Fed can't keep the rates low

[Gregmal]

You're welcome.

March_Investor_Presentation_FINAL_2021.03.01.pdf

[LearningMachine]

I've been thinking about this scenario for years.  Oil stocks were good to buy during the dip.  They did well in 1970s too.

 

With timber, it is hard to predict for me because ownership is too fragmented.  There doesn't seem to be possibility of something like OPEC consolidating pricing power and we likely haven't reached higher cost timber areas which can provide a bottom for the price.  I'm thinking the numerous competing owners will likely resolve the supply side issues with timber.  However, it is possible it could trigger higher inflation expectations during the early bottlenecks and the price ends up sticking somewhat.  Hard to say with certainty though.

 

Wonder what else could be the cause when looking back this time, maybe somethings where the higher price is set by single or few collaborative owners, similar to oil in 1970s? 

 

The scarce licensed spectrum might be a possibility as ownership is consolidated in three owners, and all three seem to be collaboratively signaling margin expansion.  However, I think they will have to wait for the minimum wage increases to kick in before getting a fair share of those newly increased wages.

[Dalal.Holdings]

In short - they both (Burry, Alden) don't know what they are talking about.  Alden, in particular is constantly misinterpreting the data and in 2019 thought Fed liquidity was inflating the stock market (now she says the Fed's reserves go nowhere, LOL)

 

Gold and Treasury bond yields are heading down.  I've explained why in other posts as well as this thread.  The dollar will strengthen.  There is no inflation - people always assume that a strengthening economy will cause inflation - and it never does.

 

wabuffo

 

 

I think Burry, et al. are overdoing it with the Weimar talk, but putting aside "hyperinflation" how can we be so sure there will be no inflation of significance?

 

Here is one historical parallel I keep thinking about:

 

Looking at other periods--for example, the 1940s:

The 1930s has deflation/low inflation due to long shadow of Great Depression

The 1940s had high inflation due to WW2/massive fiscal spend

 

And now:

The 2010s had deflation/low inflation due to long shadow of GFC

2020-2021 massive fiscal spend due to Covid pandemic, so... ?

[LearningMachine]

thank wabuffo, we are on the same page that the Fed is more than just a Recorder.  I had added more functions beyond Recording with the analogy

 

This short paper might help - its a good overview of modern central bank operations.  It was written before the Fed significantly expanded its balance sheet but the principles still hold.  I think you will find it informative even if you just scan the ten principles only.

 

https://core.ac.uk/download/pdf/207650683.pdf

 

wabuffo

 

Thanks wabuffo for the link.  I understand your perspective is that the money that is tied up in Fed reserves cannot be used for making loans.  However, banks can still use the portion of increased money supply that is held up in reserves to enable transactions valued at higher prices, right?

 

I'd also like to get re-confirmation of your perspective on my question earlier:

Is my understanding correct that your perspective is that we don't need to worry about inflation because "reserves circulate in the Federal Reserve accounts but never leave the Federal Reserve"?

[wabuffo]

However, banks can still use the portion of increased money supply that is held up in reserves to enable transactions valued at higher prices, right?

 

Reserves haven't been a factor in lending for a century or so.  Its bank regulatory capital (and the profitability of the loans) that is the constraint.  Mandatory reserve requirements were temporarily suspended as a response to the pandemic - so they literally are no longer a constraint.

 

we don't need to worry about inflation because "reserves circulate in the Federal Reserve accounts but never leave the Federal Reserve"?

 

I wouldn't agree with such a direct correlation between inflation and reserves.  What I would say is that we are learning, through trial and error, that the fiscal capacity of the federal government spending as a sovereign currency issuer without causing inflation is much larger than anyone previously thought.

 

wabuffo

 

 

[Dalal.Holdings]

Wabuffo, your take on today's reserve currency status vs historical pegging to gold is interesting. Quite a bit to chew on. The post is gone?

[LearningMachine]

Reserves haven't been a factor in lending for a century or so.  Its bank regulatory capital (and the profitability of the loans) that is the constraint.  Mandatory reserve requirements were temporarily suspended as a response to the pandemic - so they literally are no longer a constraint.

Thanks wabuffo, that is my understanding as well, and I've been following CET1 and other capital requirements closely.  I had brought up the issue about reserves to counter your earlier arguments about "reserves circulate in the Federal Reserve accounts but never leave the Federal Reserve" but looks like we are now more on the same page than I thought.

