US has seen this inflation cycle before

Let's hear it for the inflation prognosticators on “Team Transitory.”

Inflation in the U.S. took off with the spread of COVID-19 in 2021. Within two months, trailing 12-month inflation surged from 1.4% to 4.2%. Economists generally fell into two camps. “Team Transitory” believed inflation was a temporary phenomenon that would dissipate of its own accord. “Team Permanent” believed inflation needed to be stomped out with relentlessly higher interest rates before it morphed into a never ending upward spiral.

Team Transitory looked foolish as inflation roared higher. By the summer of 2022, annual inflation touched 9.1%. Some of this was bad luck. The Russian invasion of Ukraine sent energy and food prices soaring just as supply chains seemed to be getting back to normal.

Fast forward to 2023 and the tide has turned. The annual rate is now 4.9% after falling eight months in a row. Once the huge increases of

June and August of 2022 are in the rearview mirror, the year over year rate may fall to 4% or less.

From there, inflation should continue downward. House prices are in a pronounced downturn as are rents. Oil peaked at $122 per barrel and is now around $72 per barrel. Copper prices are down 20%. The Baltic Dry Index of shipping rates is down 75% from its peak.

A parabolic increase and subsequent decline in inflation is no surprise. The Covid experience is a mirror image of the economic travails around World War I and World War II.

During wartime, production of consumer goods dried up as factories convert to manufacturing armaments and ammunition. Incomes were high as the military enlisted millions replace them as civilian labor. Meantime, there is little to spend money on due to rationing, a shortage of consumer goods or both.

When the war ended, pent-up savings plus pent-up demand meet shrunken supply. The predictable result is elevated inflation. Once pent-up demand was sated and factories to convert from military to civilian production, inflation recedes.

Starting at less than 1% in 1915, inflation topped 15% every year from 19171920 due to World War I and the Spanish flu epidemic. Once the transition from wartime to peacetime was completed, prices fell 11% in 1921 and another 6% in 1922.

After increasing at an annual rate of 9%, 14% and 8% from 1946-1948 in the aftermath of World War II, prices deflated 1% in 1949 before rising again during the Korean war.

During Covid, production of consumer goods ground to a halt while incomes were maintained with government checks. When lockdowns eased off, pent-up demand plus enforced savings met snarled supply chains and shrunken capacity. The result: 4.7% inflation in 2021 followed by 8% inflation in 2022.

With Covid payments ended, savings dissipated, supply increasing and pent-up demand satisfied, it is no wonder that inflation is again proving transitory. Since peak inflation did not last as long or reach as high as post-war inflation, we may not see deflation. But a return to pre-Covid levels of inflation would be entirely consistent with history.