The Potential Economic Black Swan of 2020 — Whiplash Inflation

The coronavirus, coupled with zero familiarity with inflationary conditions, could catch every American off guard.

History has a funny way of repeating things, but to be more precise, it can reflect the condition of forgetting things.

It can also represent zero exposure to something. Case in point: how many of your friends suffered from Polio during your adolescence?

War represents a common example. Within fifteen years, every veteran who fought in World War Two will have passed from this world to the next. Their perspective about world war will only be available through video, audio, and text media.

Inflation is not as serious as war, however, the last adults that experienced inflation firsthand were 18 years old in 1982. Beyond that year, the Fed’s efforts to tamp down inflation succeeded. Concerns relating to inflation have been nonexistent since then.

If you were born after the year 1964, you have never experienced an inflationary cycle… ever. The percentage of U.S. adults that were born in 1965 or later equates to nearly 70% of the population, according to U.S. census figures.

Why would anyone care about inflation at this particular moment in history? I can think of 60 million reasons.

60 million Chinese nationals are under lockdown due to the rampant spread of the coronavirus. For weeks, China denied the WHO and the U.S. C.D.C. entry into the country. If we learn the Chinese were not completely honest, a pandemic alert may be issued as early as this week.

If you’re sitting in your house wondering how this is going to affect you, provide me the courtesy of reading a few more paragraphs.

The second-largest economy in the world is going to contract in the first quarter of this year. Anyone who does not believe that or is willing to accept an inflated economic number reported by the Chinese government is deceiving him or herself. Business travel, transportation, and Chinese businesses located on the mainland are all suffering from the consequences of contagion.

What happens if the number of infected individuals rises past 100,000? It’s a scary thought.

What’s even more terrifying is there’s a kid named Mack in Dayton Ohio who is counting on his parents to buy him an iPhone as a birthday present before he enters high school.

If that doesn’t make you think, then I’ve lost you. Here’s the crux of the matter and why inflation is going to spread faster than anything we’ve ever seen if a pandemic is declared.

Everyone in Western society, the developing world, the Middle East, and throughout Asia still want things. They want a better phone, stove, car, pair of sunglasses, sneakers, TV, alarm clock, smart phone-watch-wearable device and they want it now.

China, in many cases, provides the supply — from semiconductors to solar panels to 5G network equipment (that serves more than one purpose). A multitude of components, especially microprocessors, are manufactured in a part of the world that is a whisper away from a pandemic.

Demand… is not… going to slow down. This represents a scenario that could usher in inflation and no one is prepared to manage it because no one under the age of 56 has ever experienced it.

And the Federal Reserve will have to do something to combat it.

Paul Voelker was the Chairman of the Federal Reserve who took on the challenge of inflation during the 70s and 80s and won. The methods he used are worth noting. Consider the annual historic averages, where inflation was +8% over the past 106 years:

Between the years 1979 and 1981, inflation was rampant. Paul Voelker made two decisions. First, he raised the prime rate significantly to retract excessive liquidity in the market. It topped out during this time in December, 1980, at 21.5%.

Paul Voelker and President Jimmy Carter, photo courtesy NY Times.

The rate to borrow money from a bank, to buy a 30-year mortgage at this point in history, was 14.8%. This represented a magnified effort by the fed to control inflation. Paul Voelker went further and required banks to withhold 20% of their cash reserves, raised from 10% during this period.

Cash becomes very expensive during inflationary cycles, and compared to the low rates we’ve enjoyed for 10+ years, borrowing money today is relatively cheap.

Consider the global consequences if China’s role in the global pipeline supply is curtailed for months on end. Demand, as noted previously, is not going to recede in the rest of the world. Friction will emerge between corporate and consumer buyers as supply begins to dwindle. This would change the fundamental economic dynamics we’ve grown accustomed to.

A final example to share — a product you use every day. China produces nearly 13.5 billion pairs of shoes/sneakers every year. No other country comes close in terms of production and consumer demand will remain steady in this category for obvious reasons.

If the coronavirus takes root and contagion spreads on China’s mainland, consider new strategies in the short term to assure you do not suffer from inflationary whiplash. Homebuyers especially need to consider future implications, and those with ARM mortgages may be affected in the long term as well.

I’m the author of the forthcoming book, The Father Apprentice, schedule to be released by Familius Publishing in 2021 —