stagflation - Authers (may four)

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...The developed world has been cured of stagflation for almost four decades now, and the market collectively appears totally confident that this will continue. The experience of 2008, when a big hit to markets and then the economy proved deflationary, reinforced this belief. 

Could stagflation return? And why would inflation reappear this time when it didn’t after the similar desperation tactics of 2008?

There are broadly four answers (summarized beautifully by Chris Watling, founder of Longview Economics in London). 

1. After the GFC, governments responded with austerity. That isn’t going to happen this time. Politicians have grasped they will need to try to revive the economy, even at the risk of a growing deficit. A decade ago the Tea Party movement was arguably motivated at first by opposition to fiscal irresponsibility. Any populist pressures this time around will be in a completely different direction. If governments are actually going to spend money, inflation becomes far more plausible.
2. Fiscal stimulus this time is being directed straight at people’s wallets, at least in the U.S. Meanwhile, measures by governments across the Western world to keep paying a decent proportion of people’s wages while quarantine constricts their spending should mean a lot of people with significant cash piles and a big incentive to spend them.
3. As we were told in Economics 101, there is both “cost-push” and “demand-pull” inflation. With many suffering through a major economic shock, there is no demand-pull at present — although it remains a possibility post-quarantine or post-vaccine. But cost-push appears already to be with us. Interrupted supply chains make it more expensive to get goods to consumers, meaning that costs have to be passed on in higher prices. Reduced supply also leads to higher prices. The worries about meat shortages should be a foretaste of wider problems.
4. Finally, there is deglobalization. We saw some of this a decade ago, but not as much as many had feared. Few countries attempted to raise tariff barriers and China’s growth helped the world pull through. Nothing like this is going to happen this time around. The simple decision by many governments that they are over-reliant on countries a long way away for vital supplies will lead them to find local alternatives. These will be more expensive, fueling inflation. 

Add the risks that helicopter money, once started, could be politically impossible to stop, and you have a very sound case for future inflation far in excess of what the market is currently predicting. Is it wise to bet against the bond market? No, not always, but it is hard to find much relationship between bond yields and subsequent inflation over history, as this chart from Vincent Deluard, global macro strategist for INTL FCStone Financial Inc., shows: