# Is Inflation About to Get Much Worse?

An episode of [Patrick Boyle On Finance](https://invisiblenetwork.ai/podcast/1547740313), 3 May 2026, 33 min.

Audio: https://traffic.megaphone.fm/APO1574427382.mp3

U.S. consumer sentiment has fallen to a 74-year low. Brent crude is above $125 a barrel. And several highly credible economists had been warning that inflation was coming back — long before the first missile was fired. In this video, we look at the structural forces — demographic, fiscal, and geopolitical — that are making inflation much harder to control, and why central banks may no longer have the tools or the political independence to do anything about it.Based in part on the new book "The Unanchored Central Banker" by Manoj Pradhan and Charles Goodhart. https://amzn.to/4n7hklUMy second channel: https://www.youtube.com/@PBoyleInterviewsMy interview with Manoj Pradhan: https://youtu.be/EuhdSV_WTVI Patrick's Books: Statistics For The Trading Floor: https://amzn.to/3eerLA0 Derivatives For The Trading Floor: https://amzn.to/3cjsyPF Corporate Finance: https://amzn.to/3fn3rvC Ways To Support The Channel: Patreon: https://www.patreon.com/PatrickBoyleOnFinance Buy Me a Coffee: https://www.buymeacoffee.com/patrickboyle

## Transcript

[0:00] The S&P 500 is currently sitting near an all time high.
[0:04] Equity traders seem to have decided that a war in the Middle
[0:08] East, one that has effectively closed the world's most critical
[0:11] energy choke point, is simply a great opportunity to buy the
[0:15] dip. And buying the dip has become
[0:17] such a winning strategy in recent years that dips don't
[0:21] really happen much anymore. The average consumer is a bit
[0:25] less convinced. U.S. consumer sentiment has
[0:29] recently fallen to a 74 year low.
[0:32] To put that in perspective, those 74 years included the
[0:36] assassination of JFK, the 1973 oil embargo, September 11th, the
[0:42] global financial crisis, and a global pandemic.
[0:46] And people are more miserable now than they were during any of
[0:50] those times. That is not a great number if
[0:54] you're an incumbent politician running for office.
[0:57] The immediate cause of this collapse in sentiment is the
[1:01] closure of the Strait of Hormuz, though as we'll see, the
[1:05] problems run much deeper than that.
[1:08] In late February, an assault on Iran shut down the transit of
[1:12] roughly 20 million barrels of oil a day, about 1/5 of the
[1:16] global supply. Martin Wolf, riding in the
[1:19] Financial Times, points out that the Strait is a vital artery of
[1:24] the world economy, a place in which one starts a war only
[1:28] after careful consideration of goals, means and risks.
[1:33] He goes on to say that's not what happened.
[1:36] Brent crude has, as of the time of this recording, been pushed
[1:41] above $125.00 a barrel. As I mentioned in last week's
[1:46] video, oil prices feed directly into the cost of food,
[1:50] fertilizer, and shipping, so that increase is rapidly working
[1:54] its way into everything you buy. Politicians would very much like
[1:59] to blame our current cost of living problems entirely on this
[2:03] geopolitical bad luck. And while the energy shock has
[2:07] certainly acted as a massive accelerant, several highly
[2:11] credible economists had been warning that a surge in
[2:14] inflation was sitting in the pipeline long before the 1st
[2:18] missile was fired. The war merely exposed the
[2:22] problem, according to a new book by Manoj Pradhan and Charles
[2:27] Goodheart. For three decades, central
[2:29] bankers have been taking credit for a structural decline in
[2:33] global prices that had almost nothing to do with their policy
[2:37] decisions. They had the wind at their backs
[2:41] and mistook it for the power of their own legs.
[2:44] Now that the windows changed direction, the job of central
[2:47] banker has become one of the most difficult and politically
[2:51] dangerous roles in public life. Pradhan and Goodhart argue that
[2:56] from about 1990 until recently, the global economy was coasting
[3:01] on what economists call a demographic sweet spot.
[3:05] The baby boomer generation had entered the workforce, female
[3:09] labor participation rose sharply, and China and Eastern
[3:13] Europe joined the global trading system.
[3:16] This essentially amounted to a once in history doubling of the
[3:20] effect of global labor force, which is a very reliable way to
[3:25] keep wages and prices from going up.
