Charts of the Month - February '21
Low rates are Not Inflationary, Commercial Bank Credit, Historical Inflation Subcomponents, Bridgewater’s Outlook, Steepening Yield Curve, and the US Debt Forecast
In a recent Real Vision interview, Brent Johnson and Russel Napier discussed their rationales for the coming inflation (or not). In it, Russel makes two very interesting points highlighted below.
Though money is created when money is borrowed (evidenced by the growth in Commercial Bank Credit), which is naturally inflationary, as that money is paid back, the principal portion of the loan is removed from the monetary system and is naturally deflationary, while only the interest portion stays in the system. Therefore, low interest rates are actually long term deflationary, as evidenced by perpetually decreasing interest rates, accompanied by decades of disinflation.
We can see below that in times of crisis (’07 – ’09 and ‘20), Monetary Base expands at a greater rate than Commercial Bank Credit. So the Fed creates a larger base of money, but that base does not make its way to the public (otherwise we would see a commensurate increase in bank credit).
In order to make the banks lend (and thus bring liquidity to the public), the Treasury will need to guarantee the principal of their loans (because Congress likely cannot force them to lend) as financial institutions are unwilling to take on credit default risk. This would be a similar loan structure to the PPP, where defaults are backstopped by the Treasury.
If you haven’t noticed by now, we’ve been trying to peel back the layers of the CPI prints to really understand where there is meaningful inflation, and what has been holding this aggregate down.
In this week's view, we see what technology, typically understood as a deflationary phenomenon, has done to consumer goods and services over time. One look at this chart and it appears tech R&D has driven deflation for leisure, but inflation for living.
From Bridgewater’s 2021 Global Outlook:
“As unusual as the pandemic has been, and as novel as the policy responses have been, their effects can be understood by way of how they pass through an economy’s sources and uses of funds. For any entity, its sources of funds must equal its uses of funds, and for an economy these sources of funds take the form [of the chart below].
The net of where we are today is that globally there has been more than enough money and credit produced to offset incomes lost, producing a net surplus of income in relation to spending. That excess is now sitting in cash earning near-zero nominal yields and negative real yields, looking for places to go. What happens with it will be an important influence on the near future.
In this environment, we’d expect to see the devaluation of cash relative to well-diversified portfolios of assets. And with respect to the economy in the near term, as the influence of the virus fades there will likely be some release of pent-up demand, particularly in those forms of spending that have been most impacted.”
Since our latest Markets Update, the boogeyman that keeps J. Powell up at night has become more real by the day. This past Tuesday saw markets react to higher rates, with major tech companies losing some ground only to rapidly bounce back after Powell reaffirmed his commitment to easy monetary policies in his testimony to the Senate Banking Committee.
We point out that if this trend continues, you should expect your entire Twitter feed to be stocked with overnight Yield Curve Control experts prophesizing on the imminent shattering of the global monetary construct by way of US Government Debt defaults and probably frogs raining from the sky.
We prefer to highlight that we’re still below 2019 levels, and even if we go past that, we don’t think that Armageddonsim will do us any favor. Keep you cool, life’s good.
In Episode 14 of The End Game (Grant Williams and Bill Fleckenstein podcast), Grant and Fleck interview Paul Singer, and amongst many insights made, he highlights an obvious (in retrospect) point about how we deal with all this debt:
Fleck asks: “How crucial is psychology in terms of psychology changing at the start of the process?”
Paul responds with this genius/comical diatribe:
“It’s the ballgame. It’s the whole ball of wax. Let me answer it by reference to one of the key tenets of central bank policy and practitioners thinking about central bank policy. Because the arithmetic is compelling, the combination of actual debt plus entitlements in the developed world…are unpayable. They’re absolutely unpayable. The arithmetic is clear. And when I say unpayable, I’m not talking about the nominal currency, I’m talking about purchasing power. You will not get, in your Social Security, Medicare, Medicaid and the government bonds, the value that you put in plus a rate of return on that value. Okay. That’s easy.
So what practitioners and economists say is, “Well, there’s a variety of ways to deal with this. One is de¬fault. Great. The other is inflating your way out of it. The reason the statement, “We can inflate our way out of it is preposterous,” is exactly what your question was. It’s investor psychology. Investors lose confidence in central bankers, and some combination of the dollar, bonds, and the ability to control inflation. You can paint pictures, you can imagine scenarios, and they’re not trivial scenarios. If that happens, they will front-run or attempt to front-run inflation.
How do you do that? You do that by selling down the bonds. What is the Fed going to do, own all the bonds? The way the central bankers have gotten away with this for 13 years is Mario Draghi will do whatever it takes. Well, you stand up there, and you’re fierce enough and you beat your chest, and you look strong enough and you start growling. People say, “Wow, they’ll do whatever it takes.” So you don’t have to do anything. If people actually lose confidence in money, I think it’s going to be an interesting fight. Let’s call it a fair fight between investors trying to get out, and governments, at least at the begin¬ning, helping them to get out by holding up the prices.”