What Inflation Alarmists Missed: A 1970s Lens on Today's Structural Drag

The central investor question is why the inflation alarmists have been wrong. For years, figures like Paul Tudor Jones, James Grant, and Jeff Gundlach issued dire warnings. Jones declared "all roads lead to inflation", Grant proclaimed "persistent inflation" is the new norm, and Gundlach predicted a "reckoning is coming" for U.S. debt. Their logic was straightforward: ballooning deficits and dollar debasement would inevitably force Treasury yields higher. The forecasts have not panned out, at least so far, because they overlooked a critical structural reality: the very forces they cited-Debt, Deficits, and Demographics-act as a drag on demand, not a fuel for inflation.

The alarmists' mistake was in treating money supply growth as a simple, direct driver of prices. They pointed to M2 charts and screamed "debasement." But that view misses how money actually works in a modern economy. As the Bank of England explained, "loans create deposits". Money is not "printed" by the government; it is lent into existence by banks in response to economic activity. This means money supply growth is endogenous, closely following the economy's growth, not driving it. The key metric is not M2 in isolation, but M2 relative to GDP. Historically, these two have tracked closely. Even during the pandemic shock, the M2/GDP ratio remained below 100%, indicating money supply growth was broadly aligned with economic output. Today, that ratio is falling, not rising. This is the crucial evidence: money creation is not exceeding economic growth; it is keeping pace with it.

This structural alignment explains the failure of the alarmist forecasts. In a consumer-driven economy, inflation occurs when demand consistently exceeds supply. The "3-Ds" create the opposite condition. A debt-saturated economy with an aging population and rising deficits acts as a powerful headwind on aggregate demand. Consumers are stretched thin, businesses face higher financing costs, and government spending is constrained by its own borrowing needs. This drag on demand makes a sustained, systemic surge in prices far less likely than the alarmists assumed. The inflation spike of 2021 and 2022 was a temporary phenomenon, driven by a unique combination of massive government interventions and global supply shocks, not a permanent shift in the monetary system.

The bottom line is that the alarmists misjudged the nature of money creation in a debt-saturated system. They saw a growing money supply and assumed debasement. In reality, the system is self-correcting; money supply growth contracts when loan demand weakens, regardless of central bank policy. The structural weight of the "3-Ds" ensures that any surge in money supply is absorbed by the economy's need for credit, not by a speculative explosion in prices. Until that structural drag is broken, the "reckoning" they predicted remains a forecast, not a fact.

Actual Outcomes vs. Predictions: The Forecasting Record

Professional economic forecasts are a staple of market analysis, but their reliability is a coin toss. The data shows that while forecasters were largely accurate for 2025, their track record for predicting 2026 is deeply uncertain. This gap between expectation and reality is a core source of risk for investors.

The immediate past offers a mixed picture. For 2025, the consensus forecast for real GDP growth was 1.9%, and actual growth is now estimated near that mark. Similarly, forecasts for the unemployment rate and 10-year Treasury yields were quite accurate. This recent precision can create a false sense of security. However, the historical record tells a different story. Over the period from 1993 to 2024, actual real GDP growth fell within the range of the top and bottom 10 individual forecasts less than half the time. This is not a minor inaccuracy; it is a fundamental limitation of the forecasting process.

The forecast for 2026 crystallizes this uncertainty. The consensus outlook for real GDP growth is 1.9%, but the range of individual forecasts is stark. The average of the most optimistic projections is 2.5%, while the average of the most pessimistic is 1.2%. This 1.3-percentage-point spread means forecasters are split on whether the economy will grow at a moderate pace or barely expand. For inflation, the consensus forecast for 2026 CPI is 2.9%, with a range from 2.5% to 3.3%. This dispersion signals deep disagreement on the inflation outlook, a critical input for interest rate expectations.

The bottom line is that professional forecasts are not reliable guides for the near-term future. The historical mean absolute forecast error (MAFE) for real GDP growth is 1.0 percentage point. This figure is the best statistical estimate of how far off the consensus forecast is likely to be. In practice, it means a forecast of 1.9% growth implies a realistic range of roughly 0.9% to 2.9%. When the forecast itself is uncertain, the investment decisions based on it become speculative. The market's challenge is to price in a range of outcomes, not a single point estimate.

Market Pricing: The Breakeven Inflation Gauge

The market's forward-looking signal on inflation is clear, and it's far from the alarmist narrative of runaway price growth. The primary gauge is the 10-year breakeven inflation rate, a measure derived from the yield difference between regular 10-year Treasury bonds and Treasury Inflation-Protected Securities (TIPS). This rate implies what investors expect average inflation to be over the next decade. As of the latest data, that rate sits at a level that is elevated but nowhere near the crisis levels of the 1970s.

