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Inflation Might Keep Rising in 2021…But What Happens After That?

Debate is raging about whether the recent burst of inflation is temporary or here to stay…

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This article was originally published by The Conversation.

The US Federal Reserve has just reassured the markets that it doesn’t expect inflation to get out of hand in the coming months. It comes as concerns about serious inflation damaging the global economy have reached fever pitch, particularly since recent Labor Department data showed that American inflation rose 4.2% over the 12 months ended April – the highest since the global financial crisis of 2007-09. In the euro area, inflation seems certain during the rest of this year to break out above the European Central Bank target of “close to but below 2%”. Central bankers on both sides of the Atlantic say that these price rises are a temporary consequence of the whiplash effect of the COVID-19 pandemic on demand. Supply chains in everything from commodities to semiconductors have been disturbed by demand first collapsing and then surging back, making prices very volatile. On this rationale, inflation will settle down once the pandemic recedes. Critics point to the risks of price pressures setting off a chain reaction where everyone expects future price rises, causing a true inflationary episode where prices persistently increase across the board. This debate about the near-term outlook is matched by an equally lively debate about long-term inflation, relating to drivers such as the effect of baby boomers retiring, China’s changing labour force, automation and so on. So who is right in all this? Are the inflation numbers a blip or are we seeing a gathering storm?

Lessons of the 2010s

In Remembering Inflation, a book I published in 2013, I attempted to weave together various strands of this subject by looking at the breakthroughs in economists’ thinking about the causes and cures of inflation inspired by the “stagflation” of the 1970s, where inflation and unemployment both sharply increased. My timing with that book was poor. The global economy’s faltering recovery from the global financial crisis was characterised by the opposite problem – deflation – where people expect prices to fall. As overstretched firms and households retrenched during the early 2010s, it should have fallen to governments to generate needed demand by ramping up public spending. Instead, fashionable notions of balancing the books using austerity got in the way. UK inflation rate 1960-2021
UK inflation chart since 1960
Macro Trends, CC BY
US inflation rate 1960-2021
US inflation rate graph 1960-2021
Macro Trends, CC BY
Central banks were left to do the heavy lifting through cutting headline interest rates and using unconventional monetary policies like quantitative easing (QE) – that is, “printing money” – to buy large quantities of government bonds and other financial assets. This helped to drive down long-term interest rates – even into negative territory in Europe – making things like mortgages and business loans cheaper. Yet the only “inflation” that resulted was rising asset prices in everything from property to stocks and shares. It made the rich richer, engendering even wider inequalities than before. All the while, official consumer price inflation – which refers to the average change in prices of a basket of specific household goods – remained persistently below the 2% level targeted by the major central banks. According to what is known as the Phillips curve, inflation should have been stimulated by the fact that unemployment fell in countries such as the UK, but it turned out this relationship had been suspended.
Row of houses with For Sale signs
House prices boomed in the 2010s. Tejvan Pettinger, CC BY
One reason - particularly apparent in the US - was that the falling rate of unemployment was flattered by increasing numbers of people giving up looking for work and dropping out of the labour force altogether. This was a symptom of the core problem of insufficient demand from businesses and consumers. A related symptom was the structural shift in the labour market. Where new jobs were created – sometimes, as in the UK, even to the extent bringing people back into the labour force – these were concentrated in low-skilled and low-paid openings in sectors like leisure, hospitality and logistics. Increased demand for such services was the meagre limit of the “trickle-down” effect from ever-richer asset owners. All this meant that there was not much real wage growth which, along with associated increases in bank lending, is essential for creating inflation. So it was that, in the 2010s, monetary policy not only failed to stimulate the economy but actually proved counterproductive.

