Questions on Inflation and Debt Answered

Why is inflation “low”?

   1.  Velocity of money has not increased.  

         Why?  Because the Central Bank is filling the bath tub with money but Commercial Banks are pulling the plug on the bath by not increasing lending nearly as much.

          This has been the case not only in the U.S. but in Japan since the 1990s.

          Japanese debt/GDP is > 250%.  U.S. debt/GDP > 100%.

How can inflation be created?  Why?

   1.  If the government controls both the Central Bank and the Banking System, it can create as much inflation as society will accept.  Governments may want inflation to reduce debt/GDP rather than default on debt.

        Examples:  France and the UK after WWII – France through the banks/central bank had high inflation from 1944 to the 1950s, the UK did it slowly, from 1945 to the early 1980s.  

Each country’s debt to GDP went well below 100%, France quickly, the UK slowly.

The U.S. different.  Why does the U.S. not have as much inflation as other countries?

   1.  The U.S. dollar is the world’s reserve currency– other countries want to hold U.S. dollars, so the dollar has not gone down, but up.  If the dollar goes down, U.S.  inflation will increase.

   2.  Most U.S. trade is with itself, in very key areas– energy (oil, nat gas), so price moves up for these do not impact the U.S. as much as other countries.  

Look at Turkey for contrast: (1) weak currency others do not want to hold, (2) large energy importer.  Turkey has historically had high inflation rates and high debt levels. The UK in the 1970s also had these issues.

What is the downside of money printing?

   1. Without controlling where money goes, the easiest place for it to go is into financial assets.

       This pushes financial assets higher, so those with financial assets benefit.

       So, ultimately, unequal distribution of wealth results.  (see charts below)

   2. Politization of credit: 

        Who is worthy of getting govt money/loans – carmakers or speculators?

        Who controls money/credit flows?  Who decides?

        Do citizens want this level government control?

   3. The public may not realize their purchasing power is being eroded or know why (food costs, services (college, healthcare) have rates of inflation much higher than goods)

Why are no ‘credible’ economists talking about this?

   1. Some are, though the govt and banks have incentives not to (see below)

   2. Credible economists are saying there will be inflation, just not immediately.

         It takes time for money to flow / demand & supply to balance (years)

   3. David Rosenberg:  independent economist, does not manage money, provides research. 

https://www.rosenbergresearch.com

https://twitter.com/EconguyRosie

https://ttmygh.com/hmmminars/  Interview – inflation mentioned at 29.38 and 50.13  

“At some point we will get ‘cost-push inflation…demand will at some point stabilize, people do not realize if you have a 3-5 year view…inflation will come back…inflation hit 5% in the late 1930s”

“Most of the world is services, initial impact is a decline in demand, deflationary outcome for now, maybe for a year, but at some point it stabilizes”

“Supply curve will become inelastic – weaker productivity, more regulation, higher costs (inventory, local supply chains)…stagflation”

“Companies will have higher cost structure (airlines, restaurants, movie theaters – less capacity)”

   4. Russell Napier:

   Publisher of a global macro report, founded a course and finance at the Edinburgh Business school, called a Practical History of Financial Markets, founder of "The Library of Mistakes"

https://www.financialsense.com/contributors/russell-napier

https://podcasts.apple.com/gb/podcast/98-russell-napier-gold-the-euro-and-capital-controls/id1301360737?i=1000474983530

Govts & Banks have incentives for inflation in financial assets yet still have other inflation “appear” to be low:

   1. Government has incentives to:

       Sell more debt / keep interest rates low –- govt pays less interest (>20% of budget) 

       Increase financial market values –- more tax revenue from inflationary gains

       Keep inflation stats low –- lower social security payments

   2.  Banks have incentives:

        For financial markets to increase

        Make money on government debt sales

It is a career-limiting move to speak against the consensus at the Federal Reserve, academia & private industry!!

Wealth inequality by generation is surprising:

"We never quite achieved the catharsis necessary to stoke a deep re-evaluation of our wants, needs and fears"

While it is preferable to read rather than see Mr. Burry's presentations, he makes some very compelling points at the end....

From 19:00 onwards the speech is most coherent and at times compelling.  I definitely have not agreed with many things Dr. Burry has said in the past. Also, what he says here I also do not want to believe, however, his observations have credence, and he makes the case that individuals and families should seek to take action for another fat tail event.  

Watch from 19:00 onwards:

Dr. Burry's Vanderbilt Speech

What do investing teams think about possible outcomes here?  Are they sensitive to this tail risk, or do they write it off as many did before 2008 (what to they think about junk bonds at all time highs)?

Some interesting quotes:

"We never quite achieved the catharsis necessary to stoke a deep re-evaluation of our wants, needs and fears; importantly the toxic twins: fiat currency and activist Fed, remain firmly entrenched, even more-so with the financial reforms last year. In fact, the Federal Reserve, having acquired new powers of regulation, has insisted specifically that nothing in the field of economics or finance was of any help in predicting the crisis...it guarantees that we will make the same mistake again and again"

"Arguments on blooming economic recovery must be considered alongside the fact that all this debt and all the money being printed is very much a real bill, a real tax on our future:  it is debtors' prison for our children, it has not yet come true today except for savers and those on a fixed income."