 

we don't need to worry about inflation because "reserves circulate in the Federal Reserve accounts but never leave the Federal Reserve"?

I wouldn't agree with such a direct correlation between inflation and reserves.  What I would say is that we are learning, through trial and error, that the fiscal capacity of the federal government spending as a sovereign currency issuer without causing inflation is much larger than anyone previously thought.

Thanks wabuffo for clarifying your position.  We are now more on the same page.  Earlier, I had thought that you were making that correlation because your tone sounded very certain to me when in response to inflation thread, you said "reserves circulate in the Federal Reserve accounts but never leave the Federal Reserve".

 

Great exchange to understand each other deeper and realizing we are more on the same page than I had thought earlier.

 

[wabuffo]

Wabuffo, your take on today's reserve currency status vs historical pegging to gold is interesting. Quite a bit to chew on. The post is gone?

 

sorry about that - I was worried that I was going down a rabbit hole so I took it down to rework it.  I'm reposting it below.

 

how can we be so sure there will be no inflation of significance?

 

We can never be sure. 

 

One thing I wanted to point out though is that prior to 1971, the US Federal government was in effect spending and borrowing in a "foreign currency".  Of course, foreign currency here means gold since the US dollar was pegged to a fixed gold price.  One cause of inflation is when a sovereign borrower can no longer borrow in a foreign currency at the old peg and must default and devalue its sovereign currency at a new, lower, peg value.  When the default/devaluation happens, inflation is the result as buyers/sellers and borrowers/creditors readjust and reset terms of trade of their contracts over time.

 

Your reference to the 1930s/1940s and 1970s both reflect this - in 1933, the US, under Roosevelt, reset the gold price to $35/oz from $20.67/oz and in 1971 Nixon ended altogether the US dollar's fix to the gold price.  There was follow-on inflation in both periods for over a decade after the devaluation/default.  There have also been other periods in the US history where the peg was temporarily suspended and then re-established (eg Civil War).  By pegging US currency/obligations to gold, US monetary policy pre-1971, was like that of Hong Kong or Greece or even Illinois since none of these governments control their own currency.

 

Since 1971, we are slowly finding out, through trial and error, that the fiscal capacity of the United States is much larger than anyone ever thought since we are a sovereign issuer of our currency (which also happens to be the reserve currency).  So I think comparisons are difficult between today and pre-1971.  I would even say they are difficult pre-GFC and post-GFC because of vastly different Fed monetary regimes in place since the GFC.

 

wabuffo

[LearningMachine]

Wabuffo, your take on today's reserve currency status vs historical pegging to gold is interesting. Quite a bit to chew on. The post is gone?

 

sorry about that - I was worried that I was going down a rabbit hole so I took it down to rework it.  I'm reposting it below.

 

how can we be so sure there will be no inflation of significance?

 

We can never be sure. 

 

One thing I wanted to point out though is that prior to 1971, the US Federal government was in effect spending and borrowing in a "foreign currency".  Of course, foreign currency here means gold since the US dollar was pegged to a fixed gold price.  One cause of inflation is when a sovereign borrower can no longer borrow in a foreign currency at the old peg and must default and devalue its sovereign currency at a new, lower, peg value.  When the default/devaluation happens, inflation is the result as buyers/sellers and borrowers/creditors readjust and reset terms of trade of their contracts over time.

 

Your reference to the 1930s/1940s and 1970s both reflect this - in 1933, the US, under Roosevelt, reset the gold price to $35/oz from $20.67/oz and in 1971 Nixon ended altogether the US dollar's fix to the gold price.  There was follow-on inflation in both periods for over a decade after the devaluation/default.  There have also been other periods in the US history where the peg was temporarily suspended and then re-established (eg Civil War).  By pegging US currency/obligations to gold, US monetary policy pre-1971, was like that of Hong Kong or Greece or even Illinois since none of these governments control their own currency.

 

Since 1971, we are slowly finding out, through trial and error, that the fiscal capacity of the United States is much larger than anyone ever thought since we are a sovereign issuer of our currency (which also happens to be the reserve currency).  So I think comparisons are difficult between today and pre-1971.  I would even say they are difficult pre-GFC and post-GFC because of vastly different Fed monetary regimes in place since the GFC.

 

wabuffo

 

Thanks wabuffo, that is a great point that changing of the peg itself can trigger inflation.

