Investing During Inflation

THE BUDGET

I am writing this the morning after the budget. The budget has slowly become a non-event, which is exactly what it should be. It is only the financial media which, more driven by TRP – a form of incentive caused bias, keeps it at the center of events. In essence, the budget has two components. The first is a presentation of finances for the ongoing financial year. The next is a plan of allocation of financial resources for the next year. That’s it. The plan for the next year is an intent. It is not cast in stone. And the plan also is updated based on updated situations during the year. At most the budget can give a feeler in terms of the intent of the government for the following year.

Even without the pronouncement during the budget, most of those who follow the financial sector, knew that the focus is on infrastructure building which in turn leads to what economists’ term as “crowding-in effect”. That is when government spending is followed by private spending due to a rise in overall economic growth. Overall, this leads to a rise in jobs, wages and hopefully, more prosperity all around.

The other areas of government expenditure are social spending under various names and heads and a push for “Atmanirbhar Bharat”.

INFLATION

Perhaps the biggest threat to global equities today is inflation. Some economists say it is because of temporary supply side constraints whereas others believe it to be more structural in nature and occurring due to the massive injection of ‘helicopter money’ by central banks post the pandemic.

I am not an economist. So, my thoughts are more theories based on my observations.

When I look at the production of any commodity, I don’t see any dip in supply.

I cannot find any industry where supply is way below what was there before the pandemic began. Even in the most well-known case of semiconductor shortage, the aggregate production has not really gone down. It is just that the demand has increased sharply and also some companies like Intel are also now outsourcing their fab work to TSMC and their likes till their own expansion is in place. (ref: https://www.gizmochina.com/2021/09/22/intel-explains-why-it-is-outsourcing-chip-manufacturing-to-tsmc/)

The second fact that can be seen is the “Great Resignation” in the US. Literally millions of people, more low wage workers than their higher paid counterparts, are leaving the job market. There are many reasons being cited. From being overworked and underpaid to location constraints.

THE AGE OF DEGLOBALISATION

The last thirty odd years had seen a major shift in production of goods and services. For various reasons which are now well known, both manufacturing and services shifted to Asia (China, India, Vietnam, South Korea, Thailand, Philippines, Malaysia etc). This was presented as a win-win as it helped customers in developed countries tide over labour shortages and get their products cheaper than producing it at home. The global supply chain started working in a completely optimized and efficient manner.

Additionally, the Asian countries have also developed in this period and the cost of production has started growing there are well. Wage rise and reduced working hours in China is a classic example. Stricter adherence to environmental norms is another such example.

RISING INEQUALITY

Another phenomenon that started taking shape parallelly was the rise of inequality across the world. People with higher education earned more and over three decades the gap that has been created has become substantial. This has many repercussions. We have started seeing social unrest across the globe. Countries and political parties have started becoming more hardline to protect domestic jobs and a lot of countries have started incentivizing domestic production. Free movement of labour across borders are also now being met with lot of skepticism and protectionism.

DEGLOBALISATION AND INFLATION

The net result of all these is that the manufacturing and services is likely to shift away from its lowest cost production centers globally in the next two-three decades. China+1 is just one such example. Similarly, we have seen Indian IT companies hiring significantly more in US and other “nearshores”.

INVESTING IN AN INFLATIONARY WORLD

We should witness a persistent inflation that is higher than what we are accustomed to in the past.

Governments straddled with mountains of debt would want to run a few years of high inflation and negative real rates.

The best part of all this is that companies that adopt technology which tends to have a disinflationary characteristic, are able to pass on cost increases to its customers (preferably global), are likely to benefit the most in the future.

This post first appeared in The Economic Times