What Unites Buffett and Powell? They are Both Wrong About Inflation.

by | May 10, 2021

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.

Say what?

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.

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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