[3:28] Central bankers looked at this massive structural gift of cheap
[3:33] labor and cheap goods and concluded that their success was
[3:37] down to their own financial genius.
[3:40] To understand why this matters, we need to talk about something
[3:44] called the Phillips Curve. It's one of the most important
[3:47] relationships in economics, and for years people thought that it
[3:51] was broken. The Phillips Curve is the idea,
[3:54] dating back to 1958, that when unemployment is low and workers
[3:59] are scarce, wages go up and prices follow.
[4:04] When there's lots of spare labor, prices stay flat.
[4:08] Simple enough. But for the last two decades,
[4:11] central bankers kept interest rates at rock bottom.
[4:15] Unemployment fell to historic lows in several countries, and
[4:19] inflation barely moved. Economists started writing
[4:22] papers about the death of the Phillips curve.
[4:26] Central bankers took credit for having conquered inflation
[4:29] through sheer competence. Pradhan and Goodhart argue that
[4:34] the Phillips curve wasn't dead, China had just put it in a coma.
[4:39] The author's insight is that we shouldn't be looking at
[4:43] inflation as one big number. There are two separate inflation
[4:47] dynamics running at the same time.
[4:50] The 1st is a domestic services curve.
[4:53] Your hairdresser, your plumber, your lawyer, the people who have
[4:57] to physically be where you are. Their prices are driven by your
[5:02] local labour market. When workers are scarce, those
[5:06] prices go up. That relationship never broke
[5:09] down. The second is a goods curve, and
[5:13] for the last 30 years this one was essentially made in China.
[5:18] When you offshore most of your manufacturing to a country where
[5:22] labour is cheaper, the price of physical goods falls
[5:25] relentlessly. And that goods deflation was so
[5:29] powerful that it masked the fact that services inflation, the
[5:34] domestic part, was ticking along quite normally the whole time.
[5:39] What this meant in practice was that central banks in the US and
[5:43] Europe were essentially outsourcing their inflation
[5:46] targets to Chinese factories. Politicians got to enjoy solid
[5:51] economic growth with low borrowing costs.
[5:54] Workers in the services sector got steady pay rises and nobody
[5:59] had to make any difficult decisions because cheap
[6:02] televisions and cheap clothing from China were pulling the
[6:06] average down. It was a great arrangement for
[6:10] everyone. The workers who lost those
[6:12] factory jobs didn't vanish. Most of them ended up in the
[6:16] services sector, which is one of the reasons services inflation
[6:20] never actually went away. But that era is now coming to an
[6:25] end. The world's population is aging
[6:27] rapidly, and the global labor force is beginning to shrink.
[6:31] China is still flooding certain sectors with cheap goods.
[6:35] European car manufacturers can tell you all about that.
[6:39] But the structural force that kept global prices falling for
[6:43] 30 years is running out of Rd. China's own population is aging
[6:49] faster than almost any major economy.
[6:52] It's workers are moving out of export driven manufacturing and
[6:56] into domestic services, and on top of that tariffs and trade
[7:01] barriers are now actively blocking whatever cheap goods
[7:05] China does produce from reaching western consumers at the old
[7:09] prices. The The structural tailwind that
[7:13] made central banking look easy for 30 years hasn't just faded.
[7:17] It's being erased by demographics, by geopolitics,
[7:21] and by deliberate policy. And if you're a central banker
[7:25] operating without that tailwind, in an economy where workers are
[7:29] scarce, where services inflation is persistent, and where your
[7:33] government is running enormous deficits that it has no
[7:37] realistic plan to pay for, the job starts to look very
[7:41] different. If you think this structural
[7:43] shift sounds like an abstract long term problem for future
[7:47] generations to worry about, it's not.
[7:50] The bill is already coming, due back in January, before the
[7:55] Strait of Hormuz was closed, before Brent hit 125, Adam
[8:00] Posen, the president of the Peterson Institute for
[8:03] International Economics, and Peter Orszag, the CEO of Lazard,
[8:08] published a piece arguing that US inflation could hit 4% by the
[8:13] end of this year. That is double the Federal
[8:17] Reserve's target. And their argument had nothing
[8:20] to do with an energy shock. They were warned that the
[8:24] ingredients for a resurgence in inflation were already in place.