This forward expectation is a critical counterpoint to current headline inflation. The latest PCE price index shows a year-over-year increase of 2.8%. The market's breakeven rate, however, is not pricing in a continuation of that pace. Instead, it suggests an expectation for inflation to moderate over the coming decade. This gap between current inflation and market expectations is the key signal. It implies that investors believe the Federal Reserve's policy tools will eventually bring inflation down to a more stable, lower range.

The bottom line is that market pricing is one of the most reliable forward-looking indicators. The current breakeven rate, while above the Fed's 2% target, reflects a managed expectation. It does not signal panic or a belief in a permanent inflation regime shift. Rather, it points to a market that expects policy to work, even as it acknowledges the near-term persistence of price pressures. For investors, this is a more nuanced and actionable signal than any single monthly PCE print.

Historical Parallels: The 1970s Inflation Episode

The inflation alarmists of today echo a familiar refrain, but the structural drivers of the 1970s offer a critical lens. That decade was defined by a self-reinforcing wage-price spiral, where inflation expectations became unanchored and rose with actual inflation. Workers demanded higher wages to keep up with expected price hikes, businesses passed those costs to consumers, and inflation accelerated. The key difference now is that inflation expectations are not on a similar trajectory. The Federal Reserve's long-standing effort to anchor expectations at 2% has, for the most part, held. This is the first major divergence: today's monetary policy is not facing the same challenge of unanchored psychology.

The second, more fundamental difference lies in the relationship between money supply and economic activity. The alarmist narrative often hinges on the idea of unchecked "money printing" leading to inevitable debasement. This view misses the mechanics of an endogenous money system. As the evidence shows, the growth of the money supply closely follows the economy's growth. Loans create deposits, not the other way around. This means that money supply growth is a consequence of economic demand, not its primary cause. In the 1970s, this link was less clear, and monetary policy was less effective at managing expectations. Today, the ratio of M2 to GDP is actually falling, not rising, indicating that money supply growth is not outpacing the economy. This is the opposite of the dynamic that fueled the 1970s inflation.

The third and perhaps most significant difference is the structural drag on demand. The 1970s occurred in a period of relative demographic expansion and lower debt burdens. Today, the economy faces the "3-Ds" of Debt, Deficits, and Demographics, which act as a persistent headwind. An aging population and high leverage limit the capacity for a sustained surge in consumer demand that could drive broad-based inflation. This structural constraint makes the kind of explosive demand-driven inflation seen in the 1970s far less likely.

The bottom line is that while the 1970s provide a cautionary tale about unanchored expectations, the current environment is structurally different. Money supply growth is aligned with economic output, expectations are anchored, and demographic and debt headwinds limit the scope for a wage-price spiral. The alarmists are testing a historical playbook against a new set of economic conditions.

Expectations Anchoring: The Fed's Crucial, Yet Fragile, Guardrail

The Federal Reserve's primary tool for controlling inflation is not just interest rates, but the anchor it provides for expectations. The alarmists' narrative missed a critical vulnerability: the risk of inflation expectations becoming unanchored. If households and businesses start to believe inflation will stay high, they will demand higher wages and raise prices preemptively, creating a self-fulfilling wage-price spiral. The data from late 2025 shows this guardrail is holding, but it is showing signs of strain.

Household expectations, a key input for the Fed, remain stubbornly elevated. The New York Fed's survey shows median one-year-ahead inflation expectations unchanged at 3.2%. This is a level that would be considered too high for the Fed's 2% target. More concerning is the divergence in business sentiment. While firms' short-term inflation expectations are steady at 2.2 percent, their long-term outlook is shifting. The Atlanta Fed's survey reveals that firms' median expectation for long-run U.S. inflation moved up to 4.0 percent, following nine consecutive quarters at 3.0%. This tick-up in the long-term anchor is a red flag, as it suggests businesses are building in a higher permanent inflation rate.

The mixed signals from firm expectations highlight the fragility. On one hand, firms are expecting smaller price increases for their own goods and services, with the mean forecast for next quarter down to 2.6 percent. On the other, their expectations for their own compensation costs remain elevated at 3.3 percent. This disconnect is critical. If businesses expect to pay more for labor but plan to raise their own prices less, their profit margins will be squeezed. The only sustainable way to maintain margins is to pass those higher labor costs onto consumers, which feeds the inflation cycle.

The bottom line is that expectations anchoring is a high-wire act. The Fed has successfully kept short-term expectations from spiking further, but the long-term anchor is showing cracks. The risk is that a persistent gap between short-term and long-term expectations becomes entrenched. If households and businesses come to believe the Fed cannot or will not bring long-term inflation down, the wage-price spiral could gain momentum. The Fed's challenge is to demonstrate it has the tools and resolve to re-anchor those long-term expectations, or risk a more persistent and damaging inflation problem.