The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

Industrial Portfolio Strategy
The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -29- Legg Mason Wood Walker, Inc.
Exhibit 20 – M2 Velocity Versus CPI Inflation, 1960 to 2001
16.0%
14.0%
12.0%
M2 growth is back to the 1960s
to 1970s level. Future inflation
trouble?
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
-4.0%
Mar-60
Mar-62
Mar-64
Mar-66
Mar-68
Mar-70
Mar-72
Mar-74
Mar-76
Mar-78
Mar-80
Mar-82
Mar-84
Mar-86
Mar-88
Mar-90
Mar-92
Mar-94
Mar-96
Mar-98
Mar-00
M2 money supply, SA, y/y% change
CPI Urban inflation, all items, y/y% change
Real U.S. GDP, y/y% change
Source: U.S. Dept. of Commerce, U.S. Bureau of the Census, U.S. Federal Reserve
Although investors have benefited from the 1990s’ monetary policy, we would not confuse benefit
with benevolence. As an offset to inflation, we do expect a cyclical bounce in productivity in the next few
years, as the demographics that support labor productivity are now at their zenith, in our view. Later, however,
if productivity loses momentum as we expect, prompting unit labor costs to climb, we ask rhetorically
“Will the Fed tighten and risk bringing lingering balance sheet problems to the fore, possibly laying waste
to a leveraged global financial system?” We do not think so. Despite a rise in liquidity preferences, asset
inflation and debt are less fleeting, in our view, and we know of no example in which prolonged money
supply growth above the rate of GDP expansion, or borrowing based on inflated assets, did not invite
financial difficulties and, as a response, Fed over-accommodation that reduces real equity values.
The Outlook for Domestic Productivity as An Offset To Loose Monetary Policy
The outlook for domestic productivity as an offset to loose monetary policy is favorable, in our view,
but may be peaking in terms of beneficial impact in the next few years. Productivity quantifies output
per hour, and if a case can be made for exceptionally strong real GDP growth via productivity and/or labor
force expansion, inflation may be kept at bay. Taking a longer view, employers in the next decade may be
forced to pay more for workers, health benefits packages, and the commodity inputs to cost of goods sold,
which has the effect of squeezing profit margins unless prices and/or productivity can be raised to offset the
pressure. In Exhibit 21, we show U.S. productivity growth in relation to the experience profile of the U.S.