Blain’s Morning Porridge – 17th Feb 2022: Inflation – Cassandra Speaks
“The way to crush the bourgeoise is to grind them between the millstones of taxation and inflation.”
This Morning: Inflation should be front and centre for markets – give or take Ukraine, Oil, etc. How real is it, and just how bad could the consequences be? Not talking about it is one way to ensure it hurts.
Contrary to expectations, World War Last didn’t break out yesterday. Either the Russians are stepping back or they are retreating in a forward direction while adding thousands of new troops… Who knows..? Who to believe? In the absence of evidence or a credible reason for Putin pressing the auto-destruct button while he’s winning, (er, yes, he probably is as the West discomboffulates around the issue, beset by leadership crises, division, energy prices and distrust), can we now look forward to Spring?
And get back to worrying about real stuff. Like inflation?
The news this morning is UK inflation hitting a 30-year high, home price rises in the US and UK earning more than the average working wage, and the Fed Minutes – yawn. Put these together and it looks torrid. Yet the market seems unbovvered… There is a strong likelihood the Fed will hike 50 bp in March and up to 10 times in the next (whatever length of time) years/months/minutes… Whateva… Expectations of aggressive moves in rates have doubled in recent weeks.
Commentary in the bond market ranges from the risks of over-aggressive policy mistakes, arguments about how long “transitory” inflation might last, and the risks of further supply and wage driven inflation hikes. Surprisingly few comments I can find deal with rising stagflation risks – which seems likely to me in the face of a consumer price shock, the Fed aggressively tightening rates, and I as alluded to a few days ago, a looming credit-shock as banks kick away supports for sound but struggling companies. (I reckon we are about to see a corporate Armageddon unless banks ease their risk parameters.)
It’s worth remembering: most Central Bank tightening cycles end up in a downturn.
Let’s try to go back to basics on inflation.
Conventionally, inflation is “everywhere a monetary phenomenon”, apparently. If money is too cheap, it will unbalance demand and supply causing prices to rise – so goes the conventional theory. For the last 12 years we’ve seen incredibly easy monetary policy (aka experimentation) distort the price of money absolutely – negative yields, NIRP and ZIRP. But, apparently, there was no inflation. Inflation remained stubbornly below target.
Except of course there was massive inflation within the system.
The mechanisms that drove cheap money since 2010 did nefarious damage within the financial asset system. Quantitative Easing buying back bonds to force interest rates lower caused the relative price of financial assets to shift. Negative interest rate policy forced investors to take more risk for less yield. The money pumped into the financial markets did not fertilize the real economy by boosting “real” lending – but was internalised within financial assets, pushing up the prices of bonds massively, and stocks by insane amounts. Inflation – pure and simple. The corporate bond market saw record volumes – but much of that remained in the financial asset market as debt was used to buy-back stock.
The result was 12 years of record inflation in financial assets while the real economy effectively deflated. Now – in a host of ways – financial asset inflation is crossing back over into the real economy. All it took was a catalyst: the Pandemic.
Most economists think in terms of linear process. Action A causes result B. They worry about time-lags in policy implementation, or that central banks will make policy mistakes, turning recovery into a downturn by being overaggressive on monetary tightening. Press a button here, pull a lever over there, and inflation can be stemmed. A few think austerity politics, and raising taxes, is the right way to control spending and deflate inflationary expectations.
Expectations is an interesting word. The reality is inflation is about consequences and the predictably unpredictable way individual’s expectations respond to economic stimuli and signals. I heard a very interesting example of this earlier this week on a podcast: the theory our perceptions of inflation are coloured by our learned experience of it.
When I was young, working and trying to buy my first flat in the inflationary bubble that was the late 1980s, I knew and feared high inflation. I remember scrambling to buy a flat, any flat, because inflation meant house prices could only go higher, thus driving up flat prices…. And being left in negative equity when it inevitably popped.
My perception today is inflation is now thoroughly embedded in the economy – while supply chains may sort themselves, and energy scarcity may prove short-lived, a host of consequences, driving more consequences are now on the march. Inflation is driven not just by the prices of money, but by scarcity, wage demands, producer debt, and currency fluctuations. All of these are unstable and will see inflation rattle and roll markets for years rather than months. On top of that, put a layer of expectations – which will get progressively worse – and they trigger a vicious negative feed-back loop of inflation reinforcement.
Check back on the Porridge website – I’ve been warning about this for years! Hence, calling this porridge: Cassandra Speaks.
In contrast, one of my much younger (and a darn-sight cleverer) colleagues thinks inflation will still prove transitory, that shocking CPIs are a lag effect of the pandemic and supply chain stresses. He reckons wages will kept in line by corporate competitiveness – no one can afford to pay higher wages.. He thinks the only risk is Central banks driving the global economy into an unnecessary recession. (His scenario will get interesting as private sector workers start to demand the kind of wage rises the public sector is achieving..) Problem is – he ain’t seen it before..
To illustrate some real risks, let’s think about the UK and Europe.
- To call the UK politically fragile would be an understatement. There is a serious risk the multiple political failures to monetise Brexit, to “level” the economy, and control graft and corruption, even as the national debt balloons will result in crashing economic confidence in the nation. The result of these negative factors will be/is a run on sterling – and a crashing FX rate is the fastest way to ramp up inflation.