 

Playing devil's advocate, not having a peg at all could also mean there is no limit to how much you can devalue the currency, creating potential of ushering in even more inflation, and entering a viscous cycle that causes people to question even more their faith in the currency, in turn causing more inflation, in turn causing more loss in faith.  It might not happen, but probability is non-zero, and we cannot ignore the probability of it happening to some small extent.

[Dalal.Holdings]

Since 1971, we are slowly finding out, through trial and error, that the fiscal capacity of the United States is much larger than anyone ever thought since we are a sovereign issuer of our currency (which also happens to be the reserve currency).  So I think comparisons are difficult between today and pre-1971.  I would even say they are difficult pre-GFC and post-GFC because of vastly different Fed monetary regimes in place since the GFC.

 

Still chewing on this... The fear in this scenario is that as U.S. politicians grow accustomed to lack of limits ("through trial and error"), eventually they push it too far which threatens the reserve currency status...maybe we are far from that point, but surely there is a limit.

[TwoCitiesCapital]

Since 1971, we are slowly finding out, through trial and error, that the fiscal capacity of the United States is much larger than anyone ever thought since we are a sovereign issuer of our currency (which also happens to be the reserve currency).  So I think comparisons are difficult between today and pre-1971.  I would even say they are difficult pre-GFC and post-GFC because of vastly different Fed monetary regimes in place since the GFC.

 

Still chewing on this... The fear in this scenario is that as U.S. politicians grow accustomed to lack of limits ("through trial and error"), eventually they push it too far which threatens the reserve currency status...maybe we are far from that point, but surely there is a limit.

 

I'd argue the reserve status is already threatened. You already have large countries like China trading in yuan/rubles with Russia to buy oil/gas.

 

The weaponization of the U.S. dollar is not just a burden for the handful of countries we target - it's also a burden for all of our allies to have to rework their entire financial systems to comply with our restrictions. Consider how frustrating it must be to be Germany right now with the US sanctioning Russia to prevent the Nordstream pipeline that Germany wants. But Germany also has to force its financial system to comply with the USD sanctions to prevent money from flowing to the construction of the very pipeline that it wants to be built.

 

At some point, our allies will grow weary of effectuating U.S. foreign policy via the weaponization of the USD, the countries targeted by sanctions will find willing market participants to trade in a currency other than the USD (like Russia and China currently do), and the U.S. status as reserve currency gets eroded by slowly reducing it's required involvement in global trade.

 

We're witnessing this slow erosion happen as we speak.

[Spekulatius]

At some point it is inevitable that China‘s Yuan becomes a reserve currency. The Chinese don’t want this yet and that’s  why they essentially have pegged their currency to the USD. about think about this, if the their Economy become larger and larger and exceeds the US economy, it really can’t be avoided due to sheer amount of economic activity in Yuan and trade.

 

The reason the Chinese government doesn’t want it is yet is that it will cause dislocations in their economy and probably a higher exchange rate and loss of control.

 

As far as inflation is concerned it seems that the price action in gold indicates that it is going to be short lived. Gold is weak on days when interest rates go up for example. There is no speculative run towards gold as this money goes into crypto etc it seems.

 

 

As far as QE and reserves are concerned, I don’t think any of this matters really. What matters however is spending and that spending is going up financed by federal deficits. At some point we will see the limits of what can be done without penalties, but it does not seem we are there yet.

 

As for now, you got to dance as long as the music is playing.

[spartansaver]

Since 1971, we are slowly finding out, through trial and error, that the fiscal capacity of the United States is much larger than anyone ever thought since we are a sovereign issuer of our currency (which also happens to be the reserve currency).  So I think comparisons are difficult between today and pre-1971.  I would even say they are difficult pre-GFC and post-GFC because of vastly different Fed monetary regimes in place since the GFC.

 

Still chewing on this... The fear in this scenario is that as U.S. politicians grow accustomed to lack of limits ("through trial and error"), eventually they push it too far which threatens the reserve currency status...maybe we are far from that point, but surely there is a limit.

 

I'm not sure 50 years is a long enough time period on a macroeconomic level to draw too many conclusions about a single piece of the macro framework. Fiscal policy does not exist in a vacuum. An infinite number of macroeconomic combinations have played out over the past 50 years that contributed to our current situation. I'm a poor historian, so perhaps there are some cases in history where this lasted for several hundred years instead of 50, then touche.

