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What Causes “Transitory” Inflation to Become “Persistent”?

What Causes “Transitory” Inflation to Become “Persistent”?

You are the CEO of Acme Widget Factory. Among your many duties is overseeing production…

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This article was originally published by Real Investment Advice

What Causes “Transitory” Inflation to Become “Persistent”?

You are the CEO of Acme Widget Factory. Among your many duties is overseeing production and profit margins related to your core product, widgets. Competition in your industry is stiff, with over a half dozen widget producers.

The pandemic and recovery are throwing the widget industry for quite a loop. In the spring of 2020, there was no demand for widgets. You laid-off employees and limited production while focusing on survival. During the summer of 2020, fiscal stimulus was percolating through the economy, and demand soared. It continues at a robust pace.

Acme’s future is brighter, but as CEO, you face a new set of problems. Your factories are running at full force, as are your competitors, but demand appears insatiable. At the same time, the prices of the materials needed to make widgets keep rising. Further, new and existing workers are demanding higher wages.

The problem facing Acme’s CEO is occurring in executive suites across America. Their decisions about how to navigate through 2022 and beyond in this unprecedented period illuminates a potential source for “persistent” inflation. 

Acme Widgets

The price of widgets is up 20% in just the last year. However, demand weakens with each recent price increase. In economic speak, demand for widgets is elastic. Consumers demand fewer widgets as prices rise.  

Even with the slight reduction in demand, the industry cannot produce enough widgets. The good news is profit margins are higher than average as widget prices are rising faster than expenses.

As the CEO of Acme, you have a tough decision to make. Do you keep production capabilities as is or boost production with a new factory and more employees?

The CEO’s Transitory Dilemma

The biggest unknown you, the CEO, face in making the decision above is forecasting the future. In particular, the following questions:

  • How will widget sales be in 2023 and beyond?
  • Will input prices continue to rise?
  • Can you pass on rising costs to consumers?
  • Assuming inflation remains hot, will employees demand higher wages and more benefits?
  • If needed, can I even hire more capable employees?  

Most CEOs closely track economic activity and forecasts. Unless they are hiding under a rock, they recognize recent economic strength is primarily driven by the pandemic – specifically, the government’s massive spending and benefits programs.

CEOs, aiming to make the right decisions, must appreciate the economy’s heavy reliance on Washington in their strategic plans.

The President and Democrats are trying to keep money flowing through the economy. They are currently proposing massive spending bills. Blocking their plans is the upcoming 2022 midterm elections. Political games will make it much trickier to pass spending bills than in 2020. Democrats in office realize weak economic growth is not a winning ticket. Those Republicans, wanting their seats, also understand that.

 As CEO, we are beholden to our lobbyists to help us make decisions about Widget production. A strong economy typically results in better widget sales. As the economy continues to re-open and consumer behaviors normalize, personal consumption is likely to revert to longer-term averages unless Uncle Sam continues to be very generous to consumers.

As the CEO, we must determine if continued massive fiscal spending is likely or a one-time pandemic action.

The Fed’s Opinion

CEOs also need to decipher what the Fed thinks of future economic growth and how they may steer policy.

Per the Fed- “The Federal Reserve Board employs just over 400 Ph.D. economists, who represent an exceptionally diverse range of interests and specific areas of expertise.”

The Fed has the greatest army of economists in the world. What they say and their economic forecasts should have a profound impact on our decisions. Unlike guessing about how Washington plans on spending money, the Fed is easier to decipher.  

Transitory

Via official policy statements and minutes, the Fed describes the recent bout of strong economic growth and inflation as “transitory.” By this, they suggest economic growth will moderate, and swelling inflation will revert to norms.

According to Merriam-Webster’s dictionary, transitory implies a short period.

Transitory is a vague term. It can mean minutes or hours or infer years or even decades. 400+ economics Ph. D.s are not dumb. They likely chose the word because it has no clear-cut definition.

Had they defined the period of excessive price and economic growth with a specific range of months, they risk being wrong. They will be technically correct with the current phrasing if inflation and growth normalize tomorrow or in two years.

The graph below from Google Trends shows the search term “transitory inflation” is popular after being largely non-searched.