Stimulus and the pandemic

During the pandemic, the situation has been different. Central banks have again been trying to stimulate the economy by expanding QE, but governments have also been using debt-funded spending to substitute for the normal demand that has disappeared because of the shutdowns. Major governments seem determined to correct the flawed policies of the past decade. This is especially true of the Biden administration, whose massive programme of increased spending aims to drive up labour participation and wages – thereby avoiding the deflationary troubles of the 2010s. The administration is firmly supported in this by Federal Reserve chair Jerome Powell. In August 2020, the central bank changed its inflation policy to “average inflation targeting”. Whereas in the past, the Fed targeted 2% inflation and would raise interest rates in response to low unemployment in the belief that inflation would otherwise start rising, it is now ready to allow inflation to rise to say 3% in the name of increasing employment to help stimulate economic recovery. The success of this strategy depends on demand for more workers materialising from US businesses. But critics like Larry Summers, the former Democratic treasury secretary, argue that the government’s fiscal stimulus will create demand beyond the economy’s present production potential, risking persistent inflation.
Pound coin being squeezed in a vice
The big squeezy. Steve Heap
The administration and its supporters counter that there is more slack in the economy than people like Summers believe, because so many discouraged workers have dropped out, and higher production of goods and services will result from reversing the long dearth of domestic business investment. All such happy effects will, according to the plan, flow from using government spending to generate demand. The jury remains out on whether this will cause unmanageable inflation – either in America or, potentially, in Europe if the ECB, together with the EU and its member states, follow their apparent inclination to emulate the US.

A danger and an opportunity

Returning to my own studies of the exit from the “great inflation” of the 1970s, two lessons emerge that should help the jury in its deliberations about where we go from here. One points to an opportunity, the other to a danger. The first lesson has to do with confidence and the expectations of firms and households, which dominate any discussion about inflation. The 1970s inflation was only really subdued after central banks were given operational independence from politicians to pursue low and stable inflation. As monetary policy became more credible, people no longer expected prices to rise so fast. This was the main reason for the flattening of the Phillips curve – that is, inflation no longer jumps up smartly as unemployment falls. Present-day policies to stimulate demand benefit from well anchored inflation expectations. Put bluntly, policymakers will “get away” with more stimulus before having to pay an inflationary price, and this should improve their chances of success. A key figure in the development of such thinking about expectations in the 1970s-80s was the American economist Thomas Sargent. His work on “systematic changes in inflation policy” also underlies the second – and more cautionary – lesson for today’s policymakers and the present inflation outlook. This was crystallised in a 1982 paper by Sargent and Neil Wallace called Some Unpleasant Monetarist Arithmetic showing that monetary and fiscal policy are inextricably intertwined. At the heart of this thinking sits the idea of a government’s budget constraint. If government spending stimulates demand to the extent of driving up inflation, and monetary policymakers then respond by raising interest rates, a nasty surprise can ensue. Higher interest rates increase a government’s interest payments on its debt. If the government responds by issuing even more debt to finance its activities, it can make inflation rise even faster – as the government’s extra spending would end up driving up demand just as the central bank is trying to curb it. In other words, a government can only run so much of a deficit before unforeseen problems crop up. Today this lesson is even more relevant than Sargent and Wallace could have imagined. Nowadays, interest rates can no longer be a central bank’s first instrument of monetary policy: public and private debt are so high that raising rates could potentially make repayments unmanageable for many. To take the US as the most prominent example, the Fed would instead start out by cutting back the level of government bond purchases going on to its balance sheet. This bond purchasing has ballooned in the past decade, particularly since governments’ heavy deficit spending during the pandemic. The problem is that the money created through QE ends up, for reasons that don’t need to be explained here, in the reserves of commercial banks held by the central bank. In the US, these sums now approach a fifth of all of the Fed’s assets. As and when the Fed decides to “taper” QE – now running at US$120 billion (£85 billion) of purchases per month – as a first step in tightening policy to lean against inflation, this will result in a lower proportion of banks’ assets being lodged with the Fed in the form of reserves, and increase the scope for banks to lend to the real economy. Such credit expansion and the associated increase in the velocity of money is likely to fuel the inflation pressures that the Fed wants to counter. Since one of the main aims of QE is to increase bank lending, it’s a paradoxical effect – just like the previous example of higher interest rates increasing inflation. The bottom line is that public debt has expanded to the extent of becoming unaffordable in a free market. Today’s conundrum created by QE is just the latest demonstration of the reality that disregarding government budget constraints will result, by one way or another, in higher inflation.