[Dalal.Holdings]

I'm not sure why we are trying to read the price of gold as a predictor of inflation. Clearly the equity and bond markets are not foreseeing much inflation, so why should we expect gold investors to? Does the efficient market hypothesis apply to gold? Are gold investors somehow accurate predictors of the future?

 

My thoughts are that all markets may be mis-pricing the risk of inflation/rate uptick (that includes gold), so there is no asset out there that would provide insight on that. Also, as I pointed out, rates merely need to rise to 3-4% to cause big problems for equities. You don't need hyperinflation to cause problems for equities, just moderate inflation. Gold might not even move much if that happens because inflation could be 5% in that scenario.

 

As far as reserve currency, the U.S. has a lot of goodwill and many nations benefit from its hegemony. I think an alternative rising in the next decades is unlikely unless the U.S. abuses its position significantly beyond current levels. There are major political barriers that prevent the others from being accepted as a reserve.

 

And clearly if you look here, it's not just the U.S. that is engaging in this grand experiment, so why would the Euro or Yuan be preferred here when they are behaving just like the Fed:

 

https://www.yardeni.com/pub/peacockfedecbassets.pdf

[wabuffo]

I'd argue the reserve status is already threatened. You already have large countries like China trading in yuan/rubles with Russia to buy oil/gas.

 

At some point it is inevitable that China‘s Yuan becomes a reserve currency.

 

I think this is almost an impossibility - not quite, but almost.  That's because of three important factors that must be in place to replace not just the US dollar but also the US rules-based global trading system that the USD supports.  Its not just about setting up a tiny oil market in one corner of the world that doesn't use the USD in its trades.

 

First, for the rest of the world to use and save a portion of its wealth in your new reserve currency, your country must run an extremely large trade deficit with every large country.  No country other than the US wants to do that - not China, not Japan, not Russia (too small an economy anyway), not Euro-land.  They all want to be net exporters - not net importers.

 

Second, you must have the pre-eminent military to peacefully (or not) enforce the global trading system.  China doesn't even have a blue water navy, just a coastal defense force.  Only the US (and Japan's SDF) have true deep water navies.  The US maintains the world's ocean-ways free from harassment so that every country does not have to worry about its ability to trade around the world and get whatever resources it needs. Who can even replace the US doing this?  Who even wants to bear the cost of this?

 

Finally, there's geography.  Which country enjoys both the greatest protection and the greatest benefit from where it is situated geographically?  Which ones are the most weakened by their geography.  I think that answer is pretty obvious.

 

Sure, countries gripe and complain about the US "hegemony" especially when they don't like the US throwing its weight around enforcing its system, but let's face it they have all benefited - Germany, France, Japan, even China have all gained the most -- but also have the most to lose from a decline in the US global rules-based system, if it were to happen.  And that's because none of them could replace it. 

 

Its not perfect, but I would hate to see what a world without the US dollar as a reserve currency would look like.

 

wabuffo

[wabuffo]

As far as QE and reserves are concerned, I don’t think any of this matters really. What matters however is spending and that spending is going up financed by federal deficits. At some point we will see the limits of what can be done without penalties, but it does not seem we are there yet.

 

I agree - just because it turns out we have much more fiscal capacity than we previously thought, doesn't mean we might not push the monetary engine past its red-line.

 

The thing that worries me is that all the MMTers say "don't worry - the deficits will be reigned in if we see inflation".  First, I think inflation builds very slowly but breaks out very suddenly such that by the time the Fed and the US Treasury react, it will be too late.  Second, the MMT response to inflation seems to be "if inflation, then raise taxes on the rich".  That's why you are starting to see discussions about very high tax rates and even wealth taxes.  This is almost the opposite of "supply-side economics" of the 1980s where marginal tax rate cuts grow the economy but spread the wealth unevenly. MMTers want to tax at high rates and even tax wealth in order to send stimulus checks directly to everyone below a certain income in order to stimulate the economy.  They are very excited about what they saw in 2020.

 

Taxing at high marginal rates and taxing wealth is the way to turn inflation into hyperinflation, IMHO.  They don't call it the misery index for nothing.

 

wabuffo

[wabuffo]

In addition to all the worries about too much stimulus spending stoking inflation, I think there are some interesting things happening in Fed and US Treasury policy over the next four and a half months that one should really keep an eye on.  Warning – this is a technical discussion that goes a bit deep in the weeds of the US monetary system.  The 99% of you who don’t care about this stuff should STOP READING NOW.