Fed Forecasts

Since the Fed is not defining transitory in terms of a specific time, we need another way to quantify their vagueness.  Fortunately, the Fed’s FOMC members periodically put out expectations for growth, inflation, and unemployment. While the results are based on the forecasts of FOMC board members, we have little doubt they represent the work of the Ph.D. army.

The three charts below show their expectations for the remainder of this year as well as 2022, 2023, and 2024. We also include their “long-run” forecast and the average from 2017-2019 for historical context.

The first graph points to economic growth normalizing in 2023. After that, they expect GDP growth to be weaker than pre-pandemic levels.

Inflation will return to near normal but run a little hotter than before the pandemic.

Fed members expect the unemployment rate to fall below the pre-pandemic average in 2022 and remain there for at least two more years.

Transitory vs. Persistent

With our fiscal policy expectations and the opinions of over 400 Ph. D.s, we, as CEO, have a tough decision to make. Should we construct a new factory, hire workers, and boost production to meet current demand?

If the Fed is correct, the recent boost in widget sales is transitory. Further, per their expectations, future economic growth, ergo widget sales, may be weaker than pre-pandemic levels. Adding a new factory and more workers may be profitable while the boom lasts. However, doing so may result in excess capacity and too many workers in the long run. If the industry adds production capability, supply will certainly outstrip demand and reduce prices down the road.

In addition to weaker expected economic growth, we must also consider expectations for a lower unemployment rate and higher prices than were normal pre-pandemic. In theory, those conditions should result in higher wages and production costs in a few years.

As CEO, we must think in terms of at least 5-10 years. While the current outlook is good, it may also be transitory. Per the Fed forecasts, our sales and margins are likely to shrink. Boosting capacity into such an environment seems foolish.

Taking permanent steps to cure short-term needs can be a costly trap. Unless runaway fiscal spending becomes the norm.

Conclusion

As COVID spread around the globe, economies were shuttered. At the same time, governments around the world flooded consumers and some companies with unprecedented amounts of cash.

As a result of limited production and strong demand, prices soared. This is the source of current inflation.

If demand stays high, in part due to more fiscal spending and supply lines and production remain fractured, inflation will continue to run hot. If such a scenario plays out as many CEOs decide not to invest in new production facilities, “persistent” inflation becomes much more likely.  

We strip you of the CEO title. As an investor with CEO insight, you have a lot to consider. Primarily, “persistent” is not “transitory.” Nor is persistent in the Fed’s forecast. Persistent inflation requires the Fed to take detrimental actions to investors.

This is not our outlook but given the oddities of the current environment and our fiscal leaders’ carelessness, it’s one we must consider. 

The post What Causes “Transitory” Inflation to Become “Persistent”? appeared first on RIA.




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Economics

“Beyond What We Anticipated” – Kimberly-Clark Slashes Forecast Amid Inflation, Supply Chain Debacle

"Beyond What We Anticipated" – Kimberly-Clark Slashes Forecast Amid Inflation, Supply Chain Debacle

Now that companies are reporting their…

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“Beyond What We Anticipated” – Kimberly-Clark Slashes Forecast Amid Inflation, Supply Chain Debacle

Now that companies are reporting their latest quarterly financial results. Investors are becoming increasingly concerned about inflation impacting the performance of companies. The latest example is from Kimberly-Clark Corporation, which missed analysts’ forecasts as inflation and supply chain disruptions dented sales. 

Kimberly-Clark shares slumped the most in six months after the maker of toilet paper, Huggies diapers, Kleenex tissues, and tampons, among other household items, slashed its annual forecast amid inflationary pressures and supply-chain woes. 

Kimberly-Clark reported a Q3 net income of about $469 million, or $1.39 per share, compared with $472 million, or $1.38 per share, last year. Adjusted EPS of $1.62 missed consensus of $1.65. Sales of $5.01 billion were up from $4.68 billion last year and higher than the consensus of $4.99 billion.

“Our earnings were negatively impacted by significant inflation and supply-chain disruptions that increased our costs beyond what we anticipated,” CEO Mike Hsu said in the statement.

The company is raising prices to offset soaring commodity prices sparked by supply chain issues that are not likely abating anytime soon. 

