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TACIT THOUGHT – Weekly Insights And Views

At Tacit, we focus very much on real returns: returns adjusted for inflation. Over time, the value of your investments needs to rise more than the compounded inflation rate for you to preserve your purchasing power. This is a difficult concept for many to grasp as the year-to-year changes in prices, the inflation rate, is what is generally presented in the media as new data is released, and politicians certainly like to crow when the rate of inflation is falling. But the reality for the pound in your pocket is the cumulative effect of inflation; put simply, last year’s inflation is locked into prices and becomes the base from which the future rate of inflation is measured.

The current political mood in the US, and indeed in the UK, is, we would suggest, actually being driven more by the overall price level rather than by the current inflation rate from month to month. In fact, the polls show that this is the primary factor which led swing voters to cast their ballot for President Trump, rather than the more right-wing campaign policies. A sudden increase in price levels leaves people feeling poorer than does a slow increase to the same price level over a longer period. This is human nature.

The chart below, produced for our quarterly Investment Strategy Group meeting this week illustrates just how the price level in the US has shot up in recent years and this has scarred voters.

The price level and inflation are related but distinct economic concepts that can significantly impact voting patterns.

The price level refers to the average of current prices across all goods and services in an economy at a specific point in time. It’s like a snapshot of prices, giving us an idea of how much things cost overall. On the other hand, inflation is the rate at which this price level increases over time. In other words, inflation measures how fast prices are rising.

Understanding this difference is crucial when examining voting behaviour. While people generally dislike both high prices and high inflation, research suggests that unexpected inflation surprises have a more pronounced effect on voting patterns. When inflation is higher than anticipated, it can lead to a significant increase in support for extremist and populist parties in subsequent elections.

This political shift occurs because inflation shocks erode purchasing power more rapidly than expected, making people feel that their wages aren’t keeping up with rising costs. It creates a sense of economic uncertainty and unfairness, particularly among lower-income households.

Interestingly, positive growth surprises (when the economy performs better than expected) tend to have the opposite effect, reducing support for extremist parties. This suggests that voters are sensitive to unexpected changes in their economic circumstances, whether positive or negative.

As the saying goes: ‘it’s the economy stupid!’

The reason for highlighting this is that a slowing inflation rate will not reverse these price increases as they are baked in. Much of the election rhetoric of the Trump campaign focused on the effects of inflation which had accelerated in the run-up to the election, and this undoubtedly created an expectation with swing voters that Trump policies would reverse the erosion of living standards. How the current policies on tariffs is expected to reverse the baked-in higher prices is not clear to us.

In fact, most conventional economic commentary expects tariffs to stoke inflation in the US and with its trading partners. If this comes to pass, we expect the same disaffection among voters to remain if not increase. If politicians cannot square the circle between their international trading policies and their domestic economy, voters are likely to vote for further change when the next opportunity arises.

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