 

Ok – here are the basic moving parts:

1) The Federal Reserve is net-buying roughly $100b in US Treasury securities per month and will keep doing that to continue its “accommodative policy”.

2) The US Treasury’s debt ceiling was suspended on August 1, 2019 as part of a budget agreement by Congress.  That debt ceiling toggles back into effect on August 1, 2021.  As part of that budget agreement, the balance in the US Treasury’s General Account at the Fed is supposed to snap back to the level it was on the day in 2019 when the ceiling was lifted.  This rule was to prevent the US Treasury from “running up its balance”.  That TGA to-be balance is $117.6b.  Current balance is ~$1.3t

https://fsapps.fiscal.treasury.gov/dts/files/19080100.pdf

3) As part of its response to the pandemic, the Federal Reserve on April 1, 2020 temporarily excluded US Treasury securities and bank’s deposits at the Fed (reserves) from its calculation of the SLR (Supplementary Leverage Ratio).  The SLR is a measure of bank capital adequacy.  Given that reserves currently make up $3.6t and US Treasury holdings make up another $1t vs total bank assets of $21t, excluding these assets from SLR calculations is a pretty big deal for the banks.  The SLR exemption for reserves and Treasury securities is set to expire at the end of this month.  If it did, bank balance sheets could get squeezed due to the change in their regulatory capital ratios.  Most likely, the big banks would sell all of their US Treasury holdings ($1t) to compensate for the over $1t increase in reserves (which they can't get rid of).

 

Its possibly (and even likely in the case of the SLR exemption) that many of these “rules” and policies could change.  But if they don’t, it sets up for some interesting interactions that could affect liquidity and risk in the US monetary system.  I will assume 1) and 2) are likely not going to change and 3) will get extended.

 

Total US Treasury debt outstanding in the private sector’s hands is $21.816t as at March 10, 2021 (per the US Treasury Daily Statement):

https://fsapps.fiscal.treasury.gov/dts/files/21031000.pdf

 

Since the Federal Reserve can’t buy its Treasury securities directly from the US Treasury (except in certain emergency circumstances in the past), it must buy them from the private sector thereby reducing the amount available (and suppressing supply and yields, in theory).  On March 10, 2021, the Federal Reserve owned $4.891t in Treasury securities per its H.4.1 report:

https://www.federalreserve.gov/releases/h41/current/

 

Thus, the amount of Treasury securities circulating in the private sector’s hands is $16.925t.

 

This becomes important because the US Treasury appears to be starting the process of running down its account balance at the Fed.  Here is the daily numbers for March so far.  Normally, the US Treasury would run with a very small balance.  This balance used to be $5b before the GFC and then grew to over $100b - $400b after the GFC.  But it stands at $1.5t near the beginning of March.

 

 

The US Treasury would fund its $125b in deficit spending from this table with more-or-less $125b of net public debt issuance and keep its TGA balance level at some much lower amount.  But that’s not happening now.  Because it is trying to lower its TGA balance, not only did it carry out $125b in deficit spending but it ALSO REDEEMED a net $106b in Treasury debt.  Keep in mind, that while this was happening the Federal Reserve was also out in the market buying probably $25b in Treasury debt. Thus, US Treasury debt in private sector hands shrank by $131b.

 

Ok - so we don't know what will happen, but what we do know is that the US Treasury must further reduce its account balance at the Fed by $1.15t between now and the end of July.  ($1.268t - 0.118t).  How much deficit spending will the US Treasury undertake over that time frame.  There is a new stimulus bill passed and some of that spending is happening right now (stimulus checks) - but there's a lot of spending in this bill that will happen over time (past the Aug 1st, 2021 date).  In addition, we are coming up to March, April and June which are big tax receipt months for the US Treasury.  April in particular is usually a big surplus month (and I think tax receipts will be surprisingly large this year - think all those people with 2020 capital gains taxes to pay that were not withheld or paid as estimated taxes).  So let's say $600b of deficit spending over this period - and therefore $550b of net further US Treasury debt reduction (redemptions > issuance).

 

Now add the Fed purchases of $100b per month = $450b and we have a potential reduction of $1t in US Treasury debt outstanding based on these assumptions.  That is a ($1t/$16.9t) = 6% reduction a 4.5 month period = 15% annualized run rate.  I think that could be a big deal in such a short time - especially with the economy growing fast (~6% GDP growth rate) over this same time frame.  A growing economy needs more US Treasury securities, not less.  Could this cause a bit of a traffic accident in US monetary policy?