“We are taking further action, including additional pricing and enhanced cost management, to mitigate these headwinds as it is becoming clear they are not likely to be resolved quickly,” Hsu said. 

He continued:

“We will continue to invest in our brands and capabilities as we navigate through this volatile and difficult macro environment. Our strategy is working, and we remain confident in our future and our ability to create long-term shareholder value.”

One of the most notable takeaways from the earnings reports, not just with Kimberly-Clark but also with other companies, is that higher inflation and labor shortages exert margin compression. At the same time, broad US major equity indexes tread around all-time highs. 

As inflation becomes more persistent and the “transitory” narrative fades into the darkness, even White House economic adviser Jared Bernstein recently had to admit that inflation is likely to stay elevated longer than previously expected. The question remaining is if the monetary wonks at the Federal Reserve will embark on a tapering program of their balance sheet, which could eventually end the stock market party. 

Tyler Durden
Mon, 10/25/2021 – 14:00




Author: Tyler Durden

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Economics

Rabo: “We Have Just Seen One Key Step Forward… And More Back”

Rabo: "We Have Just Seen One Key Step Forward… And More Back"

By Michael Every of Rabobank
A step forward – and more backwards
In the real,…

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Rabo: “We Have Just Seen One Key Step Forward… And More Back”

By Michael Every of Rabobank

A step forward – and more backwards

In the real, not the financial economy, we have just seen one key step forward – and more back.

In particular, the crisis at the port of LA/Long Beach, on the verge of truly metastasizing, has finally seen shipping containers allowed to be stacked higher than usual to provide more storage in the limited areas available. Will this help? Yes! Is it enough? No! LA/LB still has a record backlog, with more containers arriving every day; every US logistics node from there on is also logjammed; alternative smaller ports are constrained by a lack of workers and trucks; and global carriers are opting to skip larger ports, such as Boston (perhaps for good reasons, but it certainly ensures shipping rates stay sky high).

China also reports Covid is spreading again in 11 provinces, despite being largely closed off to the outside world, and is imposing limits to intra-province travel. This will not only hit an already-slowing economy, but global supply chains too. Yes, that might ease congestion in US ports again temporarily, as did recent Chinese power-cuts. However, it will only do so because goods aren’t flowing, not because they are. It’s not just a US issue either. Recall the warning here about China’s cessation of exports of magnesium, and the likely knock-on effects on European industry? Politico is now flagging EU leaders signal alarm over Chinese magnesium crunch. Add other goods, and industries, to that list, perhaps.

On the virus front, despite official pre-Budget denials, there are also health-expert warnings and cynical chatter about the UK needing another Covid lockdown – although naturally not until 30,000 people have mingled at the COP26 in Glasgow next month. Parts of the EU are also seeing soaring Covid case numbers.

Europe can also worry about the La Nina pattern emerging in the Pacific, presaging what could be a colder than normal winter for the Northern Hemisphere, which already-tight energy markets did not want to see. As Politico also notes: ‘The EU’s impotent rage at Putin’s gas games: Access to Russian gas is splitting the European Union.’ But it’s not just gas doing so. The UK still rejects the European Court of Justice (ECJ) having a role in Northern Ireland, and the Polish government is also brawling over the ECJ vs. sovereignty: the Polish PM says the EU is making demands “with a gun to our head,” and risks starting a “third world war” if EU funds are withheld. In support, Hungary’s Justice Minister has tweeted: “We remember the Hungarian freedom fighters who faced Soviet tanks on the streets of Budapest. We said no to the Soviet Empire & we say no to the #imperial ambitions of #Brussels.” Recall EU countries are talking about a joint foreign policy and army: if things get worse, intra-EU enmity will start to look as bitter as that between California and Texas!

Is it a surprise Treasury Secretary Yellen now says inflation will stay high until H2 2022? But why is she talking about inflation again? The person who should be doing that, for now, Fed Chair Powell, just stated despite all of the inflation risks, it would still be “premature” to raise rates. As an aside, following the Fed’s recent decision to ban market trading by senior officials, it turns out the ECB’s own disclosures for last year show 13 of the 25 members of the Governing Council picked their own funds, stocks and bonds – in some cases including government bonds the ECB is buying under its stimulus programmes, or shares in companies whose debt it buys. Again, how very American of Europe.

