John Greenwood, the veteran chief economist at Invesco Perpetual, believes two economic “myths” are causing investors to wrongly move into assets that offer protection from much higher global inflation.
Speaking at an event in London today (22 September) about global levels of inflation, rather than specifically in the UK, which is seeing an uptick in prices, Mr Greenwood, said the first myth is that increased government spending and running a budget deficit will lead to higher inflation.
Inflation expectations leapt when Donald Trump was elected, as investors thought he would instigate a round of tax cuts and infrastructure spending.
Both of those actions would increase the US budget deficit, and, in the view of many economists be inflationary, not just for the US but for the rest of the world.
The rise of other “populist” politicians in around the world has also led market participants to take the view that government budget deficits will rise, leading to higher inflation.
But Mr Greenwood said the link between higher government budget deficits and higher inflation is a myth, giving the example of the Reagan years in the US, when the budget deficit rose consistently, without inflation rising.
The second “myth” the economist highlighted is the perceived link between the level of employment, and the level of inflation. Economic theory calls this link the “Phillips curve”.
The idea is higher levels of employment lead to higher levels of wages, which leads to economic growth, and then inflation.
Many market participants have been puzzled by the fact that while UK and US unemployment has continued to fall sharply in the years since the financial crisis, it has not led to higher wages and inflation.
Mr Greenwood said this can only partly be explained by technological change and the rise of irregular employment.
The economist said additional regulation of the financial sector since the global financial crisis meant that banks have behaved differently since the financial crisis. Typically, higher employment leads to an increase in the willingness of banks to lend, and an increase in the desire of consumers to borrow.
Mr Greenwood said this extra borrowing, not the wage growth, is what leads to higher inflation as employment rises.
He added that tighter lending restrictions have led companies and individuals, on a global basis, to reduce their levels of debt, and that has also stopped inflation picking up.
The anticipated reduction of the balance sheet of the US Federal Reserve, announced on 21 September, will also have the effect of keeping a lid on inflation, Mr Greenwood said.
This is because companies will buy the bonds the Federal Reserve are selling, and so have less cash on deposit, which reduces the amount of cash banks are able to lend into the economy.
Mr Greenwood’s view is that UK and Eurozone economic growth will continue at the current, pedestrian level for a couple of years, but with the generally low inflation rate, be positive for equities.
Bruce Stout, who runs the £1.7bn Murray International Investment Trust, has long been a critic of global central bank policy, and also forecasted lower inflation.
He said: “It’s becoming increasingly evident that monetary policy incompetence over the past decade has created deeper structural problems than those it intended to alleviate.
"Excessive debt, excess capacity and evaporating confidence threaten to escalate deepening deflationary pressures, an environment not conducive to current euphorically priced equity markets.”
David.Thorpe@ft.com
