Warren Buffett and Jay Powell Are Both Wrong About Inflation – Barron’s

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Warren Buffett made headlines recently by declaring he is seeing substantial inflation. When Buffett talks about inflation, folks take note. All the more so because his modifier for inflationsubstantialdiffers sharply from Fed Chairman Jerome Powells 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?

Lets begin with Buffett. When providing evidence for substantial inflation, he ticked off, among others, prices for lumber and special purpose acquisition companies. 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 Buffetts haste or selective use of facts do not make Powell correct. After decades of wrong inflation forecasts (typically overestimating future inflation), faith in the prognostication powers of economists and central bankers alike is deservedly low.

Still, Powell is right about one thing. Surging demand as spending-starved U.S. 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 in Fridays U.S. employment report by a large increase in average hourly earnings.

But Powell is making a big bet that those price and wage gains will moderate. 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 Powell apparently belongs, that inflation is a 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 did no one predict the great financial crisis? And all along, that howler was right under the Feds 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, 5-year or 10-year ahead expected inflation rates are above their prepandemic 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 Buffett, they see it happening in their everyday lives, they may begin to change their behavior. 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 usPowell includedknows 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 well be grateful if he is wrong. On the other hand, if Powell is wrong, not just the Queen will wonder whether he was blinded by hubris.

Larry Hatheway and Alex Friedman are the co-founders of Jackson Hole Economics, which originally published this commentary. They are the former chief economist and chief investment officer, respectively, of UBS.

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Warren Buffett and Jay Powell Are Both Wrong About Inflation - Barron's