So the inflation outlook is now clear: high, for around a year – and then we will see, depending on supply chains. Yet the growth outlook is far from positive. Bloomberg had a long read called ‘Chinese Economy Risks Deeper Slowdown Than Markets Realise.’ (Well, some of us did.) Beijing has also announced, contrary to the Wall Street Journal, that it *will* proceed with pilot property tax schemes over the next five years. The Global Times explains: “…there is no turning back…It will not begin with tigerish energy and peter out towards the end, or leave the matter unsettled…it is best to treat the prospect of property tax with a calm mind [because] people with more houses have enjoyed more public services provided by the country and society, so they should contribute more tax…there is no need to wait until house prices fall off a cliff due to the levying of property tax. I can say with certainty that such a scenario will never happen. Our country will not allow such a situation to occur, and will not introduce radical tax reforms that could lead to the “collapse” of the housing market.”

So the tax rate will be very, very low: in which case, it won’t provide much revenue for cash-strapped government. And in the background, Evergrande is putting out pictures of the projects it is still finishing, just as another developer looks like it is to default on a 12.85% US dollar note due today. Consider the profit margins the firm must have been expecting to have borrowed at that rate; imagine the margins Beijing would prefer under ‘common prosperity’ to allow for more affordable housing.

Staying with tax, and after having almost all other avenues closed off by intra-party fighting, the US Build Back Better Act –the White House fiscal plan to stave off a growth slump, even if it also pushes inflation higher– will apparently be funded by “not a wealth tax, but a tax on unrealized capital gains of exceptionally wealthy individuals,” according to Yellen. Which means their assets, i.e., their wealth. So, in the US it is time for curbs on ‘excessive’ income and for the wealthy to give back more to society. Oh, sorry: that’s common prosperity in China. More policy mirroring, as both sides of a growing geoeconomic divide try to deal with the inequality and polarisation that Chimerica globalisation built.

In geopolitics we see mirroring too. On Friday, US President Biden stated on live TV the US would defend Taiwan if it were attacked, a major step away from the US policy of “strategic ambiguity” over this hyper-sensitive topic. The admission, not actually Biden’s first on the topic, was immediately walked back by the White House press office, but it remains to be seen if this was the president ‘mis-speaking’, or if it was deliberate messaging. Either way, Beijing’s response has been furious, with the Global Times calling the present US administration the “most incapable and degenerate in the country’s history.” With the US also pressing ahead with plans to try to allow for Taiwan’s “meaningful” involvement at the UN, tensions over this issue look set to escalate further. Indeed, with all the EU drama over “WW3” and Poland, it’s the Indo-Pacific that is still the epicentre of geopolitical fat tail risks.

So that’s the real economy. The financial economy will just do its own sweet thing today, as usual.

Tyler Durden
Mon, 10/25/2021 – 13:00





Author: Tyler Durden

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Economics

Reading The Classics: Mathematics Vs. Economics

There’s been a fun (but silly) long-running debate on Twitter whether economists need to read canonical texts: Smith, Marx, Ricardo, Keynes, etc. What caught my eye is that a mainstream economist compared economics to mathematics — why don’t we learn c…

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There’s been a fun (but silly) long-running debate on Twitter whether economists need to read canonical texts: Smith, Marx, Ricardo, Keynes, etc. What caught my eye is that a mainstream economist compared economics to mathematics — why don’t we learn calculus by studying the history of calculus? Why this is interesting is that is showed a lack of understanding of the situation in both mathematics and economics.

Please note that this article is a discussion of the philosophy of teaching at the university level, so do not expect any conclusions that will help make analysing bond markets easier. That said, there is an outline of a critique of the core methodological principles of neoclassical macro.

I will first start with mathematics.

The Eras of Mathematics

My academic background was as an (honours) electrical engineering undergraduate, with a minor in mathematics. I then ended up with a doctorate in control theory — an area of applied mathematics that is normally attached to engineering faculties. As such, I missed most of the undergraduate mathematics curriculum, but I did cover relevant courses, and hung out with mathematicians (my supervisor had a background in pure mathematics until he went to the dark applied side).

