The Consumer, Spending and Inflation

James Mee discusses this tricky trio

"Whereas one who has the traditional perspective might think that a large increase in the amount of money will be inflationary, one using a transactions-based approach will understand that it is the amount of spending that changes prices."

Ray Dalio (Bridgewater Associates founder), How the Economic Machine Works

Western central banks’ favoured policy of Quantitative Easing (QE) has injected vast sums of “money” into the financial system. Traditional economics would imply that, all else equal, increased supply of money should have resulted in significant inflationary pressure. 

For various reasons (bank hoarding, household deleveraging and weak confidence, amongst others), it has taken time for this money to reach the real economy. However, as confidence has grown, demand for money has increased, and spending has picked up. 

Source: DB, Torsten Slok

Higher spending (by both consumers and corporations) is important; in addition to driving GDP growth (the consumer accounts for c.69% of US GDP, while gross private investment accounts for c.17%1), increased spending has the potential to pull inflation upwards2. Furthermore, increased spending has a positive feedback loop effect: as consumption increases, companies are willing to invest (generating demand for business-to-business goods and services), which in turn drives GDP growth and (potentially) prices upwards. 

While we believe that the long term trend for inflation remains “lower for longer”, we do not discount the possibility of short term cyclical swings in the price level (something which financial markets are not expecting or priced for). Given the importance of the US consumer to the Global economy, we keep a close eye on confidence and spending trends. 

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1 Factset Data
2 "Demand Pull" Inflation is where aggregate demand outstrips supply, thus enabling sellers to increase prices