[8:28] The war has simply thrown gasoline on a fire that was
[8:32] already burning. Their case rests on several
[8:36] reinforcing pressures. The first is the lagged pass
[8:40] through of tariffs. When a government announces a
[8:44] massive new tariff, businesses don't raise their prices the
[8:48] next morning. They work through their existing
[8:50] inventory. They watch what their
[8:52] competitors do, and they wait to see if the policy gets reversed.
[8:57] But eventually the old inventory runs out.
[9:01] Poznan Orszag note that businesses have now depleted the
[9:05] stockpiles they built up ahead of the tariffs, and they're
[9:09] beginning to pass those costs on to consumers in smaller
[9:13] increments, which means the inflationary effect is still
[9:17] building, not fading. Then there's the labor market,
[9:21] which is tightening. When any economy loses workers,
[9:25] whether through aging, emigration or policy changes,
[9:29] the same thing happens. Labor is an input, just like
[9:33] energy or raw materials. When it becomes scarcer, wages
[9:37] rise and those costs get passed on to consumers.
[9:41] Several Federal Reserve banks now estimate that the break even
[9:46] employment level, the number of jobs the economy needs to add
[9:50] each month to keep unemployment stable, has roughly halved since
[9:54] early 2024. The labor market is considerably
[9:58] tighter than the headline numbers suggest.
[10:01] You might reasonably ask whether automation and AI could fill the
[10:06] gap, and over time, they possibly will.
[10:09] In some sectors, as Posner has argued, the history of
[10:12] technological disruption suggests that the productivity
[10:16] gains tend to arrive before the deflationary effects do.
[10:21] In the near term, scarce workers mean higher wages, and higher
[10:26] wages in the services sector means higher prices at the
[10:30] dentist, the care home, and the mechanic.
[10:33] On top of that, fiscal policy remains remarkably loose. the US
[10:38] government is expected to run a deficit exceeding 7% of GDP this
[10:43] year, which is the sort of number you usually only see
[10:47] during a war or a major recession, not during a period
[10:51] of full employment. And financial conditions are
[10:55] much more accommodating than the Federal Reserve's headline
[10:59] interest rate would suggest. Credit spreads are tight,
[11:02] household wealth is at record levels, and private credit
[11:06] markets are supplying nearly $2 trillion of alternative
[11:10] financing that sits completely outside the traditional banking
[11:14] system. As Posen put it on the Odd Lots
[11:17] podcast a few months ago, the Fed has tightened, but the
[11:21] economy hasn't really noticed. Finally, and this may be the
[11:26] most important piece, inflation expectations are beginning to
[11:30] drift. When people experience price
[11:33] increases on highly visible frequent purchases, eggs,
[11:37] gasoline, home repairs, they start to expect higher prices in
[11:41] the future. They demand higher wages.
[11:45] Businesses raise prices in anticipation of higher costs.
[11:49] It becomes self reinforcing. This is exactly what Paul
[11:54] Volcker warned about in 1979 when he said that inflation
[11:58] feeds in part on itself. The problem today is that after
[12:03] the pandemic surge, inflation never truly returned to 2%.
[12:08] We're entering this new energy shock with an economy that was
[12:12] already primed for higher prices, which is not an ideal
[12:16] starting position. This brings us to the question
[12:20] of who actually pays for all of this, because the inflation
[12:24] problem and the government spending problem are not
[12:27] separate issues. They are the same problem.
[12:31] To understand why government deficits are expanding at such a
[12:35] rapid pace, we have to look back to the 1960s, when an economist
[12:40] named William Baumol asked a fairly simple question.
[12:44] He wanted to understand why a string quartet playing Beethoven
[12:49] should be paid any more today than they were 100 years
[12:53] earlier. The instruments, he argued, are
[12:55] exactly the same. The sheet music is the same, the
[12:59] number of people required to play the piece hasn't changed,
[13:02] and the musicians productivity has not improved at all.
[13:07] The answer, it turns out, is that the rest of the economy had
[13:10] become more productive, and in such an environment, if you
[13:14] didn't pay musicians a higher wage, they would simply give up
[13:18] the violin and go work somewhere else.
