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$4.25 Filet Mignon Now Costs $70: Understanding Inflation, Stagflation And Commodities
Historical Perspective on Inflation
Inflation refers to the general increase in the price of goods and services over time. As prices rise, the purchasing power of a fixed amount of money diminishes. For instance, a $100 bill might have bought you 10 items a decade ago, but today it might only purchase seven items if the price of each item has increased.
This phenomenon is driven by the fundamental principles of supply and demand. When the money supply expands, the value of money erodes over the medium and long-term. An increased money supply results in higher prices as more dollars chase the same amount of goods.
Short-term fluctuations in the money supply might not immediately manifest in the economy due to a concept known as "money velocity," which refers to how quickly money circulates. Newly printed money can remain inactive in savings accounts or under mattresses before entering the economy. Over the medium and long-term, all newly printed money eventually finds its way into the economy.
The Roman Denarius
Inflation and currency devaluation have occurred in nearly every civilization using fiat currency (paper money and non-precious metal coins) throughout recorded history. The Roman Empire experienced significant devaluation of its currency, the Denarius, due to its expansive influence and costly military campaigns.
The Denarius was originally a silver coin, but over time its silver content diminished as the Roman government devalued its currency. Silver, like gold, is considered a semi-precious metal and is valuable due to its scarcity. Gold and silver have served as stores of value and mediums of exchange for over 5,000 years. Bitcoin's value proposition is also based on scarcity; the total number of Bitcoins that can ever exist is capped at 21 million, making it scarcer than gold, which continues to be mined.
Roman emperors reduced the value of the Denarius over time to cover mounting expenses. Periodically, the Roman mint would collect existing coins, melt them down, and reissue new ones with less silver. This allowed the empire to produce more coins without needing additional silver.
Citizens recognized the declining silver content and the increasing number of coins in circulation, leading to higher prices to adjust for the greater supply. At its peak, a cup of ordinary wine cost about one-eighth of a Denarius. After inflation set in and the number of Denarii increased, the same amount of wine cost eight Denarii (a 6,400% inflation rate).
Modern Day Inflation – A $4.25 Filet Mignon Now Costs $70
Prices generally increase over time, a fact well-known to everyone. However, when compounded at high rates, these changes can become substantial.
Compound interest is often referred to as the eighth wonder of the world. Understanding it leads to earning it, while failing to grasp it results in paying it.
Inflation tends to fluctuate cyclically, sometimes high and sometimes low. The long-term median inflation rate for most developed countries is around 2-3%. History reveals periods of strong persistent inflation that significantly reset economies.
One notable historical example of prolonged inflation was the hyperinflation in the German Weimar Republic following World War I. While Weimar received the most attention, broader continental Europe also experienced significant inflation. European nations accumulated massive debts during WWI and resorted to inflating their way out of debt after the war.
Weimar's inflation was particularly severe for three reasons: 1) The debt burden was heavier due to the Treaty of Versailles' reparations, 2) Germany lost tax jurisdiction over many industrial areas that generated substantial tax revenue, and 3) persistent state deficits had swollen to more than 30% of GDP at the time.
High inflationary bursts lead to considerable wealth destruction and monetary devaluation due to their compounding nature. If inflation compounds at 15% for five years, prices double and purchasing power falls by half. Compound interest can be remarkably powerful. For instance, $100 compounded at 50% for five years yields a profit of $659, not $250 ($50 times five years) – the difference of $409 is compound interest.
Annual Inflation Changes Since the 1950s
The chart below shows the annual change in the five-year rolling average Consumer Price Index (CPI). Notice how inflation oscillates over time, and current inflation is relatively low compared to longer-term trends.
Inflation data from the U.S. Bureau of Labor Statistics indicates that goods prices increased about 950% between 1953 and 2021. The median inflation rate was 2.6%, but there was a pronounced burst of inflation during the 1970s. Had inflation remained steady at 2.6% for the same duration, prices would have only increased about 475%, not 950%. The difference is due to a strong inflationary burst that compounded vigorously.
Other economic data sources, including ShadowStats, suggest that actual inflation is higher than officially reported inflation over this time frame. There are numerous methods to calculate consumer price inflation.