Advice for the Vanderbilt students:

"There is nothing wrong with breaking with the social norm to ensure good outcomes....It is not a time for a responsible individual to tolerate any level of blind faith toward any man or woman.  It is absolutely not a time to follow."

IMF Draft Rules Endorse Capital Controls as Last Resort

For now, capital controls are being contemplated by those countries with strong currencies and large capital inflows to keep money from flowing into these countries/currencies (Brazil, etc...).

Should the U.S. fiscal position not be dealt with, when will capital controls be considered for the U.S., KEEP MONEY FROM LEAVING?

Watch this closely, this is not a positive development at all.

From Bloomberg News:

IMF Draft Rules Endorse Capital Controls as Last Resort

Nations should be able to use capital controls as a last resort to manage inflows of money that threaten their financial stability, according to draft guidelines discussed last week by the board of the International Monetary Fund.

Such controls should be applied only after countries strengthen their banking systems and adopt economic measures such as building up reserves, tightening fiscal policies and lowering central bank interest rates, according to the draft guidelines, obtained by Bloomberg News.

“In the past, capital controls were not in our toolkit,” IMF Managing Director Dominique Strauss-Kahn said separately in a statement posted on the fund’s website. “Today, we see them more as part of the toolkit, although only in specific circumstances and not, of course, as a substitute for good macroeconomic policies.”

More here...  

IMF Draft Rules Endorse Capital Controls as Last Resort

Berkshire Wrote Down U.S. Bancorp, Swiss Re After SEC Query

I am still not sure how Berkshire can only partially mark its equity portfolio to market....


While it is certainly encouraging that they are marking some positions to market, it seems that they are resisting markdowns on Wells Fargo and Kraft (surprising that they would not mark down Kraft in particular because high food prices will ultimately reduce margins or lead to increased product prices and resultant switching away from their name brands....as for Wells Fargo, if anyone can really analyze any of the major banks, please let me know!)


From the Bloomberg article:   “As a result of our discussions, we recognize that the staff” of the SEC believes that impairments on the investments may be required according to generally accepted accounting principles, Berkshire Chief Financial Officer Marc Hamburg wrote. 

Not a particularly strong endorsement of the GAAP which companies other than Berkshire are required to follow....


From Bloomberg news...
Berkshire Wrote Down U.S. Bankcorp, Swiss Re After SEC Query


    (Updates with Berkshire refusing to write down Wells Fargo, Kraft in the fourth paragraph.)

By Andrew Frye
    March 28 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc. wrote down the value of holdings in U.S.  ancorp, Sanofi- Aventis SA and Swiss Reinsurance Co. after a query from the Securities and Exchange Commission over valuations.
    The adjustments to the equity stakes were made to Berkshire’s fourth-quarter results in its annual Form 10-K
report, according to a Feb. 4 letter from Omaha, Nebraska-based Berkshire to the regulator. The letter was filed today on the SEC’s website.
    “As a result of our discussions, we recognize that the staff” of the SEC believes that impairments on the investments may be required according to generally accepted accounting principles, Berkshire Chief Financial Officer Marc Hamburg wrote.
    Berkshire, which held $61.5 billion of equities as of Dec. 31, was asked by the SEC in January for more information about stockholdings that traded below the prices paid by the company. The firm recorded equity impairments of $938 million in the fourth quarter. Berkshire told the SEC that it wasn’t writing down its holdings of Kraft Foods Inc. and Wells Fargo & Co. because it expects the stocks recover.


continued here...
Berkshire Wrote Down U.S. Bankcorp, Swiss Re After SEC Query

The SPX and the SPX vs Gold

The SPX vs USD does not look like it has had a bad run, particularly over the past year....in fact, it may perhaps have a bounce (though I believe that it will retest 1265 at some point this year).

However, when you look at the SPX vs Gold, a very different picture, and far less bullish picture, emerges....will SPX vs Gold push above the 200 day moving average?

I am much less sure of this but also would expect some pullback in gold as well this year, particularly if the Fed were to indicate any normalization of interest rates, making gold, at least at the margin, a little bit more expensive to hold...however, as long as real rates are less than zero I would not bet on a large pullback, just enough to squeeze out some who have been late to the party...

Some confirmation of what you may be hearing on the elevator or train...

Every so often you hear something strange on the elevator or train which, although completely anecdotal, may subtly or not so subtly influence your investment decisions, at least until you can gather facts and examine the situation somewhat objectively....


Examples for me have included:


1. The 'Pets.com' sock puppet coming back years later as the mascot for the '1-800-bar-none' sub-prime lender.
(this may have been a once in a lifetime event - recall that Pets.com paid millions for a superbowl add with this mascot and then went bust; only to have the same mascot resurrected years later for a sub-prime lender at the top of the subprime wave}


2. Very large multi-strategy hedge fund controller prior to 2008 bragging to a friend about how all their fund had to do is stay in business several years and they would all be rich....


