Inflation never disappeared; it is only misstated. Its true definition would be the loss of purchasing power suffered by revenues not indexed to stock markets. This two-tiered purchasing power is bad for growth.
The economy used to be all about consumers and their salaries. Now it is largely about the level of stock indices, an indicator used by countries to convey the «wealth effect». This wouldn’t be a problem if the former fully reflected the latter, except that it doesn’t.
During the last decade, the unprecedented rise of stock markets, essentially fuelled by central banks, created purchasing power that was exclusively concentrated in the hands of anyone owning and investing capital. As to the rest of the economy, it didn’t manage to create anything close in terms of purchasing power, because salaries on average didn’t increase in OECD countries. This gap between the purchasing power of investment income and that of wage income is creating inflation for the mass of wage-earners not participating in the stock market appreciation.
Asset appreciation equals inflation when money is printed to make it happen. If markets owed their rise solely to the private savings of investors, the rise would be a non-inflationary reflection of fundamental growth and it would be accompanied by a comparable adjustment in salaries.
The only catch is that the rise of markets was made possible through central-bank money printing. The Fed, in the U.S., created money out of thin air, in order to jump-start markets by injecting liquidity and buying assets. It put rates at zero, further encouraging investors to borrow cheap and take risky bets.
The rise owes therefore much to printed money and borrowed money. This process is quite different from a market rise induced by investors’ own wealth and thrift. The effect of money creation is to devalue the purchasing power of the currency. The best way to verify this loss of value is to measure the currency against a tangible asset, like gold. The chart below shows how the dollar lost value over the last 20 years against an ounce of gold. One dollar buys almost 10 times less gold than in 1998. Prices increases measured in gold are tightly correlated to Fed money-printing phases. We are close to new record highs in gold, despite the metal prices being notoriously manipulated.
This type of inflation means that the purchasing power of the currency declines over its previous levels. The only way of retaining purchasing power when massive printing is done is by being invested in stocks, so that one can compensate for the devaluation. In other terms, the rise in a stock or an equity index is not an absolute return, it is the same value, expressed in debased dollars.
Investors get a «raise» through their market return, or subsidized wins, to compensate for the inflation created. Wage earners, on the other hand, don’t get such a thing. While the trillions of dollars created by central banks multiply the means provided by inflated market returns, they considerably depreciate wage income relative to investment income.
The second graph below shows how, during the last market downturn, it was natural sellers who got rid of their stocks, panicked by the real consequences of the pandemic, but it was not natural buyers who made it initially rebound as quickly as it did. The rebound was triggered by huge amounts of central bank liquidity.
It took unlimited QE (quantitative easing), corporate bond, junk bond and ETF buying by the Fed, the ECB and the BoJ, plus zero interest rates, to get markets to forcibly snap back, stopping the fall short. The chart takes the example of the spectacular Nasdaq rebound and outlines how the Fed stepped in in order to counter any further selling, therefore providing printing-press purchasing power to those who would «co-invest» with the central bank.
An investor of the Nasdaq 100 has already regained almost 30% since the March 23 bottom, following the massive central bank printing. Over one year, the index is up 20% without much downside: any serious market drop will be aggressively countered, and sellers would be squeezed. Since 2009, world equities are up 152%.
The non-invested carry alone the cost of this strategy, which is inflation. Their wage money can buy less and less things that inflated market returns can buy. The lower end of the wage scale can only access the deflated segments of consumption and services, produced with cheap labor elsewhere, and deteriorating public services, in which governments have underinvested, as well as social security shared with ever larger numbers.
The phenomenon of inflation can therefore be defined as the loss of purchasing power suffered by those whose revenues are not indexed to stock markets. Inflation dynamics are unfavorable to non-investors. The purchasing power gap between the 20% poorest (uninvested) and the 20% richest (invested) is widening compared to the same gap 10, 20, 30 years ago.
Before the coronavirus pandemic hit us, growth was already challenged and slowing down all over the developed economies. Explanations were limited to the US-China trade war and to declining company profits. What was already ignored, was how financial inflation eats away the purchasing power of the common worker. When there is financial asset inflation, coupled with real economy deflation, wage earners get outrun by capital investors at blazing speed.
One might argue that every Swiss worker has pension assets which are fortunately invested in stock markets. But pension funds have been lowering their technical interest rates, which went down by 40% over the last decade, and the effective interest rate paid on pension assets was 1,38% in 2018. As to conversion rates, they went down from 6,74% to 5,73% since 2010, which means a 15% cut in retirees’ pensions. Over 30 years, retirement pensions are down 30%, despite equal contributions. So pension assets are but a poor proxy for direct market participation.
Inflation is misunderstood because it still relies on definitions such as the consumer price index, a basket that excludes health insurance premiums in Switzerland, as well as inflation in assets like stocks or real estate. Yet, if the cost of acquiring a Tesla share in dollars goes from 185 to 900 over a year, this of course affects the ability of the commoner to access it, and to access all that this stock’s returns can buy.
In summary, the purchasing power of an ordinary employee keeps shrinking and depreciating in relative terms: he can acquire less and less items that capital owners can acquire by converting into cash their inflated portfolio assets. What we have is an expanding gap between stocks’ subsidized purchasing power and salaries’ frozen purchasing power over year X, versus over year Y. This means that market returns will buy increasingly more expensive things, while salaries are constantly losing their relative purchasing power. We are looking at a clear misallocation of resources, preventing any broad-based growth policy.
To conclude, modern-day inflation derives from the extremely skewed distribution of purchasing power in favor of stock-market beneficiaries. If these asset prices were any reflection of fundamental growth, real wages would be bound to capture some of it, and mass spending and consumption would ensue on a wide basis. The global slowdown has been hiding in financial inflation, whose effects have been misrepresented for a decade and can only worsen in post-Covid times.