While visiting the Banff Springs Hotel, we noticed a historical menu from the late 1940s/early 1950s. Prices were remarkably low compared to today's standards. For instance, a fine-grade filet mignon could be purchased for $4.25 Canadian Dollars. Today, that same steak costs $70 Canadian dollars – a 15-fold increase.
Banff Springs Restaurant Dinner Menu Circa Late 1940s/Early 1950s
Source: Equipment Radar
Note: The menu above is from a restaurant inside the Banff Springs Hotel, circa the late 1940s/early 1950s. The hotel opened in 1888 and is about an hour outside of Calgary, Alberta, Canada (we highly recommend visiting the historic hotel, Banff, and the Canadian Rockies – all are excellent).
Takeaway: The filet mignon cost $4.25 Canadian dollars (see arrow), which was about $4 US dollars at the time.
Banff Springs Restaurant Dinner Menu Today
Source: 1888Chophouse.com Online Menu at Banff Springs Hotel.
Takeaway: The Banff Springs steakhouse charges $70 Canadian dollars (about $56 US dollars) for a similar filet mignon today, representing an increase of about 15x.
Banff Springs Hotel
Source: Wikipedia.
Note: Canadian Pacific Railway opened the hotel in 1888. It is a magnificent architectural landmark surrounded by the pristine Canadian Rockies landscape.
Food Inflation Is Tame If You Exclude Certain Items
Earlier this month, the White House's National Economic Council Director Brian Deese addressed higher food costs by stating that food inflation is tame if you make certain adjustments.
"About half of the overall increase in grocery prices can be attributed to significant price increases in three products: beef, pork, and poultry. And in beef and pork, we've seen double-digit increases in prices over the last couple of months... If you take out those three categories, we've actually seen price increases that are more in line with historical norms."
The United Nations monitors global food prices in its monthly FAO Food Price Index. The index tracks a broad basket of common foods including meat, sugar, cereals, dairy, and vegetable oils. Over the past year, food prices have risen about 33% globally. The UN's data seem to contradict Director Deese's statement – meat has increased the least out of all food groups in the index.
Source: UN FAO.
Takeaway: Food prices are rising at the fastest rate in several years. Meat (light blue line) increased the least compared to other food items.
Even if Director Deese's statement is true, it's not realistic at all. About 95% of the population in the United States eats meat. Beef, pork, and poultry are core dietary components for the majority of the population.
In the United States, the average household expenditure for food is about $8,000 per year. In 2020, the overall expense dropped because many households shifted food purchases from dining out to dining in (likely a temporary trend due to restrictions). Food expenditures represent about 10% of household income, which is reasonable. Food can be closer to 35-50% of household income in many developing countries where the average income is lower. Higher food costs have a real impact on developing countries and geopolitical stability.
Higher Commodity Prices Are Driven By Supply And Demand
The global economy is interconnected – changes in one country or industry have ripple-through impacts on others. Higher food costs are often a result of higher input costs. For instance, beef prices tend to rise when feed costs (corn, hay, etc.) rise. Vegetable oil prices increase when canola prices increase. Corn prices increase when fertilizer and machinery costs increase. Machinery costs increase when steel prices increase. The pattern goes on and on.
Commodity prices usually follow the basic economic principle of supply and demand.
Supply | Demand | Prices
-------|--------|--------
↑ Higher | ↔ Flat | ↓ Lower
↔ Flat | ↑ Higher | ↑ Higher
↓ Lower | ↔ Flat | ↑ Higher
↔ Flat | ↓ Lower | ↓ Lower
Over the past few years, the global supply of many commodities dropped (see related article on commodities). Supply took a further hit when many businesses (including commodity producers such as miners, chemical companies, farmers, etc.) reduced output due to general business uncertainty and restrictions.
Demand increased rapidly through the second half of 2020 and into 2021 due to fiscal stimulus distributed to consumers and businesses. Supply chain shortages (such as semiconductors) are limiting production in many industries including farm and construction equipment, heavy-duty trucks, and cars and pickup trucks. The combination of reduced supply and higher demand has resulted in higher prices for many goods.
