OPINION

For the past 40 years, inflation in the western world has not triggered any emotion…until now. Naturally, the question we must ask is: What exactly has caused the sudden panic, fear, and obsession with the subject of inflation?

In central banks’ pursuit of taming inflation, we have seen the blunt instrument of raising interest rates being applied worldwide. This has negatively impacted most asset classes, especially property and shares.

Since 1990, the general trajectory of interest rates has been downward, ultimately reaching the floor of a 0.1% p.a. official cash rate in Australia. In other words, “free money”. This led to an unprecedented demand for almost any time type of asset that can store wealth.

It is no surprise that with the onset of rate hikes, as well as wild predictions of the share market and property market falling in excess of 60% and 30% respectively, all types of investors have their eyes and ears fixated on what will happen next in the global economy.

On the topic of interest rates, it must be noted that if rates are raised too quickly, they could trigger a recession. On the other hand, if inflation is unchecked this could lead to deeper and more damaging recessions worldwide. It may take decades to return to normality.

This is undoubtedly the most pressing economic issue of our time.

To understand the origins of inflation and to arrive at possible antidotes, one needs to dust off their economics textbooks from an era that experienced this phenomenon firsthand – the 70s.

As one of my favourite sayings goes – “History doesn’t repeat itself, but it often rhymes.”

What is the True Origin of Inflation?

Milton Friedman is one of the most highly regarded economists of modern times, reinforced by his receiving of the 1976 Nobel Memorial Prize in Economics for his work on the study of inflation. He is the principal architect of modern monetary policies applied by western central banks.

The words Friedman uttered during his era are all the more relevant to today’s economic climate. As he put so simply: “Inflation is a monetary phenomenon. It is made and stopped by central banks.”

In other words, it is the volume of money being printed, which can be economically summarised as an increase in the money supply, that is relevant to the question of inflation.

Increase In The Money Supply

Since the onset of COVID, the increase in money supply has never been more significant in our economic history. We have been paid a raft of various government benefits to sit at home and disrupt normal business and spending habits. At the same time, the RBA increased the money supply to counterbalance the loss of productivity. Central banks were essentially “printing more money” at a rapid pace, while lowering interest rates and allowing the bank to issue more credit.

Also, let us not forget quantitative easing, where the government buys and issues debt, reducing the cost of capital and creating massive liquidity in the financial markets.

According to Friedman, once a rapid increase in money supply occurs, it takes anywhere between 6 to 18 months for inflation to work through the economy. We are seeing this phenomenon firsthand here in Australia and around the world, with inflation rates not seen since the 70s.

Friedman also noted that inflation is not a global phenomenon but a home-grown problem that is caused by central banks and can be remedied by central banks.

Supply/Demand for Goods And Services

In the normal free-market economic system, prices of goods and services adjust according to demand, with businesses either increasing or decreasing production. Over time, this results in new business entrants increasing supply, or businesses leaving the market and decreasing supply.

Counterintuitively, these disruptions do not cause persistent inflation. From the onset of COVID, the stop-and-start nature of the global economy has resulted in supply chain issues and overnight demand for certain services, with employers needing to re-skill and re-tool their businesses to cope with unexpectedly high demand.

Once again, using free-market logic, these issues will eventually resolve themselves over time. Economists often refer to these impacts being ‘transitionary’ impacts of inflation; that is, temporary.

Looking back at the ’70s inflation crisis, many governments around the globe tried to lay blame on the 1973 war in the Middle East that disrupted oil production and increased its price by as much as 400%. Comparisons can be drawn to the Russian-Ukraine War and its effects to supply chains and commodities globally.

Despite this, the teachings of Milton Freidman tell us that these supply shocks provide short-term inflationary pressure. In the long-term, free-market economics will find a way to adjust the demand and supply of these goods.

Future Price Expectations

Perhaps the most ignored and least discussed aspect of inflation is future price expectations.

In the US, Australia and most western economies during the ‘60s, inflation had been unchecked for many years, rising from 1.5% to 5% during the ’60s, and reaching more than 14% in the ‘70s. In addition, wage inflation in Australia for the five years during 1969-1974 went up by 98%.

If businesses and employees are accustomed to long periods of persistent, rising inflation, a natural response to the rising cost of living will be employees demanding an adjustment to their wages, leading to higher prices and higher inflation. In such a situation, inflation becomes embedded in expectation and becomes a self-perpetuating inflationary issue that is commonly referred to as the ‘wage-price inflationary spiral’.

The main lesson to be learnt from the 70s is that we cannot allow unanchored inflation expectations. Central banks must act swiftly to tackle inflation and maintain the status quo of people having anchored expectations of inflation so as to maintain faith in our financial system. This is to avoid inflation becoming uncontrollable and inflicting unnecessary harsher pain to the economy.

This is precisely why despite Labor’s promises to support the market with 5.5% wage inflation, the RBA recommends that it remains capped at 3.5%. Lower wage inflation guards against a wage-price inflationary spiral.

Thus, we reach a conclusion that a short recession is better than losing control of inflation and letting loose future price expectations.

Looking back at our central bank, the current actions taken by the RBA are taken right out of pages in Milton Freidman’s economic textbook. They are acting swiftly and assertively.

We believe the next 6 months will have a heightened level of volatility in both the property and share market until there is evidence that the inflation beast has been tamed. We anticipate that this will only occur towards the end of the year once we receive data reflecting lower inflation.