[13:21] So to keep the quartet playing, the concert venue has to pay
[13:25] them more and ticket prices have to go up.
[13:29] This concept is known as balm oil's cost disease, and while
[13:33] it's very useful for explaining why concert tickets are
[13:36] expensive, it also explains the structural nightmare currently
[13:40] facing global government budgets.
[13:43] I should clarify that when economists talk about a lack of
[13:47] productivity in certain jobs, they aren't insulting anyone's
[13:51] work ethic. In economics, productivity just
[13:55] means output per hour. A factory worker with a new
[13:58] machine can build 10 times as many cars today as they could 50
[14:03] years ago, but a nurse, no matter how hard they work, can
[14:07] still only care for one patient at a time.
[14:10] This type of work is strictly constrained by the linear near
[14:14] nature of time, which economists generally find quite
[14:17] frustrating. As Pradhan and Goodheart point
[14:21] out, the classic examples of balm oil's Cos disease are
[14:25] education and healthcare. They are highly labor intensive
[14:29] services that are provided in person and are thus famously
[14:34] resistant to productivity gains. And while an aging population
[14:39] might not need much in the way of primary schooling, they do
[14:43] require an exponential increase in medical care.
[14:46] As the proportion of elderly people rises, so does the
[14:50] incidence of neurodegenerative diseases and the complex
[14:54] comorbidities that come with living longer.
[14:57] And despite what our tech elites might like to tell us, your
[15:01] grandparents are highly unlikely to be satisfied with a robot
[15:05] visiting them in the care home. Japan has actually been trying
[15:09] that approach for years, spending billions on healthcare
[15:13] robotics, and only 2% of its caregivers regularly use them.
[15:18] The elderly require human carers, and because those carers
[15:23] have the option of working in other increasingly productive
[15:26] sectors of the economy, you have to pay them steadily higher
[15:30] wages to maintain the exact same level of care.
[15:34] You are essentially paying more and more for the string quartet,
[15:38] except the quartet is your entire healthcare system, and
[15:41] the audience is getting older by the day.
[15:45] This all brings us to the fiscal problem.
[15:48] Because healthcare spending is structurally locked in to rise
[15:52] much faster than GDP, governments are staring down the
[15:56] barrel of massive structural deficits that have very little
[16:00] to do with which party happens to be in power.
[16:03] In the United States, the nonpartisan Committee for a
[16:07] Responsible Federal Budget estimates that the One Big
[16:10] Beautiful Bill Act passed by the current administration will add
[16:15] roughly $4 trillion to the national debt over the next
[16:18] decade. And there's also the well known
[16:21] Social Security Cliff approaching in 2033, when the
[16:25] trust fund that pays retirees is expected to run dry.
[16:29] Pradhan and Goodhart believe, and I think most honest
[16:33] observers would agree, that when that moment arrives, the
[16:37] politicians of the day will bail the system out rather than
[16:40] impose a 24% cut in benefits on the most reliable voting bloc in
[16:45] America. If you ask a politician how they
[16:49] plan to pay for all of this, they'll invariably point to a
[16:53] spreadsheet showing that their policies will generate a massive
[16:56] boom in GDP growth. This boom will supposedly lead
[17:00] to huge primary surpluses at some vaguely defined point in
[17:05] the future. This sounds great, except that
[17:09] these promised future surpluses almost never actually
[17:13] materialize. They serve as a convenient
[17:16] accounting fiction, allowing the current administrations to spend
[17:20] money today while leaving the bill for whoever happens to be
[17:24] sitting in office a decade from now.
[17:26] The result is a slow, grinding, structural deterioration in the
[17:31] public finances of almost every major economy.
[17:35] And when governments can't or won't fix their fiscal problems
[17:39] through spending cuts or tax increases, the pressure
[17:42] inevitably lands on the one institution that can still print
[17:46] money. If governments are unwilling to
[17:49] cut spending or raise taxes, they have to find more creative
[17:53] ways to manage the debt. In the United States, Treasury
[17:57] Secretary Scott Percent has chosen a particular approach,
[18:02] actively shifting the government's borrowing towards
[18:05] the short end of the yield curve, issuing more Treasury
[18:09] bills and fewer long dated bonds.
[18:12] There's a certain irony in this. During the previous
[18:15] administration, Besant was among the most vocal critics of Janet
[18:20] Yellen for doing essentially the exact same thing.