- The ECB faces an even deeper crisis. What should it do to balance the inflation hawks like Germany – an economy in recovery, versus the weakening southern brethren that are increasingly dependent on ultra-low rates to fund flatline economies, and EU largess to fund social and infrastructure rebuilds? Without the ECB as buyer of first and last resort, who will buy Greece or Italy (or Spain or Portugal) debt? As the unsupportable unstable debt mountains become obvious – what price the Euro? Or how will national politics trump the politics of Brussels? All happening as the ECB is run by a political appointee with little expertise in inflation…
My point is simple…. Inflation is here, it’s here to stay and it’s here to really, really, really ***k us up.
Changing the topic – Meta
A Clegg is the name a particularly nasty horsefly in Scotland. If it bit you …. you knew about it.
Paradoxically, if you ever met Nick Clegg, former deputy prime minister and leader of the UK Liberal Party, it’s unlikely you would recall much beyond an earnest and dull moment. A very “nice” chap would be my damning indictment of the man. Thus far Nick Clegg’s wiki obituary would have said something about being David Cameron’s stooge and fall-guy, becoming the first UK party leader to lose his seat at a general election because the electorate considered his sell-out of his party’s core-values so he could sit at Dave’s big table to be unforgivable.
Apparently not.. He will now become Meta’s (aka Facebook) President of Global affairs – meaning he will be the fall-guy for its death by a billion regulatory cuts. Mark Zuckerberg said Nick will “lead our company on all our policy matters”, which should be yet another massive sell signal for the beleaguered stock. Not only has Facebook’s obsolescence as an advertising revenue farm been exposed, and the Metaverse is not only unproved and unlikely, but now they are entrusting a man who couldn’t find his way out of a wet paper bag to lead the company through a political minefield. Ok – I’m being harsh… but seriously?
And, finally, a topic I must write more about: New Finance and the Death of Banking.
Yesterday Citigroup effectively gave up its efforts to remain/join the big league in investment banking. It’s going to focus on more profitable sectors – which seems to mean banking the middle corporate market, trade and treasury services, and wealth management… which incidentally are all areas where “De-Fi” (the hip term for doing banking better than banks) is likely to eat their lunch. When I started reading the reports this morning I was thinking to myself how much like fellow banking dinosaur HSBC Citigroup now looks, but the FT beat me to it in: Citi’s Jane Fraser ditches ambition to break into Wall Street’s big league.
It’s difficult to see how banks are going to compete in a new market. Regulation has dramatically reduced their risk appetite. Risk is now held in the asset management business. Their tech systems are older than steam-punk and not-fit-for-purposes. Their only cache in fight for customers is their brand and personal branch service – I jest. What branch service. High Street banks are faceless.
Which is interesting, because increasingly Goldman and JPMorgan dominate global finance by monetizing their reputation and brand. No one ever lost their job for giving a mandate to Goldman Sachs… Ha. Ha. Ha. said the former president of Malaysia.. One does hope the Vampyre Squid sucking the face off humanity will get calamari-ed as a result of 1MDB scandal…..
No time for five things to read this morning.. Got to do my day-job..
Bill Blain
Strategist – Shard Capital
In a strange way, today’s post was a comforting. I’m old enough to remember the 70s and 80s and there’s a sense of Back to the Future. Now I’m off th channel my inner Russell Napier.
Russell is brilliant – but he does make me sound happy!
Good afternoon Cassandra. I’m also an old-timer having started in money markets in 1984. I happen to agree very much with your young colleague that policy error is imminent due to central bank aggressiveness, most of the price increases stem not from and central bank efforts, but rather helicopter dumps from US Treasury (actual ‘money’) causing demand pull in an economy running at 50%. The inversion of the eurodollar curve back in Dec ’21 reminded me of late 2018 (globally synchronised growth) when the fed saw inflation and the need for rate increases. The eurodollar curve inverted then and by early/mid 2019 we were nearly in recession. The inversion in eurodollar curve now is deeper and with more breadth than the worst of the late ’18 inversion. Maybe this gets us to your stagflation.
I am certain that central bank QE (Japan, US, EU…doesn’t matter which one) is grossly ineffective. The Japanese have been at it for nearly 20 years and can’t generate inflation. The San Fran Fed wrote a paper in 2005ish (i forget, maybe 04, maybe 06, but certainly well before the GFC) pointing out that Japans QE can only work if the banking system participates fully. Why? Because central banks don’t print money. They print bank reserves. So if i flood the system with reserves I’m counting on the banks to (fractional reserve) lend against those reserves to increase the money supply. Globally the majors have all seen these programs and yawned. They went out and bought gov’ts to sell back to their central bank or dumped their reserves into (over here in US anyway) the feds IOER program.
Yep.. I keep forgetting about Japan… a lesson from history.
My first house I bought in 1984, recently out of college, with a mortgage rate of 14%. The housing market would totally collapse at half that rate today.
Increasing money supply did not increase inflation because it went into the Current Account Deficit. Increasing imports were financed and those imports were cheap – cheaper than the US could produce at the Currency Exchange rates generated by teh fact that the USD has been the world reserve currency. More imports meant lower inflation.
So, it has all been a magical virtuous circle. More money = more imports = lower inflation which allows the FED to print more money – as long as you have zero interest in your national sovereignty.
The really really BIG problem now is that the country, that WAS the source of your low inflation, is now driving inflation. There is little to nothing the FED can do about inflation in China. Sure, a very nasty recession/depression in the USA will damage Chinese output but that is not a happy choice.
Don’t look for ANY solutions from current policy makers – the answers lie back in time.