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Good morning. For some reason, I get to feel a little guilty about writing about inflation, as if forcing my readers to eat spinach or inflect irregular verbs. But it is worth remembering why the topic is so important. In the temporary-against-stick debate, the market has put all its chips on transient. This is most visible in bond yields, but it is also associated with stock valuation. The chances of several years of inflation well above (say) 3 percent seem small to me, but if that’s how the dice come up, we get some wild times. So put up with me, and read on. Send me an email: [email protected]
Do we have inflation in the 1950s?
I often describe inflation as the thing that everyone always makes mistakes of. In my adult life, there has only been one thing to say about it that did not come back and bite you in the ass: “It goes lower and gets lower, no matter what and forever.” Anyone who said anything other than that has ended up looking stupid.
Of course, inflationary neuroticism may eventually be justified. But it is worth thinking about why so many have been so wrong for so long. In this context, this blog post from Gabriel Mathy, Skanda Amarnath and Alex Williams is interesting. It argues that when we think of inflation, we should think more about the 1950s and less about the 1970s. Here is their statement about the standard narrative of the 1970s:
Unemployment became too low in the late 1960s (3.4%), boosting inflation through a Phillips curve. This inflation then caused workers and price setters to reset their inflation expectations higher, and these higher expectations resulted in higher inflation over the following decade. This tug of war then continued until the Volcker Fed raised interest rates far enough to cause a major recession that reset everyone’s inflation expectations. ”
MA&W is right: Talk to 100 people about inflation, and 95 of them will talk about it like this. Most of us have only three tools in the box. One: a Phillips curve idea that there is some level of unemployment below which any effort for economic stimulus must result in inflation. Second: the idea that inflation expectations are self-fulfilling prophecies because pricers are trying to get ahead of them. Three: to say “inflation is always and everywhere a monetary phenomenon” without reflecting too closely on what exactly it might mean.
And when those are the only inflation concepts you have, the conclusion you will come to is that the Federal Reserve needs to be more vigilant.
But the 1950s, MA&W points out, saw very low unemployment at the beginning of the decade, and a subsequent “inflation outbreak”, and no interest rate hike tactics were used to bring it down.
So what was the difference? In the 1950s, inflation rose sharply as America went to war in Korea, but:
“When it became clear that the Korean War would not require the same level of economic oversight or active leadership as World War II, inflation expectations were quickly normalized. . . The account of ‘inflation expectations’ that this experience implies is one centered around world events, rather than previously realized values for inflation. This version adds a degree of empirical realism, but sacrifices the idea that inflation — once started — will create a self-sustaining upward spiral. Instead, inflation rises and falls as expectations of future change. ”
In the 1970s, MA&W believes, the problem was not a spiral of expected and realized inflation, but a restructuring of the economy that led to persistent capacity bottlenecks and unsustainable labor markets. The difference with the 1950s was not about expectations; the underlying economic changes were simply much greater.
The key word, of course, is that the economic changes we are seeing today are not as dramatic or as permanent as in the 1970s, and even if they do last a few years, inflation expectations do not have to scare us, and we do not need it to worry about a political mistake.
MA&W wants a super-tight job market (their blog is called “Employ America”). So like everyone else, they have a political agenda. I do not support their theory. I do not know enough economics to assess it correctly. But I am convinced that their starting point is correct: any serious way of thinking about inflation must start by accepting that the most long-standing and widely accepted view of it has been proven wrong.
Aswath Damodaran at ESG
When I say that environmental, social and administrative investment harms the world, people assume that I am exaggerating for effect; that what I am writing is clickbait. Nix. I’m sure the ESG investment complex is well-intentioned, but I’m just convinced the world would be a better place without it. To use Tariq Fancy’s analogy, the industry sells wheatgrass juice as a cure for cancer: it does not help; it reduces the chance that the patient will seek the right treatment; and it’s not cheap.
It’s a lonely view to have, so I was pleased to discover that Aswath Damodaran, a professor at New York University and highly quoted valuation expert, has the same view. He comes up with some of the arguments that Fancy and I have put forward, but he makes many of them clearer and stricter than both of us, and adds some new wrinkles.
I must note that he and I disagree on one point. He believes that what constitutes good corporate conduct will always be disputed, so that the lack of coherence between ESG rating schemes cannot be resolved. I believe that there is agreement on key issues (climate change, transparency in the supply chain, shareholder rights, compensation for managers). That’s why the ESG industry loves to talk about this problem. It is solvable, unlike the ESG’s other contradictions and conflicts.
Damodaran highlights two key points with particular elegance. One is that, in equilibrium, it does not make sense to insist that ESG portfolios can surpass non-ESG portfolios:
“The notion that adding an ESG limitation to investment increases the expected return is counterintuitive. After all, a limited optimal can at best match an unlimited, and for the most part, the limitation will create a price. ”
It’s the best expression I’ve read about the sheer truth that ESG finances good-by-doing good marketing is just shit.
Next, he highlights the important point (also highlighted here) that ESG attributes can only drive outperformance during transition periods when investor preferences change. Then the cost of capital differences must mean underperformance:
“During the adjustment period, the highly valued ESG shares will surpass the low ESG shares, as markets are slowly incorporating ESG effects, but this is a one-off adjustment. When prices reach equilibrium, highly rated ESG stocks will have greater values, but investors should be content with lower expected returns. ”
But most importantly, he asks a crucial question:
“If ESG is a flawed concept, perhaps fatal, and if the flaws are visible to all to see, how do we explain the huge push [for it] in both business and investment settings? ”
The answer is that ESG is a deep trough where investment managers, accountants and consultants can feed. Damodaran’s chart of this is a pleasure:
A good read
The thing that keeps happening with big companies in China? It happened again.
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