[18:23] His argument was a serious one, that the Treasury market derives
[18:28] its special status precisely from not being managed for short
[18:33] term convenience. the United States government can borrow
[18:37] more cheaply than almost any other entity on earth.
[18:40] Because the Treasury market is the deepest, most liquid, and
[18:44] most stable asset market in the world.
[18:47] Investors accept lower yields in exchange for that reliability.
[18:52] When you start gaming the maturity structure for political
[18:55] advantage, you erode the very thing that makes U.S. debt
[18:59] special and that tends to show up eventually in higher
[19:03] borrowing costs. It was a compelling critique at
[19:06] the time, and it remains A compelling critique today.
[19:11] Which makes it all the more remarkable that the man who made
[19:14] it is now doing precisely what he warned against.
[19:18] The logic behind the strategy is straightforward.
[19:21] Short term rates are lower, so borrowing short saves money
[19:26] today. And if you believe that rates
[19:28] will fall significantly in the future, you avoid locking in
[19:32] today's higher long term yields. The problem is the other side of
[19:37] that bed. When you borrow short, you have
[19:40] to keep rolling the debt over, and if rates don't fall, you
[19:44] find yourself refinancing at whatever rate the market is
[19:48] charging at the time. Given everything that we've just
[19:51] discussed, structural inflation, aging demographics, persistent
[19:56] fiscal deficit, there's no obvious macroeconomic reason to
[20:01] expect a dramatic decline in interest rates.
[20:04] The strategy makes sense if you believe that the pandemic error
[20:08] interest rate environment was normal and will return.
[20:12] Most of the evidence suggests that it was not and that it will
[20:16] not. There is one component of the
[20:19] inflation picture that both the Treasury and most traditional
[20:23] macroeconomic models tend to quietly set aside, and that is
[20:27] housing. Shelter costs make up more than
[20:31] 1/3 of the Consumer Price Index, the single largest component of
[20:35] any category. If you read the research
[20:38] predicting a return to low inflation, you'll notice that
[20:41] housing is almost entirely absent from the analysis.
[20:45] That is quite an omission. In the year to March, US shelter
[20:50] costs rose by 3%, already above the Federal Reserve's 2% target,
[20:56] while overall inflation came in at 3.3%.
[21:00] And critically, the official CPI measure actually understates the
[21:05] real time pressure because it captures rents across all
[21:09] existing leases rather than what new tenants and new buyers are
[21:13] actually paying today. Anyone currently looking for
[21:17] somewhere to live knows that the number on the ground feels
[21:20] considerably worse than 3%. The reasons are structural
[21:26] Tariffs have driven up the cost of construction materials, the
[21:30] contraction in the labor force has tightened the supply of
[21:33] construction workers, and mortgage rates above 6% have
[21:37] created what economists call the lock.
[21:40] In effect, existing homeowners refused to sell because moving
[21:44] would mean surrendering the cheap fixed rate that they
[21:47] locked in years ago. The result is a market with
[21:50] almost no supply, rising costs of new construction and no
[21:55] obvious relief mechanism insight.
[21:58] New household formation still happens.
[22:01] People still fall in love and want somewhere to live.
[22:05] But increasingly that requires building a new home at precisely
[22:10] the moment when building one has never been more expensive.
[22:14] And as I've discussed in previous videos, the broader
[22:17] story of housing affordability across the developed world,
[22:20] where house prices have risen far faster than wages for three
[22:24] decades, is now creating a self reinforcing intergeneration
[22:28] operational problem that no government seems willing or able
[22:32] to solve. Older homeowners vote in large
[22:36] numbers and have direct financial interest in keeping
[22:39] prices high. Politicians who propose serious
[22:42] measures to increase supply are essentially asking their most
[22:46] reliable constituency to accept a fall in their net worth, which
[22:51] is one of the reasons that the problem has persisted for as
[22:54] long as it has. For the purposes of this video,
[22:57] though, the the key point is simpler.
[23:00] Housing inflation is structural, it's understated in the official
[23:04] data, and it's not going away. Which means that the single
[23:09] largest component of the inflation basket is working
[23:13] against anyone who's hoping for a return to 2%.