I took a course in the history of mathematics at McGill. My comments here reflect my hazy memory of that course — as well as an editorial bias that might horrify some historians, but probably reflects how many mathematical students would approach the topic. 

(I grabbed the cover of the book History of Mathematics (Amazon affiliate link) to give a pretty picture to distract from my text. The text looks interesting, and overlaps the topics in the course I took, although my course terminated at an earlier historical period. I have not read that book, but I would give 100% odds that it is a more reliable source about the history of mathematics than myself.)

I would divide mathematics into three eras.

  1. Modern. Mathematics pursued in a fashion that is consistent with what is done in the present research literature.
  2. Early Modern. Mathematics that is structured in a fashion similar to the present (although perhaps more “wordy”), but often uses proof techniques not used in the modern literature.
  3. Pre-Modern. Any mathematics that a present-day math undergraduate would need a historian to explain the context.

Modern Mathematics

If we look at the output of modern mathematicians, we see two main classes of texts: articles, and long-form texts. Long form texts include textbooks, monographs, and theses (which is a monograph published at a University instead of publisher). Meanwhile, a “textbook” is just a monograph that has been optimised for teaching purposes.

When we look at monographs, a significant portion of the text is devoted to a survey of the field, as well as setting up notation (which is typically tied to the survey). The reason is straightforward: attempting to review a monograph that consists of purely new results would be a daunting task. It might happen in a brand new area of mathematics, but that is unusual (almost by definition).

We can then see why mathematical teaching does not consist of “reading canonical texts”: the underlying texts are a huge volume of journal articles, along with monographs that survey the journal literature. For reasons of time, teachers use the surveys — but students are expected to be able to go into the primary literature as needed.

(Jumping ahead, this is how many neoclassicals like to view economics.)

With respect to textbooks, within an area of specialisation, the textbooks generally evolve to meet teaching needs. However, the core contents are often relatively uniform. For example, both Rudin and Kolmogorov were popular textbooks for real analysis when I was student. Once you worked through one, you could cover the other without picking up much new content.

Early Modern Mathematics

For a philosopher of science, early modern mathematics (as I define it) is probably way more interesting. There were a lot of debates on how to prove results.

Unfortunately for the pre-moderns, the typical reason why a debate existed was that both sides were wrong. Over time, more robust proof techniques were developed, and the debates were ended.

A modern student of mathematics would be expected to be able to go through that literature, and very easily demonstrate the weaknesses (if not outright errors) of the old proof techniques.

This is not usually covered, although it can appear in surveys. For example, Rudin covers both the Riemann and Lebesgue definition of the integral, and explains the advantage of the Lebesgue formulation.

These debates are otherwise not covered for the basic reason that it is impossible to find properly-trained mathematicians who take the old proof techniques seriously. To what extent a debate exists, it would continue within “modern” mathematics.

Calculus

Calculus has its roots in the “early modern” period (as I define it). There were debates on how to do proofs. But, those debates were settled, and the modern proof techniques that settled the debate are the ones taught in courses.

Although those were important debates, they are not a major feature of university level teaching for an important reason: calculus is barely considered to be a university level subject. For example, in Quebec, local students have a 3 year university program, and for students in the mathematics/science streams, Calculus I (differentiation) and II (integration) are taught in CEGEP — a pre-university level of education. (Students from outside the province have an extra year, where they learn calculus.)

Calculus is a settled area of mathematics, far from the research frontier. The only pedagogical interest in teaching it is to find the way that best fits the backgrounds of the enrolled students. For students of Calculus I/II, teaching them invalid proof techniques is distracting and not helpful.

Pre-Modern Mathematics

What about the canonical texts of pre-modern mathematics? Well, here is my list of such canonical texts.

  • Euclid’s Elements.

Until relatively recently, Euclid was taught. The catch was that it was taught to school children (such as generations of English schoolboys). Although not assigned, I read the Elements in either junior high or high school.

What about everything else? Well, we need to look at what pre-modern mathematics consisted of. Firstly, people lumped a lot of things in with “mathematics” that mathematicians have dumped on other faculties, such as applied sciences and mysticism about numbers. What about the rest? We see the following areas of interest.