Long-term trends

The final question is how all of this relates to long-term trends in the labour market and elsewhere. It is often said that in the past couple of decades, globalisation and technology have both helped to reduce inflation. Globalisation has kept wages lower by moving production to poorer countries. Technology has made it cheaper to produce goods and therefore brought prices down, while the the gig economy has reduced the cost of services. But a recent book by British-based economists Charles Goodhart and Manoj Pradhan argues that the years to come will be far less deflationary, for several reasons. China’s labour market participation is rising, which is increasing wages, and baby boomers are retiring, taking a very large generation out of the labour market and making workers more scarce and therefore more valuable. It’s a fascinating argument, but still very debatable. For example, possible inflationary effects of ageing populations might yet be outweighed by the deflationary effect of rapid technological change automating more jobs. This will reduce workers’ bargaining power and therefore act as a brake on wage growth. Also, most people consume less in retirement, and certainly do not borrow as much: the ageing of the baby boomers will therefore be another source of deflation. In sum, there is good reason to expect inflation in the short to medium term, but the longer term picture is more mixed. The seeds of higher long-term inflation are surely present, but the chances of their germinating will depend to a large extent on to what extent the extra fiscal stimulus from the US and elsewhere leads to increased production, as opposed to only consumption. If there is higher business investment and labour participation, government budget deficits will narrow faster as the private sector gets back into gear and pays more in taxes. This will also help the Fed to find a smoother path through the minefield of the exit from QE, since the increased bank lending will be more likely to be unlocking sustainable economic growth. If so, it is still possible that the central banks’ claims that inflation will only be transitory could still be proven right.

Brigitte Granville does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Fed Chair Powell Just Said The Quiet Part Out Loud

Fed Chair Powell Just Said The Quiet Part Out Loud

Authored by Lance Roberts via RealInvestmentAdvice.com,

Regarding the surprisingly strong…

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Fed Chair Powell Just Said The Quiet Part Out Loud

Authored by Lance Roberts via RealInvestmentAdvice.com,

Regarding the surprisingly strong employment data, Fed Chair Powell said the quiet part out loud. The media hopes you didn’t hear it as we head into a contentious election in November.

Over the last several months, we have seen repeated employment reports from the Bureau of Labor Statistics (BLS) that crushed economists’ estimates and seemed to defy logic. Such is particularly the case when you read commentary about the state of the average American as follows.

“New Yorker Lohanny Santos publicly vented her frustration after her attempts to go door-to-door with her CV in hand in the hope of finally landing a job were unsuccessful.

It would appear that other young jobseekers could relate to Lohanny’s struggles. The USA and Canada rank fifth out of seven when it comes to youth unemployment and third when it comes to total unemployment, according to World Bank data based on an International Labor Organization model for 2020, as per Statista.” – Business Insider

Even M.B.A.s are finding it difficult.

“Jenna Starr stuck a blue Post-it Note to her monitor a few months after getting her M.B.A. from Yale University last May. “Get yourself the job,” it read. It wasn’t until last week—when she received a long-awaited offer—that she could finally take it down.

For months, Starr has been one of a large number of 2023 M.B.A. graduates whose job searches have collided with a slowdown in hiring for well-paid, white-collar positions. Her search for a job in sustainability began before graduation, and she applied for more than 100 openings since, including in the field she used to work in—nonprofit fundraising.” – WSJ

These stories are not unique. If you Google “Can’t find a job,” you will get many article links. The question, of course, is why individuals with college degrees, no less, are having such a tough time finding employment. After all, aside from record-smashing employment reports, we also continue to see near-record low jobless claims and high numbers of job openings, as shown below.

The Washington Post touched on part of the problem and why the unemployment rate for college graduates is higher than for all workers.

“Part of the problem is that the industries with the biggest worker shortages — including restaurants, hotels, daycares, and nursing homes — aren’t necessarily where recent graduates want to work. Meanwhile, the industries where they do want to work — tech, consulting, finance, media — are announcing layoffs and rethinking hiring plans.”

