Beware the cure

The AFR ran an article today warning about the hidden dangers of inflation, namely that recent events point to “a future in which we need to worry more about inflation than in recent years”. It contained the following, which is far more concerning than the author realises:

“More widely, the consensus among policymakers is also grounded on some firm evidence of temporary problems in the global economy. A significant part of the recent jump in prices has come from bottlenecks in global supply chains, especially in semiconductors.

Raising the price of imported goods and domestic manufactured products, this surge in costs will bring new investment in manufacturing plants and, eventually, its own cure. Increased spread of the delta variant of COVID-19 is already moderating the recovery in household spending.”

Rising productive investment does indeed “cure” inflation — the number of goods will increase relative to the amount of dollars chasing them — but it also sows the seeds of the next recession.

That’s because demand has been artificially stimulated, and not sustainably so. If supply increases at the same time as demand subsides (or simply stops growing) due to a fading global fiscal and monetary stimulus impulse, many of those so-called inflation-curing investments in manufacturing plants will prove unprofitable.

Businesses will fail, debt will be defaulted upon, many of the employees hired to expand production will be laid off and a chain reaction of resource reallocation could very well sink the economy into a recession.