  1. Plane geometry. Any culture that had access to the Elements took it seriously, and you could use the plane geometry either in it or as taught in modern high schools to solve the problems that the ancients faced.
  2. Arithmetic. This is taught in modern primary schools. The best way to teach arithmetic depends upon your numbering system, and even modern schools keep experimenting.
  3. Word problems. These can be solved by using high school algebra. The rise of modern notation is probably where you can draw a line between “pre-modern mathematics” and the rest.

This is reflected in how my history of mathematics course was taught. We got a small potted history in lectures, but for testing purposes, we were expected to solve problems using the mathematical techniques available to a given culture. Although a fun challenge, this is more a form of entertainment than serious mathematics. Solving a problem that you already know the answer to (courtesy of knowing modern techniques) is not that big a deal.

This ease would not hold for the earlier mathematicians. It took an effort to translate other cultures’ mathematics to their own conventions, and would be shocked by the coursework by a modern mathematics faculty.

Economics

The Twitter debate about reading the classics largely consisted of a fiesta of name-calling and strawman attacks. In other words, the kind of entertainment that I go onto Twitter for. If we wanted to be serious, we realise that there are three separate questions that are being mangled together.

  • What do we expect an undergraduate in a field to know?
  • What should academic researchers in a field know?
  • What is the best way to teach an undergraduate (possibly graduate) students?

That is, we need to differentiate between what is considered required knowledge for an undergraduate versus researchers. In engineering, a knowledge of project finance is a requirement. I am out of the loop, but I believe that any Canadian faculty without such a requirement would face accreditation issues. This is despite the fact that it is exceedingly unlikely that faculty at engineering departments will publish research in the area of project finance.

I do not claim to be trained as an economist, and I leave it to the reader to decide whether a person can leave a university with an undergraduate degree in economics without knowledge of the thought of Smith, Ricardo, Marx, and Keynes (etc.).

At the graduate level? The reality is that students can parachute into an economics graduate program without an economics undergraduate degree. Since post-grad degree programs are already far too long in most places, you cannot shoehorn in an undergraduate degree into the program. That said, one does not normally crow about ignorance of a subject that is taught to undergraduates in their field. (My supervisor had an obligation to tutor undergraduates, and so he often left meetings with me to return home to study the next lecture of thermodynamics so that he could answer question. This is how academics should work.)

Finally, what is the best teaching technique? Speaking as someone who barely read any authors before Keynes, I am in the camp that secondary sources are probably the most time efficient teaching technique. That said, there is a catch: the secondary sources need to take the primary sources seriously. It should be possible for the reader of the secondary source to read the primary and go to almost any passage and understand what the original author is going on about.

Dunking on the Mainstream

With that out of the way, let’s have some fun and dunk on the mainstream’s positions in this area. More accurately, I will relay some critiques that I am aware of, without claiming that they are true.

  • We cannot compare many areas of economics — such as my only area of interest, macroeconomics — to calculus, since the questions are not settled. The research frontier has not completely moved away from what Keynes was writing about.
  • To what extent a mainstream academic argues that undergraduates do not need to be aware of foundational topics in their field since they are not current topics of research is out of line with accepted practice in every other university department that I have had contact with.
  • Heterodox authors claim that neoclassical summaries of economic debates are botched because they do not take critiques of underlying assumptions seriously. Debates that neoclassicals consider “settled” are still disputed.
  • Related to the previous: the survey undertaken neoclassicals of the literature is obviously biased. The case in point is MMT: from the perspective of a mainstream academic, MMT did not exist until the articles dunking on it by neoclassicals appeared. We have the obviously dysfunctional situation of earlier neoclassical articles on MMT critiquing it without citing any journal articles, with later neoclassical articles begrudgingly citing them since MMT has refused to disappear off the radar screen. I have encountered barriers to citation in my old area of academia, but nothing even slightly close to this behaviour.

Most of the discussion in this article could be viewed as academic mud wrestling, which not everyone is interested in. However, the latter point does affect the output of the neoclassical research program, and thus is of interest to anyone with an interest in macroeconomic theory.

Email subscription: Go to https://bondeconomics.substack.com/ 

(c) Brian Romanchuk 2021

Author: Brian Romanchuk

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