[23:17] If you look at all of these factors, the housing market, the
[23:20] tightening labor market, the trade barriers, and the fiscal
[23:24] deficits, you might assume that the public is fully aware of the
[23:28] inflation risk building in the system.
[23:31] According to a recent NBE, or working paper on inflation
[23:35] expectations, they are not. The researchers studied how
[23:39] ordinary people and businesses formed their inflation
[23:42] expectations, and they discovered a pattern they call
[23:46] the of selective inattention. It turns out that when inflation
[23:51] is low and stable, people simply do not pay attention to monetary
[23:56] policy. They ignore the Federal Reserve,
[23:59] they don't know what the inflation target is, and they go
[24:02] about their lives. This is entirely rational
[24:05] behaviour. You don't tend to read the terms
[24:08] and conditions of your home insurance policy until water's
[24:11] already pouring through the ceiling.
[24:14] But when inflation surges, as it did after the pandemic, people
[24:19] suddenly start paying very close attention.
[24:21] They check the news, they learn about the Fed, and they start
[24:25] tracking inflation data. The problem is that they're
[24:28] learning about monetary policy at the exact moment when the
[24:31] central bank appears to be failing, which means the only
[24:35] lesson they ever absorb is a -1. I mentioned earlier that
[24:40] inflation expectations are beginning to drift.
[24:43] The new research helps explain why this is so dangerous.
[24:47] When people expect higher prices, they demand higher
[24:51] wages. Businesses raise prices in
[24:53] anticipation. It becomes self reinforcing,
[24:57] which is precisely what happened in the 1970s.
[25:01] The paper points out that the recent trajectory of household
[25:04] inflation expectations looks almost identical to the lead up
[25:09] to the inflation surge of 1974, which is, generally speaking, a
[25:14] suboptimal baseline for long term price stability.
[25:19] This brings us to the political reality of central banking.
[25:23] If the Federal Reserve wants to bring inflation back down, it
[25:27] has to keep interest rates restrictive.
[25:29] But restrictive monetary policy makes government debt more
[25:33] expensive to service, slows the economy, and makes politicians
[25:38] deeply uncomfortable, particularly politicians who are
[25:42] running for re election. As Pradhan and Goodhart point
[25:45] out, in any lasting conflict between government and central
[25:50] banks, the central banks lose. This is not a partisan
[25:54] observation. It's been true under governments
[25:57] of every political stripe in every country for as long as
[26:01] central banks have existed. When fiscal conditions
[26:04] deteriorate and the debt keeps rising, the political pressure
[26:08] to cut rates becomes overwhelming, regardless of what
[26:12] inflation is doing. We are already seeing this
[26:16] tension play out. The current US administration
[26:19] has offered some rather direct feedback to the Fed chair on
[26:23] social media, initiated a Department of Justice
[26:26] investigation into the central bank's office renovations, and
[26:30] nominated Kevin Walsh to take over for the institution.
[26:34] Borsch has called for what he describes as regime change at
[26:38] the Fed, which is an unusual choice of words when discussing
[26:42] monetary policy. But it would be a mistake to
[26:45] treat this as a uniquely American or uniquely partisan
[26:49] problem. The research on central bank
[26:52] independence suggests that amongst the strongest predictors
[26:55] of whether a central bank will lose control of inflation or
[26:59] frequent turnover of its leadership and being pressured
[27:03] to buy government debt directly in Turkey and Argentina, we've
[27:07] seen what happens when politicians take full control of
[27:11] monetary policy. You get rapid turnover of
[27:14] central bank governors, the government forces the bank to
[27:17] buy its bonds, and the currency loses its purchasing power.
[27:22] The advanced economies are obviously in a very different
[27:25] position. They've deeper capital markets,
[27:28] stronger institutions, and the enormous advantage of borrowing
[27:32] in their own currencies. But the underlying mechanics of
[27:36] inflation do not change depending on the size of your
[27:39] economy. When a government runs
[27:41] persistent deficits and refuses to cut spending or raise taxes,
[27:46] the pressure to monetize that debt to quietly print the
[27:50] difference becomes very difficult for any central bank
[27:54] to resist indefinitely. It is, for all intents and
[27:58] purposes, a slow motion tax on everyone holding the currency.
[28:03] And unlike an actual tax, no one has to vote for it.