As the Washington Post summed up:

“The result is yet another disruption for a generation of college graduates who have already had crucial years of schooling upended by the pandemic. In interviews, many said they’d struggled to adjust to remote-learning in early 2020 and felt like they had missed out on opportunities to forge connections with professors, employers and other students that could have been crucial in lining up for postgraduate work. Now, as they enter the workforce, they say they’re feeling increasingly disillusioned about the economy, which is fueling political discontent and causing them to rethink the financial independence they thought they’d achieve after college.”

Of course, it isn’t just the shuttering of the economy and the shift to working from home causing the problem. It is also the shift in demand from consumers to more service-oriented conveniences, combined with the need by employers to maintain profitability.

Fed Chair Powell Says The Quiet Part

Since the turn of the century, the U.S. economy has shifted from a manufacturing-based economy to a service-oriented one. There are two primary reasons for this.

The first is that the “cost of labor” in the U.S. to manufacture goods is too high. Domestic workers want high wages, benefits, paid vacations, personal time off, etc. On top of that are the numerous regulations on businesses from OSHA to Sarbanes-Oxley, FDA, EPA, and many others. All those additional costs are a factor in producing goods or services. Therefore, corporations needed to offshore production to countries with lower labor costs and higher production rates to manufacture goods competitively.

During an interview with Greg Hays of Carrier Industries, the reasoning for moving a plant from Mexico to Indiana during the Trump Administration was most interesting.

So what’s good about Mexico? We have a very talented workforce in Mexico. Wages are obviously significantly lower. About 80% lower on average. But absenteeism runs about 1%. Turnover runs about 2%. Very, very dedicated workforce.

Which is much higher versus America. And I think that’s just part of these — the jobs, again, are not jobs on an assembly line that [Amerians] really find all that attractive over the long term.

Fed Chair Powell emphasized this point in a recent 60-Minutes Interview. To wit:

“SCOTT PELLEY: Why was immigration important?

FED CHAIR POWELL: Because, you know, immigrants come in, and they tend to work at a rate that is at or above that for non-immigrantsImmigrants who come to the country tend to be in the workforce at a slightly higher level than native Americans. But that’s primarily because of the age difference. They tend to skew younger.

The suppression of wages, increased productivity to reduce the amount of required labor, and offshoring has been a multi-decade process to increase corporate profitability.

A Native Problem

Following the pandemic-related shutdown, corporations faced multiple threats to profitability from supply constraints, a shift to increased services, and a lack of labor. At the same time, mass immigration (both legal and illegal) provided a workforce willing to fill lower-wage paying jobs and work regardless of the shutdown. Since 2019, the cumulative employment change has favored foreign-born workers, who have gained almost 2.5 million jobs, while native-born workers have lost 1.3 million. Unsurprisingly, foreign-born workers also lost far fewer jobs during the pandemic shutdown.

Given that the bulk of employment continues to be in lower-wage paying service jobs (i.e., restaurants, retail, leisure, and hospitality) such is why part-time jobs have dominated full-time in recent reports. Relative to the working-age population, full-time employment has dropped sharply after failing to recover pre-pandemic levels.

However, as noted, full-time employment has declined since 2000 as services dominate labor-intensive processes such as manufacturing. This is because we “export” our “inflation” and import “deflation.” We do this to buy flat-screen televisions for $299 versus $3,999. Such is also why the economy continues to grow slower, requiring ever-increasing debt levels.

For recent college graduates, this all leads to a more dire outlook.

Immigration Is Needed, But It Has Consequences

To keep an economy growing, you must have population growth. In other words, “demographics are destiny.” As such, there are two ways to obtain more robust population growth rates – natural births and immigration. As shown below, the fertility rate in the United States is problematic in that we aren’t producing enough children to replace an aging workforce.

Such is particularly problematic given the rapid aging of older adults versus a declining working-age population. Such means the underfunding of entitlements will continue to grow, requiring more debt issuance to fill the gap.

