out to be a threat to democracy or social order. And yet, upon closer inspection, it quickly becomes clear that there’s a lot more to fear than paying 20 cents more for a carton of milk. For one thing, all those official inflation readings that everyone is basing their projections on are arguably dangerously inaccurate. The way that CPI is calculated today all but guarantees that the results will be divorced from reality, as any western citizen buying their own groceries and paying their bills can testify on at this point. A much more realistic measure of inflation, calculated by Shadowstats using the same formula the US government used before 1980, puts the rate at 15%, a much more worrying figure, not to mention the highest since 1947.

In any case, it really doesn't matter all that much whether it was a 7% or a 15% CPI rise that sent a working mother to the food bank for the first time in her life. What matters is that this is where we are now. And what matters even more, is that there is no easy way out. This is exactly why Charlie Munger’s warning should be headed: at this point, it’s not inflation itself, at the current levels, that has the potential to wreak havoc in our societies, but the real danger comes from what governments and central banks choose to do about it.

The original plan of most central banks, to “tighten and unwind” once they deemed their economies sufficiently recovered, might seem like a sensible idea, as mopping up all that excess liquidity would be the obvious thing to do to put the brakes on inflation. On the fiscal side, it would also make sense to put an end to all the “relief” programs and all the extra spending, maybe even roll back some of the preexisting benefits and welfare schemes. But as much sense as these moves might make theoretically, at this stage, they are tantamount to political suicide.

“No politician will allow breadlines to form under their watch, even if they know for sure that those lines will inevitably get longer if they do nothing. By that time, it will be somebody else’s problem."

The last thing that roadblocking truckers, protesting farmers and striking factory workers want to hear is that they must “tighten their belts”. The same goes for the already-swelling ranks of the “working poor”, seeking assistance from non-profits and community organizations. As most of them are employed and do not qualify for government welfare programs, they’re not showing up in official statistics, but this is not a trend that can be hidden behind the “full employment” data for much longer. No politician will allow breadlines to form under their watch, even if they know for sure that those lines will inevitably get longer if they do nothing. By that time, it will be somebody else’s problem.

Investment implications

As we mentioned in the beginning, investors should reassess the way they think about inflation. Of course, its short-term effects are still important, as is its impact on different asset classes. However, it is the big picture we should be focusing on.

If we look at the lessons of the past, there are several ways this could unfold. Justified public anger can lead to all kinds of unjustifiable reactions, social divisions, and dangerous political shifts. And while we have no way of knowing precisely which scenario will prevail, we can already see a common denominator emerge from all the protests around the world. In different cities and in different languages, demonstrators are holding up the same sign: “Tax the rich”.

For the moment, policymakers seem to be sticking to a “wait and see” approach, with “symbolic” rate hikes and no real plan to actually fight inflation in a meaningful way. And with austerity measures and monetary tightening being politically untenable, there really is just one way forward.

As we predicted back in September of 2020, in our Special Report entitled ,“On the Brink of a New Era: Are you prepared?”, financial repression and wealth redistribution will be the most likely “solution” that governments will choose to appease public discontent. In this scenario, in combination with crumbing currencies and sociopolitical disruptions, physical precious metals will provide the only realistic and reliable protection for investors and ordinary savers.

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