3. Recently, a junior employee of an investment firm's long-only high yield bond investment team, speaking with a more seasoned manager at a different firm:  "nothing is cheap anymore, covenants are light, but we don't care because we are supposed to buy and we will continue to buy because interest rates are zero, investors are begging for yield and if we don't buy these things, somebody else will."


From the article below, at least somebody at the Fed seems to agree, which is a good thing.  To the extent that the monetary spigots are turned down a bit, however, it would seem that investors in monetary assets will have to deal with whatever hangover as this latest binge of credit easing is pulled back....


Is it time to take a vacation and simply allocate to short term instruments in various currencies until the latest binge is over?



From Bloomberg news...
Fed's Fisher Sees 'Extraordinary Speculative Activity' in U.S.l
By Caroline Salas and Rainer Buergin
 Federal Reserve Bank of Dallas President Richard W. Fisher said he sees “extraordinary speculative activity” in the U.S. after the central bank pumped record amounts of stimulus into the economy.

“There is an enormous amount of liquidity sloshing around,” the regional bank chief, who votes on monetary policy this year, said in a speech today in Berlin. “There is abundant liquidity in the machine we know as the United States economy.”

The Fed will likely complete its planned $600 billion of Treasury purchases in June, Fisher said, reiterating his view that no further monetary stimulus will be needed after that. The 62-year-old bank president has criticized the plan, which policy makers voted to keep in place after their March 15 meeting in Washington.

“The word that we gave was that the program would end in June,” Fisher said in a Bloomberg Television interview. “That’s what I expect to happen. And the markets have in my opinion adequately discounted that.”

Fisher repeated remarks he made yesterday in Frankfurt that he’s seeing signs of excess evidenced in the surge of so-called covenant-lite loans and the return of payouts by private equity firms.

“We have done our job,” Fisher said at a forum hosted by the American Academy in Berlin. “We are certainly at risk of doing too much now.”

‘Self-Sustaining’

The U.S. economic recovery is “self-sustaining” and will withstand turmoil overseas, Fisher said in the Bloomberg Television interview. The earthquake in Japan may impact the U.S. economythrough some “price and supply chain effects short term,” and the “wars in North Africa” won’t have a “long- term impact on the nature of monetary policy,” Fisher said.

“These can of course pinch a nerve or they can give you a bit of a shiver,” Fisher said. “I don’t think they’re going to derail what’s happening in terms of the economic growth occurring in the U.S. or here in Europe.”

"Breaking up is hard to do Commentary: Fed’s love affair with easy money must end"

Another argument against QE2....

Fed's Love Affair With Easy Money Must End

By Irwin Kellner, MarketWatch

PORT WASHINGTON, N.Y. (MarketWatch) — The Federal Reserve’s love affair with easy money must end — the sooner the better.

In the face of overwhelming evidence that inflation has become a clear and present danger, the central bank continues to insist that easy money and low interest rates are de rigueur for today’s economy.

Its rationale is simple: The economy is still struggling, unemployment remains high, and the markets are reeling from a series of global shocks — the latest being Japan’s earthquake, tsunami and nuclear crisis.

If prices were stable, there would be no question that the Fed is on the right course. But prices are not stable: From basic commodities to wholesale right up to retail, prices are jumping.

As a former governor of New York used to say, let’s look at the record.

The Economist magazine’s weekly tabulation shows raw-materials prices are 35% higher than last year at this time, with non-food agricultural products soaring a whopping 76%.

Wholesale prices have risen at a 13% annual rate since November alone. Not surprisingly, the Institute for Supply Management’s measure of prices that companies pay for goods used in the manufacturing process stood at 82 last month — a sign that price pressures are common and severe.

At the retail level, consumer prices have jumped at a 5-1/4% clip over the past three months, after inching up at a more moderate 2% pace in the previous three. This has led many people to conclude that higher inflation is here to stay. Consumers polled by the University of Michigan expect prices to rise 4.6% over the next year.

The markets sniff inflation. The Treasury-TIPS spread is at a multi-year high. ( See last week’s column.) The yield curve is steep, gold is close to a record high, while the dollar has fallen in world financial markets.

Besides today’s inflation numbers, the markets are also looking at the effects of monetary ease.

The Federal Reserve Bank of St. Louis reports that the central bank’s monetary base has soared by a 54% annual rate since early November, an 83% clip since mid-December — and a thumping 152% pace over the last two months!

Adjusted reserves have climbed at an astounding 342% annual rate since mid-January, while both the money supply M2, and the St. Louis Fed’s measure of liquid money, MZM, are both up by a rate of more than 5% over the past 10 months.

Yet the Fed’s mantra seems to be “don’t worry, be happy.” Said Fed chief Ben Bernanke recently, “the most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation.”

But any increase in prices is bad news for those whose incomes are not rising commensurately — meaning most of us. Once they are up, prices rarely come down. As I pointed out in my column of Jan. 18, during the past decade the dollar has lost 20% of its buying power; since 1990 the overall loss is nearly 30%!

Central bankers would be aware of this if they shopped regularly like the rest of us, instead of sitting in their ivory towers looking at their iPads.