However, there is a vast difference between immigration policies that import highly skilled workers, capital, and education versus those that don’t. Merit-based immigration policies bring workers who earn higher salaries, create businesses, employ labor, and create tax revenues and other economic contributions. However, current policies are creating a rush of lower-skilled, uneducated labor that will work for cheaper wages, produce less revenue, and are subsidized by tax-payers through welfare programs. As noted above, these workers tend to fill the jobs in the service areas of the economy, thereby displacing native-born workers. Such was a point made by the WSJ:

“Before the pandemic, foreign-born adults were almost as likely as the overall population to hold at least a bachelor’s degree. This was mainly because of higher educational attainment among immigrants from Asia, Africa, and Europe, which offset lower levels of schooling among people from Mexico and Central America.”

Post-pandemic, this has not been the case, which is impacting native-born employment. This is not a new issue, but one addressed by Bill Clinton in the 1995 State of the Union Address:

“The jobs they hold might otherwise be held by citizens or legal immigrants; the public services they use impose burdens on our taxpayers.”

Such is the natural consequence of a change in the economy’s demands and the need for corporations to maintain profitability in an ultimately deflationary environment.

Conclusion

While there is much debate over immigration, most of the arguments do not differentiate between legal and illegal immigration. There are certainly arguments that can be made on both sides. However, what is less debatable is the impact that immigration is having on employment. Of course, as native-born workers continue to demand higher wages, benefits, and other tax-funded support, those costs must be passed on by the companies creating those products and services. At the same time, consumers are demanding lower prices.

That imbalance between input costs and selling price drives companies to aggressively seek options to reduce the highest cost to any business – labor. Such was discussed in our article on the cost and consequences of the demand for increased minimum wages.

  • Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. 

  • Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.

  • As employers pass some of those costs on to consumers, consumers purchase fewer goods and services.

  • Consequently, the employers produce fewer goods and services.

  • When the cost of employing low-wage workers rises, the cost of investing in machines and technology goes down.” – Congressional Budget Office.

Such is why full-time employment has declined since 2000 despite the surge in the Internet economy, robotics, and artificial intelligence. It is also why wage growth fails to grow fast enough to sustain the cost of living for the average American. These technological developments increased employee productivity, reducing the need for additional labor.

Unfortunately, these tales of college graduates expecting high-paying jobs will likely continue to find it increasingly complicated. Particularly as “Artificial Intelligence” becomes cheap enough to displace higher-paid employees.

Tyler Durden Fri, 02/16/2024 - 11:00

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EU Markets Not Immune From New World Disorder Of ‘No Article V’ Trump Office

EU Markets Not Immune From New World Disorder Of ‘No Article V’ Trump Office

By Teeuwe Mevissen, Senior Macro Strategist at Rabobank

This…

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EU Markets Not Immune From New World Disorder Of 'No Article V' Trump Office

By Teeuwe Mevissen, Senior Macro Strategist at Rabobank

This week shocked European leaders from Helsinki to Brussels and back via Berlin to Warsaw without skipping any of the other European NATO member capitals in Europe. What happened? During one of Trump’s campaign rallies Trump said that he would sort of encourage Russia to do whatever it wanted with NATO members that have not been meeting their defense spending fair share of 2% of GDP.

While this remark directly undermines NATO’s most crucial article V - which calls for military involvement of all NATO member countries if one of its members were to be attacked - it could hardly be real news for most of those ‘shocked’ European ‘leaders’.

Indeed it was nobody else but Trump who already told von der Leyen in 2020 that: "You need to understand that if Europe is under attack we will never come to help you and to support you," .

While it is no secret that Von der Leyen already failed miserably during her term as a minister of defence for Germany, she apparently failed again in taking Trump's words seriously back in 2020. While Trump’s recent NATO comments are everything but helping to advance America’s position on the global stage, Von der Leyen and many of her colleagues in Brussels and other mainly Western European leaders, failed to do what is necessary to prepare for a potential return of Trump or the return of his ideas embodied by someone else. They may now be coming around of that view, seeing Von der Leyen’s interview in the FT today, but precious time has been wasted.

Now imagine that Trump would win and would return to pro-fossil fuel policies that would make the US largely if not totally independent from any fossil fuels from abroad. He might pursue an isolationist approach here too, leaving the EU to scramble for much needed cheap energy from the Middle East.

Could the EU protect crucial sea lanes on its own?

That is doubtful, to say the least.