[28:07] For the last 30 years, the world essentially operated as one
[28:11] massive optimized factory. If something was cheaper to
[28:15] build in Germany or China or Taiwan, that's where it was
[28:19] built, and we relied on an open, peaceful ocean to deliver it.
[28:23] That system was extraordinarily efficient.
[28:26] It was also one of the great disinflationary forces of the
[28:30] modern era. But as the events in the Strait
[28:33] of Hormuz have demonstrated, an open and peaceful ocean is no
[28:37] longer a guaranteed feature of the global economy.
[28:41] The breakdown of international alliances and the return of
[28:45] geopolitical conflict means that countries are suddenly realizing
[28:49] that they cannot rely on their historical partners.
[28:53] This presents a rather practical problem for anyone who happens
[28:57] to rely on electricity, food or the Internet.
[29:00] Adam Posner's pointed out that Canada recently discovered it
[29:05] has almost no Internet infrastructure that operates
[29:08] independently of the United States.
[29:11] All of their cables and satellites run through their
[29:15] southern neighbor. For decades, this was perfectly
[29:18] fine. You don't worry about
[29:20] concentration risk when the relationship is stable.
[29:23] But in a world where the terms of any international
[29:26] relationship can shift rapidly, that kind of dependency starts
[29:31] to look like a vulnerability. And Canada is not unusual in
[29:35] this regard. Most countries have similar
[29:38] single points of failure that they never thought to worry
[29:42] about. So you have to build redundancy,
[29:46] and redundancy is expensive. Europe is facing its biggest
[29:50] geopolitical challenge since the Second World War Countries like
[29:54] Poland and the Baltic states are increasing their defence
[29:58] spending dramatically. Germany has launched new fiscal
[30:02] expansions to rebuild its military capacity.
[30:06] Across the globe, governments are being forced to duplicate
[30:09] supply chains, build redundant energy infrastructure and
[30:13] onshore manufacturing that they used to happily outsource.
[30:18] You are essentially taking money away from productive private
[30:21] investment and pouring it into government spending just to
[30:26] ensure that the lights stay on and the Internet keeps working
[30:29] when the next crisis hits. None of this adds to the
[30:33] productive capacity of the economy.
[30:35] All of it adds to the deficit, and this creates a cycle that's
[30:40] very difficult to break. More defence and infrastructure
[30:44] spending widens government deficits.
[30:47] Those deficits put pressure on the central bank to keep
[30:51] borrowing costs manageable. The central bank accommodates
[30:55] the politicians, as Pradhan and Goodhart argue they eventually
[30:59] will, by keeping interest rates lower than they should be.
[31:03] That fuels inflation. The inflation erodes living
[31:07] standards, which fuels populism, which further undermines the
[31:11] credibility of the very institutions trying to manage
[31:14] the crisis. For three decades, central
[31:18] bankers had the wind at their backs.
[31:20] Cheap labour, cheap goods, open trade routes and falling prices
[31:25] made the job look easy. Now the demographics have
[31:28] reversed, the trade routes are contested, the deficits are
[31:32] structural and the politicians are telling the central bank
[31:36] what to do. The wind hasn't just changed
[31:39] direction, it's blowing directly into their faces.
[31:43] Pradhan and Goodhart call this the age of the Unanchored
[31:47] Central Banker, an era in which the central bank can no longer
[31:52] single mindedly pursue low and stable inflation, not because
[31:56] central bankers have become less competent, but because the
[31:59] structural conditions that allowed them to succeed have
[32:03] been removed. At this point, the data suggests
[32:07] that the only people left on earth whose inflation
[32:10] expectations remain perfectly anchored at 2% is the Federal
[32:14] Open Market Committee itself, which is nice for them.
[32:19] For anyone who wants the detailed macroeconomic argument
[32:22] behind today's video, I'd highly recommend Pradhan and
[32:26] Goodheart's new book, The Unanchored Central Banker.
[32:30] Thanks for tuning into this week's podcast.
[32:32] If you found it interesting, I'd really appreciate it if you
[32:35] shared it with a friend, as there isn't really an algorithm
[32:38] for podcasts. They grow based on word of
[32:41] mouth. Have a great week and talk to
[32:44] you again soon. Bye.

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