Inflation, Covid, Central Banks and Politics – about half the things to really worry about…

Blain’s Morning Porridge – August 24^th 2021: Inflation, Covid, Central Banks and Politics – about half the things to really worry about…

“How many divisions does the Pope have?”

This morning: As markets shake off their summer slumbers, what should we be worrying about? Lots..! From real vs transitory inflation arguments, the long-term economic consequences of Covid, the future for Central Banking unable to unravel its Gordian knot of monetary experimentation, and the prospects for rising political instability in the US and Europe.

Same as, same as….  

Not an Apology

I’ve been told I should apologise for yesterday’s Porridge. A reader unsubscribed because I don’t treat Tesla seriously. (Shock, horror.. somehow I shall live with the pain of rejection…) Another commented: “hating Tesla must be a very difficult way to make a living.” Sure. I agree – it is. In my private Jihad versus Elon Musk I have missed massive market upside… but then again, it’s not my job to pump up illusory market valuations. It’s to paint the picture as I see it, and caution foolish markets about their gullibility. I will continue to characterise Tesla as an unjustifiably overpriced automaker, pretending to be something else, run by a narcissistic show-boater.

Meanwhile…

What should we really be worrying about?……

• China?
• US Politics in the wake of the Afghan Skedaddle?
• Overpriced Markets and Asset Bubbles?
• The future of Tech and ESG?
• Central Banks trapped by the consequences of their own monetary experimentation?
• Boom or Bust post Covid Economies?
• Inflation, Deflation or Stagflation?

Oh, so much… I probably won’t get round to them all this morning as I’ve got a conference call to jump on… but let’s see…

Inflation

Let’s start with the big one – inflation. Many market players reckon the slow-down in recent data and growth estimates being scaled back means there is little to worry about. Fears of an inflation spike are already receding – say these pundits. Wrong. That’s far too simplistic a perspective – inflation is not just about immediate and reversible supply and wage factors as the global economy re-opens after Covid.

The central banks are all plugging this “transitory” inflation story – but I don’t think they particularly believe it. Producer and Consumer prices are all expected to edge higher. What are they trying to hide….?

Inflation is also a long term consequence. It has been very much present since 2010. It’s been hidden in financial assets – where the bulk of monetary creation has been hiding – till now. Now it is spreading into the real world.

They say inflation is always a monetary consequence. Not quite, as Covid demonstrates, but let me illustrate the monetary consequences of central bank policy: in the real world ultra-low distorted interest rates makes homes more affordable, but that’s resulted in impossibly high home prices triggering pay demands and wage inflation. It’s happening at a time when unfilled job vacancies have never been so high – further fuelling wage inflation. It’s not a virtuous circle.

Meanwhile volatile oil prices, the hoarding that led to commodity spikes earlier this year, and the general rise in building materials we’ve seen across the west are partially a result of the peculiar politics of OPEC, broken supply chains, Covid and a host of other factors. It’s a simple fact of business that prices to the consumer are remarkably frictionless as they rise, but sticky as they fall. Lumber prices may have fallen… but you’d never know that if you try to buy wood.

There is also a massive element of previous credit creation now creeping into the real economy. Alternative investment firms in Private Debt and Private Equity have ridden the last 11 years of financial asset inflation higher. They are now rebalancing that money out of bubblicous stock markets and putting it to work acquiring real assets – look at the current feeding frenzy in the UK supermarket sector. That pushes up the price of real assets – inflating them. Real economy inflation derived from financial assets is just one long-term factor why we need to fear inflation more!

Former Bank of England MPC member Andrew Sentance summed it up well in The Thunderer y’day. My fear is we’ve already got the inflation burner turned on, but the global economy is still recessionary (effectively deflationary), meaning the prospects for a devasting bout of Stagflation are potentially that much higher.

Covid

Why would the global economy remain recessionary? Look at the stories this morning from Malaysia where Chip distributors are on short-time because of Covid lockdowns. Covid is just another factor to add to the ongoing trade disputes, the trend towards isolationism, closing borders due to refugee fears, etc.. The latest data on vaccines is sort of positive: if you get vaccinated you can still catch it, but you are unlikely to die. You will spend a couple of weeks ill. Just like flu, the virus is now endemic in vaxxed nations like the UK.

But around the world some nations are still fooling themselves with lockdowns – prolonging their economic detachment. Others have failed to get vaccine programmes off the ground – some simply can’t afford it. Covid has become an inconvenience in the rich west, but still a killer in second and third tier nations.

The second order effect on struggling nations is soaring and building unsustainable debt loads in the developing nations as they try to buy their way out of economic catastrophe. Strong nations with strong currencies and established debt management teams raising debt in their own script will survive. Nations that have to borrow dollars to pay Covid costs are heading towards a new series of sovereign debt crisis points.

The result is the global economy stays fractured for longer, and likely to diverge between strongly recovering Prime Economies able to bear their debt burdens, and Second Tier Economies struggling with potential default – perhaps yet another emerged and emerging market crisis in the making?

Central Banks

Lots of commentators have already pointed out the inconsistency of the US Federal Reserve holding its symposium on “Macroeconomic Policy in an Uneven Economy” in one of the richest counties in the US, Jackson Hole. Perhaps Laredo, where 21% of residents are below the poverty line would have been a better choice this year? It’s an Academic question – it’s a virtual conference.

The key will be whether the Fed gives any real policy steer on when the Taper will start. I expect they will stay stum – worried about what the negative market impact of withdrawing $120 bln of T-Bond purchases, and what it will do the Treasury market, which has looked weak and illiquid through August. When Treasuries sneeze the rest of the financial asset markets will have a stroke! And, whatever Presidents and the market would like to believe – the Fed does not yet have a market stability mandate.

Politics

In Europe all eyes are on Germany – who will lead Germany, and by default set the tone for Europe.

Meanwhile, todays markets mean Democrats face a difficult 2022 mid-term election cycle. The Fed Taper will be underway roiling markets, rising interest rates will be starting to impact Zombie debt-bombed companies and reversing declining unemployment numbers, plus all the negativity surrounding the Skedaddle from Afghanistan – resulting in even deeper Washington Gridlock, a navel-gazing fractured civil war as the Dems try to pick a Biden successor to fight Trump or his anointed heir.. Messy and the Chinese will be laughing.

And meantime… a burst in housing market as rates rise, and massive pension and saving disillusionment among voters could be in the offing. Apparently the percentage of US household assets currently invested in the stock markets is at a record high.

Never forget Blain Mantra No 1: “The Market has but one objective – to inflict the maximum amount of pain on the maximum number of participants.”

Well… I made it half-way through my list of topics this morning. I might get on to the ESG backlash tomorrow…. (There won’t be a Porridge on Thursday/Friday due to a family bereavement.)

Five Things to Read This Morning

Torygraph – Dire delays and staff shortages hold back economic recovery

WSJ – Fed Chairman Powell Navigates the Inflation Debate

FT – El Erian: Why Jay Powell should be bold at Jackson Hole

FT – Scientists warn of increased frequency of extreme weather events

Bloomberg – Mervyn King: Central Banks are Risking Their Independence

Out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital