Recently, Warren Buffett made headlines by declaring that he is seeing ‘substantial inflation’. Buffett hardly needs introducing. He is the famed midwestern value investor, often referred to as the ‘sage of Omaha’. His words are followed by millions of investors worldwide.
When Buffett talks about inflation, folks take note. All the more so because his modifier for inflation—‘substantial’—differs sharply from Fed Chairman Powell’s preferred term, ‘transitory’. A war of adjectives has opened up between two of the most influential observers of economic and financial affairs.
So, who is right?
Probably neither of them.
Let’s begin with Warren Buffett. When providing evidence for ‘substantial’ inflation he ticked off, among others, lumber and SPAC (special purpose acquisition company) prices. Yet he did not take note of broader measures of docile consumer prices and wages. Inflation is defined—at least by economists—as a broad-based increase in prices and wages. When some prices suddenly jump, that is not inflation. It is a shift in relative prices. Or, in the case of SPACs, it is the mania of crowds doing foolish things with their money.
The fact that Buffett is cherry-picking price changes, confusing relative prices for the price level, does not mean, however, that he will ultimately be wrong about inflation. He may just be early, shouting from the Nebraska rooftops about the impending storm based on the evidence of a few raindrops.
Yet Buffett’s haste or selective use of facts does not make Chairman Powell correct. After decades of getting inflation forecasts wrong (typically overestimating future inflation), faith in the prognostication powers of economists and central bankers alike is deservedly low.
Still, Chairman Powell is correct about one thing. Surging demand as spending-starved US consumers flock back to their national pastime of hedonism, powered by fiscal and monetary largesse, will push many prices higher. Shortages in supply as product and labor markets struggle to meet the avalanche of spending will contribute to price and wage pressures, as evidenced by the biggest monthly jump in average hourly earnings in Friday’s US employment report recorded since 2007.
But Powell is making a big bet that those price and wage gains will moderate thereafter. As noted, the economics profession has largely lost the plot when it comes to understanding inflation. A quarter century of next-to-no response in Japan to tsunamis of fiscal and monetary easing reinforce a consensus, to which Chairman Powell apparently belongs, that inflation is beast that once tamed cannot be revived.
Yet the consensus of central bankers and economists should not lull us into complacency. Or have we so quickly forgotten the question posed by Queen Elizabeth II at the London School of Economics in 2009: Why had no one predicted the great financial crisis? And all along, that howler was right under the Fed’s nose.
If there is one thing economists agree on regarding inflation, it is that expectations matter. Recently, long-term expected inflation, as measured by inflation-linked bonds, has risen quite significantly. Today, five- or ten-year ahead expected inflation rates are above their pre-pandemic peaks, in some instances at their highest readings in a decade.
If ordinary Americans (and residents of other countries) begin to feel that prices and wages are apt to rise at a faster clip, in part because, like Warren Buffett, they see it happening in their everyday lives, they may begin to change their behaviors. Consumers may not balk at ‘sticker shock’, workers might muster the courage to ask the boss for a raise or change jobs for better pay. And, before any of us, Chairman Powell included, knows it, inflation becomes normal again.
Warren Buffett confuses changes in relative prices for inflation. Chairman Powell suffers from the hubris of central bankers and economists. It is easy to chide Buffett, but we’ll be grateful if he is wrong. On the other hand, if Chairman Powell is wrong, not just the Queen will wonder whether he was blinded by hubris.