Note: Many professional economists today argue about how inflation is created. There is no commonly agreed-upon answer (our infographic above is one attempt at an explanation in a concise display). There are many intricacies to consider, and it is easy to get lost and not see the forest from the trees. Money is similar to most other goods and services in the sense that it follows the basic economic principle of supply and demand. All else equal, a higher money supply reduces money's scarcity and value.
Money Supply Increased Meaningfully
Global governments responded to the pandemic by increasing fiscal stimulus – in the United States, this included checks handed out directly to citizens ("stimmy" checks) and businesses (forgiven PPP loans). This stimulus is different from prior monetary stimulus because it represents cash handed out directly to households and businesses to spend immediately. This stimulus cash hits the economy much faster than prior "bond-buying" stimulus which stayed dormant in financial markets.
Money supply in the U.S. economy (see M3 data reported by the Federal Reserve) is up a whopping 33% since December 2019. Money supply increased to $20,388,900,000,000, up about $5,000,000,000,000 since the end of 2019 (no trillions label is intentional to emphasize the gigantic number). To put this in perspective, the $5 trillion increase in money supply is larger than the total amount of tax revenue the U.S. Government collected in 2020 ($3.6 trillion), and it is about 25% of U.S. GDP.
Money supply growth at these very high levels is like a sugar high after eating candy. The newly printed money hits the economy and demand increases because consumers and businesses have new cash to spend – the experience is strong and intense, but it is short-lived. Soon, the economy will experience a pullback as the sugar high wears off. The only way to keep it going is by eating more sugar… but there is a limit to how much sugar the economy can consume before it becomes very unhealthy and sick (high inflation). Soon, the fiscal stimulus that entered our economy will wear off, and we will need a new sugar injection (further increase in the money supply) to keep economic activity elevated.
Policymakers have a tough choice. They can avoid inflation by not printing more money, but that will cause a very strong pullback. If they continue printing money, it will cause high inflation and increase the risks of hyperinflation (runaway inflation). Ultimately, they will likely choose inflation because it keeps economic output elevated and avoids a broader deep economic contraction and widespread bankruptcies (deflationary spiral).
U.S. Money Supply (M3)
Source: Federal Reserve
Takeaway: Money supply has increased rapidly as a result of large fiscal stimulus and deficit spending.
Stagflation Could Occur
Another situation that could occur soon is economic stagnation in combination with higher inflation. This term is called "stagflation" by economists. The late 1970s experienced stagflation due to excessive monetary policy (similar to what we see today). Stagflation typically occurs after the money supply has expanded, but it's not enough to keep the economy at full output – so the economy naturally contracts and the new money causes prices to rise.
It's important to note that inflation (higher money supply) increases nominal GDP, however, that does not mean that living standards also have risen. For example, if your income doubles and your cost of living also doubles, then you are probably not much better off with a higher income. Living standards improve when GDP rises more than inflation (typically driven by productivity). Heavy equipment including construction and farm equipment and heavy-duty trucks help improve economic productivity.
Source: U.S. BEA
Note: Recessions are highlighted in gray.
Takeaway: Long-term the U.S. GDP has grown in nominal terms despite recessions every so often.
Equipment Demand Will Likely Remain Strong
Commodity prices increase during stagflationary and inflationary times. Higher commodity prices in turn tend to help support commodity-related industries such as agriculture, mining, forestry, aggregates and more. Commodity-related industries tend to fare better on a relative basis than non-commodity industries. As a result, demand for machinery and capital investments in equipment tend to remain elevated while the rest of the economy contracts.
If we do experience another inflationary or stagflationary future, equipment dealers and manufacturers including Caterpillar, Case, New Holland, Komatsu, John Deere, JLG, Genie, Potain, etc. should continue to experience demand better than the broader economy as prices for resources and commodities rise.
Ahead There's Probably No Other Choice Than Higher Inflation
Under normal circumstances assuming that an economy is balanced and has modest debt levels, it can withstand moderate economic recessions. The ability to tolerate recessions changes when an economy has an excessive amount of debt – the reason for this is because debt holders have a much more difficult time repaying the debt when the economy contracts.
A deep contraction can trigger bankruptcies and liquidations, which has the potential to turn into a deflationary spiral similar to what the economy experienced during the Great Depression. After several tough deflationary years during the Great Depression, policymakers opted to devalue the currency and increase fiscal stimulus to reignite economic growth.