Investors should expect a short and fast series of interest rate rises over the next four months.

Hopefully, this will be followed by stability with minimal changes to the official cash rate during 2023. This would enable the economy to re-adjust to the psychology of normalised interest rates.

The RBA Governor, Philip Lowe, indicated that an official rate of 2.5% is the correct setting for a neutral monetary policy and money supply. Investors and borrowers should brace for this setting sooner rather than later and prepare for the fact that we will have higher interest rates and softening asset prices.

Australia’s present economic strength is significant with a low base of unemployment, plentiful natural resources and a food-rich economy. Despite this, the sudden increase in interest rates will pose an additional risk. As mortgage managers, we appreciate our risk assessment and are completely cognisant to the downward risk of depreciating property prices.

We assess the risk of properties depreciating by perhaps between 15-20% – maybe even more for some specialised properties as well as regional properties and vacant land. Additionally, some construction projects have a significant risk of delays and cost blowouts that continue to be the predominant risk factor for this type of debt over the next 12 months.

However, with the lack of supply, wage inflation, migration, low levels of unemployment, rental growth and times of inflation, property is naturally seen as an inflation hedge. Thus, property will remain relatively resilient through these inflationary times.

—

Paul Miron has more than 20 years experience in banking and commercial finance. After rising to senior positions for various Big Four banks, he started his own financial services business in 2004.

MSQ Capital

msqcapital.com

As tech leaders race to bring Windows systems back online after Friday’s software update by cybersecurity company CrowdStrike crashed around 8.5 million machines worldwide, experts share with CIO Journal their takeaways for preparing for the next major information technology outage.

Be familiar with how vendors develop, test and release their software

IT leaders should hold vendors deeply integrated within IT systems, such as CrowdStrike , to a “very high standard” of development, release quality and assurance, said Neil MacDonald , a Gartner vice president.

“Any security vendor has a responsibility to do extensive regression testing on all versions of Windows before an update is rolled out,” he said.

That involves asking existing vendors to explain how they write software, what testing they do and whether customers may choose how quickly to roll out an update.

“Incidents like this remind all of us in the CIO community of the importance of ensuring availability, reliability and security by prioritizing guardrails such as deployment and testing procedures and practices,” said Amy Farrow, chief information officer of IT automation and security company Infoblox.

Re-evaluate how your firm accepts software updates from ‘trusted’ vendors

While automatically accepting software updates has become the norm—and a recommended security practice—the CrowdStrike outage is a reminder to take a pause, some CIOs said.

“We still should be doing the full testing of packages and upgrades and new features,” said Paul Davis, a field chief information security officer at software development platform maker JFrog . undefined undefined Though it’s not feasible to test every update, especially for as many as hundreds of software vendors, Davis said he makes it a priority to test software patches according to their potential severity and size.

Automation, and maybe even artificial intelligence-based IT tools, can help.

“Humans are not very good at catching errors in thousands of lines of code,” said Jack Hidary, chief executive of AI and quantum company SandboxAQ. “We need AI trained to look for the interdependence of new software updates with the existing stack of software.”

Develop a disaster recovery plan

An incident rendering Windows computers unusable is similar to a natural disaster with systems knocked offline, said Gartner’s MacDonald. That’s why businesses should consider natural disaster recovery plans for maintaining the resiliency of their operations.

One way to do that is to set up a “clean room,” or an environment isolated from other systems, to use to bring critical systems back online, according to Chirag Mehta, a cybersecurity analyst at Constellation Research.

Businesses should also hold tabletop exercises to simulate risk scenarios, including IT outages and potential cyber threats, Mehta said.

Companies that back up data regularly were likely less impacted by the CrowdStrike outage, according to Victor Zyamzin, chief business officer of security company Qrator Labs. “Another suggestion for companies, and we’ve been saying that again and again for decades, is that you should have some backup procedure applied, running and regularly tested,” he said.

Review vendor and insurance contracts

For any vendor with a significant impact on company operations , MacDonald said companies can review their contracts and look for clauses indicating the vendors must provide reliable and stable software.

“That’s where you may have an advantage to say, if an update causes an outage, is there a clause in the contract that would cover that?” he said.

If it doesn’t, tech leaders can aim to negotiate a discount serving as a form of compensation at renewal time, MacDonald added.

The outage also highlights the importance of insurance in providing companies with bottom-line protection against cyber risks, said Peter Halprin, a partner with law firm Haynes Boone focused on cyber insurance.

This coverage can include protection against business income losses, such as those associated with an outage, whether caused by the insured company or a service provider, Halprin said.

Weigh the advantages and disadvantages of the various platforms

The CrowdStrike update affected only devices running Microsoft Windows-based systems , prompting fresh questions over whether enterprises should rely on Windows computers.

CrowdStrike runs on Windows devices through access to the kernel, the part of an operating system containing a computer’s core functions. That’s not the same for Apple ’s Mac operating system and Linux, which don’t allow the same level of access, said Mehta.

Some businesses have converted to Chromebooks , simple laptops developed by Alphabet -owned Google that run on the Chrome operating system . “Not all of them require deeper access to things,” Mehta said. “What are you doing on your laptop that actually requires Windows?”

HAS THE INFLATION GENIE ESCAPED THE BOTTLE?

MSQ Capital’s Managing Director Paul Miron thinks a small recession could be the key to economic control.