So what European leader could step up and take the lead in the much needed process to get Europe ready to engage effectively in a mass military build-up campaign fast should that turn out to be necessary?

That certainly does not seem to be Rutte as he has been responsible for the most dramatic cuts of the Dutch defence budget during his record long rein in the Netherlands.. Still he is the top favourite in securing the role of head of NATO. However, it must also be said that he has been on the forefront in supporting Ukraine and was one of the first Western leaders to provide Ukraine with fighter jets. Still it sometimes seems that for people who govern, failing to do your job properly is no barrier to continue to govern. And to be very clear, the very same goes for Trump. All of this seems to be indicating that international anarchy and global chaos resulting from it might be here to stay for the foreseeable future and markets will not be immune to this new world disorder.

One example of how for instance increasing rivalry between the West and China continues to plague companies that do business in China, was yesterday’s news regarding Germany’s automobile giant Volkswagen. Yesterday saw German luxury cars being impounded by the US after it became known that subcomponents in those cars were coming from the Xinjiang autonomous region and made by forced labour.

Or what to think of the fact that the large asset manager JP Morgan hires former chairman of the Joint Chiefs of Staff Mark Milley to advise the bank’s board of directors, senior leaders and clients on dangers around the world.

Does anybody need more proof that markets will not be immune to a new world in disorder? 

Turning back to Europe, it remains to be seen what the impact will be of Europe seriously stepping up its efforts to rebuilt a defence industry but it is likely to be an increase of taxes and a decrease of the welfare system. On a 'positive' note: The European Council and Parliament reached a provisional agreement on new budget rules last Saturday that would give member states more budgetary leeway if they carry out reforms and invest in the green and digital transition, strengthening social resilience and, where necessary, defence.

One thing is sure, peace dividend will be something of the past and again certainly European financial markets will not be immune for a new world disorder.

Looking at what is happening today we saw UK retail sales coming in much higher than expected. Overall retail sales gained 0.7% y/y where a decline of -1.6% was expected. On a monthly base the rise was 3.4% vs an expected rise of 1.5%. However looking at those volumes the data shows the picture that measured in volumes, retail sales are still below pre pandemic levels. EUR/GBP therefore moves slightly up today mainly indicating a weaker pound with the current EUR/GBP exchange rate approaching the level of 0.86.

Next to that were the final inflation figures from France, which confirmed earlier estimates that prices declined  0.2% m/m but on a yearly base (3.4%) still exceed the ECB’s target level of approximately 2%. It must however be said that the data includes January discounts which are reflected by a sharp decline of prices for shoes and clothing (-9.2% m/m) although prices for transport also dropped with 4.8% m/m.

Tyler Durden Fri, 02/16/2024 - 11:40

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Industrial Production Decreased 0.1% in January

From the Fed: Industrial Production and Capacity Utilization
Industrial production edged down 0.1 percent in January after recording no change in December. In January, manufacturing output declined 0.5 percent and mining output fell 2.3 percent; winter…

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From the Fed: Industrial Production and Capacity Utilization
Industrial production edged down 0.1 percent in January after recording no change in December. In January, manufacturing output declined 0.5 percent and mining output fell 2.3 percent; winter weather contributed to the declines in both sectors. The index for utilities jumped 6.0 percent, as demand for heating surged following a move from unusually mild temperatures in December to unusually cold temperatures in January. At 102.6 percent of its 2017 average, total industrial production in January was identical to its year-earlier level. Capacity utilization for the industrial sector moved down 0.2 percentage point in January to 78.5 percent, a rate that is 1.1 percentage points below its long-run (1972–2023) average.
emphasis added
Click on graph for larger image.

This graph shows Capacity Utilization. This series is up from the record low set in April 2020, and above the level in February 2020 (pre-pandemic).

Capacity utilization at 78.5% is 1.1% below the average from 1972 to 2022.  This was below consensus expectations.

Note: y-axis doesn't start at zero to better show the change.


Industrial Production The second graph shows industrial production since 1967.

Industrial production decreased to 102.6. This is above the pre-pandemic level.

Industrial production was below consensus expectations.

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