It does seem highly unlikely that the USA will default on its government debt. Any government that can print its own currency and also borrow in its own currency (i.e., USA, Japan, China, etc.) can simply print more money to repay its debt obligations. The printing is not a free lunch – printing more money ends up creating inflation.
Since the 1960s, debt-to-GDP has risen for the United States and most other countries. Debt has grown at a faster rate than GDP for about 60 years – long-term this is unsustainable. Whatever is not sustainable eventually ends – the question is... when will it end?
"The recognition that things that are not sustainable will eventually come to an end does not give us much of a guide to whether the transition will be calm or exciting." – Tim Geithner, Secretary of the Treasury during the Financial Crisis
Global debt data collected by the Bank of International Settlements show that global debt-to-GDP has grown considerably for most of the world. The U.S. Government Accountability Office (GAO) 2020 government financial statements and projections forecast deficits and debt-to-GDP expanding to unprecedented levels through 2050.
Historically, debt-to-GDP would rise after wars and then return to low levels as the country paid back the debt and GDP grew (GDP grew faster than debt). The rise in debt-to-GDP over the past 15 years has been driven by fiscal spending to prevent a deep recession. Pumping the system full of stimulus cash and raising debt-to-GDP works for only so long before it no longer works. Debt cannot grow faster than GDP in perpetuity. At some point the system breaks, and we could reach that point in the near future.
When looking at debt, it's important to look at the system-wide debt that includes government, corporates (businesses), and households. Most governments can control the issuance of their currencies, but households and businesses cannot – as a result, the fates of indebted households and businesses are at the mercy of policymakers. Usually, policymakers are required to step in and bail out over-indebted households and businesses (similar to bailouts during the Financial Crisis and China's Evergrande at the moment).
Takeaway: The U.S. government's budget office forecasts that debt-to-GDP will rise dramatically. It is important to note that projections do not assume a moderate or severe recession (which would further increase debt levels). Interest expense paid on the national debt will grow meaningfully going forward.
Note: The entire world has elevated debt levels. We are all in the same boat. As you can see, Japan's system-wide (government, corporates, and households) debt is above 400%. It's possible this gravy train has more room to run before it hits a wall... time will tell. In the USA, system-wide debt-to-GDP increased from 129% in 1960 to 293% today.
Inflation Experts To Follow
Dr. Michael Burry, Scion Asset Management
Michael Burry, founder of Scion Asset Management and @michaeljburry on Twitter, is a famous investor who anticipated the Great Financial Crisis of 2006-08. Earlier this year he said that people should "prepare for inflation." He has cited several data sources similar to those above and noted that history has many examples of inflationary resets. He believes that the U.S. is destined for strong inflation or even hyperinflation similar to the German Weimar Republic.
"People say I didn't warn last time. I did, but no one listened. So I warn this time. And still, no one listens. But I will have proof I warned." – Dr. Michael Burry
Burry is a thoughtful person who takes his time to research and understand issues before making a public forecast.
Michael Ashton, Enduring Investments
Bloomberg recently featured an article on inflation featuring Michael Ashton, founder of Enduring Investments and @inflation_guy on Twitter. In the article, Ashton notes how his views on inflation were not appreciated by the mainstream for many years after he founded his advisory firm in 2009. Ashton said that more recently people have started to pay attention and are asking for his advice. The large influx of money supply and the recent rise in inflation has reminded many that inflation is a factor that will always be present as long as we have an expanding money supply.
"The lack of interest [in inflation] was amazing. It’s incredible how little people thought about it — what that risk was." – Michael Ashton
Peter Schiff, SchiffGold
Peter Schiff, founder of SchiffGold and @PeterSchiff on Twitter, hosts a regular podcast discussing monetary policy and the economy. A long-time gold bull, Peter's clients experienced outsized investment gains in 2020 as the money supply increased. Peter is a student of history and has studied long-term debt cycles.
"Maybe someone should inform #Powell that prices are not rising by a mere 2/10 of a percent above the Fed's 2% target. They're rising at triple that rate in 2021, and will likely quadruple that rate or more in 2022. This is not the type of #inflation families can just shrug off!" – Peter Schiff
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