Inflation…. Forbes..
Sell assets for cash…. Its all about vicious circles….. we hold the bag… markets move to hurt the most people…
Deflation versus Inflation.
There is only one long term call in the market now. Will there be Inflation or deflation in the post-Covid world. The majority opinion is deflation because unemployment will be high and demand will be weak, while the supply chain is resilient and will storm back offering plenty of goods to tempt weak demand. The new moneypumped by central banks will allow companies the time to quickly pick up the slack in supply and buy time for companies to rebuild their business and the economy but demand issues will lag supply capacity, driving prices down. Companies propped up by cheap money will not only be able to survive but also be able to trade for a time at a loss which will let them cut prices. Therefore there will be a deflationary tailspin.
QE doesn’t create inflation. New money gained is balanced by less liquid assets lost in exchange. The new money is encumbered by this process, so isn’t easily squandered on immediate rash purchases. The economy gets liquid money and in exchange the government gets assets. It isn’t printing money, its issuing it in return for less liquid assets, further from cash, but still nonetheless wealth.
QE etc is not petrol for the economy its oil for the engine. That is why years of QE didn’t create the hyperinflation everyone expected when the process was invesnted to sort out the ‘global financial crisis.’ QE is no longer ‘unorthodox monetary policy’ it’s a proven way to manage economies.
The new stimulus will not create inflation and might not even prevent deflation but it will support and smooth out the future recovery back to normality.
The proof is in the pudding of the last 12 years of QE. QE worked, QE is safe, QE doesn’t create inflation.
The Inflation argument.
You simply cannot cancel interest rates, pump untold amounts of new money into a seized-up economy and expect it not to create inflation. It always has and it always will. QE did create inflation. It created it in stocks and Real Estate and many periphery assets like Art, Wine, Watches, Hypercars. Your low inflation rate is fake data, just like so much information today. When hotel and restaurant prices double, somehow magically the effect is cancelled out by broadband speed increases that didn’t push up my phone bill. The world is awash with empty $10m mansions that have grown like a cancer down the coasts of California and any other juicy spot developers can get their claws into. These ‘assets’ are artificial, a Frankenstein of QE and the artificially low interest rates that funds these purposeless constructions. Plastic toys from Asia might not have gone down in cost, but a packet of candy or popcorn has shrunk in size. Go measure inflation by 70s standards and you get a much higher rate of inflation that todays headline numbers.
So whatever the real rate of inflation has actually been, no one is challenging stock prices are extremely high or that house prices are way up. That is where QE inflation goes. Reverse QE and was tried in 2018-2019 and what do you know, the stock market crashes.
You might say this kind of inflation is great. Inflate houses and pay out the middle classes. Hype stock prices and give the normal guy a job because corporations can borrow huge sums for nothing then go ape with hiring, expansion and competition. Go on use QE to juice the economy and tax revenue so government can spend, spend, spend. Is QE the first economic free ride in history or is it building a skyscraper of debt.
You can build a tower of debt, that’s how bubbles work but if you keep building it at some point its going to fall. Now you can prop it up every time it wobbles but your tower gets more and more convoluted and bigger and bigger and it must at some point collapse. That is when inflation strokes because it is the only escape.
Out of control economies always end up in inflation because it’s the only way governments can default on their debts. The Romans did it. The medieval governments of Europe did it. The governments of the 18th,19th and 20the century did it and it happens today from Iran, to Argentina, from Turkey to Venezuela. It’s the path governments take, who can’t afford their budgets or the service on their existing debt and that is exactly where Europe and the US are now, off the cliff of their ability to sustain the government systems and their debt mountains.
So what is it to be? Inflation or Deflation?
Clearly the deflationists have ten or more years of experience of pumping QE on their side and a short crisp argument. High unemployment and fear = deflation. New money does not go into cash but into assets which might get pricey but don’t change the price of bread.
The inflationist argument is more visceral. You can’t make money out of thin air without producing more stuff to buy without making inflation. They don’t have much to say about being wrong for the last ten years. To inflationist inflation is just obviously coming. To inflation believers, a vast explosion of new liquidity can simply not be matched with things to buy and therefore must come through into prices rising.
So what is it going to be?
I believe it will be inflation.
Milton Friedman said: Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. … A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth.
The point I focus on is: Inflation is always and everywhere a monetary phenomenon.
Inflation/Deflation is not accidental, it is policy. Deflation is not an accident in Japan and Inflation is not an accident in Venezuela. If they were they could simply swap staff at their central banks and sort their ‘problems.’ Inflation and deflation are the result of political necessities created by events.
Deflation will make the recovery from the Coronavirus pandemic harder. Inflation will make it easier. Quantative tightening has been tried and it failed. QE has been tried and it worked. Deflation makes the situation worse, inflation makes the situation less bad. These ‘directions of travel’ means inflation is highly likely.
Will most people even notice 7% inflation a year? How many faster mobile phones will it take to conceal Bread going up 10c a loaf?
Rack that up for 5 years and you have cut about 1/3rd or $8 trillion off the national debt in real terms
Leaving that aside I prefer another argument. It relies on induction.
It goes as follows.
The market is always right.
Therefore the current ridiculous price of stocks must have a reason, based on something in the future more powerful than the biggest dip in GDP since the birth of the industrial revolution (at least to the UK central bank.)
Could it be that stock prices are going up, not because companies are going to do well but because money is going to nose dive in value?
The market is NOT actually going up in value, the market is pre-empting the value of money plummeting.
The market is simply seeing stocks, underwritten in their solvency forever by their governments, as a hedge against the coming tide of liquidity driven inflation.
Surely if the deflationists are right, the market is wrong, because you can’t have deflation, recession and also have rising stock prices. You can’t have deflation and growth, so how can there be rising stock prices. If the value of money goes up, the prices in money of stocks should go down with the other goods whos prices are depressed.
You can have inflation, recession and rising stock prices, you can also have inflation, growth and rising stock prices.
So is the market right or wrong? If the market is wrong, the market will crash, if the market is right we are in for significant inflation.
It not pretty either way.
But what is an investor to do?
I can only say what I’m doing. 50% in cash, 25% in special situation stocks and 25% in inflation hedges. That is a 50/50 hedge between inflation and deflation, so I’m taking both possibilities seriously.
I can scamper really quickly and cheaply between either poles and straddle them both if necessary. In this crazy new world it is important to be able to move between the poles of possibility fast and at low cost because be it inflation or deflation one thing is for sure, its going to be a volatile future. In such a future there is great value to being able to move fast because you don’t have to be a genius to recognise there is chaos ahead.