 

It's hard to see yields going higher in this kind of reduction.  Of course, many things could change.  The Fed could stop its buying and co-ordinate with the US Treasury as it is undertaking its TGA reduction.  I would actually recommend this strategy.  Or the Fed could decide to not renew SLR - which cause the big banks to dump their US Treasuries into the market.  (though I actually don't know if this helps since the banks' holdings are part of the total holdings of the US private sector).

 

Other things to think about.  What happens to the banks if their reserves grow to over $5t because of the TGA's reduction?  To be fair, most of this reserve growth will be accompanied by deposit growth from the US Treasury deficit spending (except for you Wells Fargo!  No asset growth for you!).

 

I'm not making any predictions - but if I did, I'd say Treasury yields go lower and the short-end even goes negative, maybe.  Gold continues to go lower til April and then starts back up.  Stocks roar higher through May or early June.

 

After that comes the great whipsaw.  Yields turn suddenly higher, the air fills with talk of tax increases and the back half of the year is a bit of a rough go for stocks.

 

Of course, this forecast is worth what you are paying for it -- because of course I could be wrong.  And regardless, macro shouldn't matter for stock pickers like us anyway  8)

 

wabuffo

[Dalal.Holdings]

 

The thing that worries me is that all the MMTers say "don't worry - the deficits will be reigned in if we see inflation".  First, I think inflation builds very slowly but breaks out very suddenly such that by the time the Fed and the US Treasury react, it will be too late. 

 

This is exactly what concerns me--that inflation will not be something that occurs gradually, but in a highly nonlinear fashion that is "unpredictable", black swan like. A lot of economic phenomena occur like this thanks to lots of interconnectedness and feedback loops existing in our modern system.

 

I say it's better to prepare for it than to ignore the risk due to extreme asset price sensitivity to rates at these levels.

[LearningMachine]

 

The thing that worries me is that all the MMTers say "don't worry - the deficits will be reigned in if we see inflation".  First, I think inflation builds very slowly but breaks out very suddenly such that by the time the Fed and the US Treasury react, it will be too late. 

 

This is exactly what concerns me--that inflation will not be something that occurs gradually, but in a highly nonlinear fashion that is "unpredictable", black swan like. A lot of economic phenomena occur like this thanks to lots of interconnectedness and feedback loops existing in our modern system.

 

I say it's better to prepare for it than to ignore the risk due to extreme asset price sensitivity to rates at these levels.

 

It's good to have a checklist item to consider what would happen to the entity that you're considering if inflation and interest rates both went to 10-15% at the most unfortunate time for the entity anytime during the next 10 years or so and stayed there for a while, e.g. before bond/mortgage renewals.  You end up realizing that a lot of entities would not do well in that scenario.  Only rare ones do.

[Cigarbutt]

^Some aspects about 1-the USD dollar being the supreme currency and fuel for trade deficits and 2-how waiting for something that will take a long time to happen may not be the best strategy.

 

Something which hasn’t been noticed or discussed has to do with a rule issued by the Commerce Department (February 2020) that allows currency manipulation potentially to be considered as a domestic subsidy under U.S. countervailing duty laws. The US, directly as the supplier of the international reserve currency and indirectly by exploring the fiscal room (and financing the consumer to continue to drive the trade deficit) has driven the global ‘recovery’ which most countries (especially developing and aiming for hegemony) desperately needed. If a true (global) downturn happens, domestic interests will dominate and even then the USD as a safe haven is likely to shine (relatively), even in a race to the bottom.

Hopefully the next crisis will not be completely wasted. There are ways to correct the various trade and fiscal imbalances but all are painful. The easier way is to hope for growth to resume at a higher rate than the growth of the imbalances. However, it looks that we have globally entered the slippery part of the curve.  Unfortunately, history shows that, at some point, the most efficient way to correct inequality is to make the rich suffer. The Coolidge prosperity era perhaps contained the seeds of its own destruction or is it only a cyclical thing?

 

This thread is about inflation picking up and many (Fed, Japan, (and many here..) etc) suggest that inflation is on its way and, obviously, it’s a very real risk and the CBO has been recurrently planning for inflation to pick up but I bet that it will be darkest before dawn (because of the massive debt overhang) .

The above is from "forecasts" released in 2020 but the 2021 recent release is similar. Cynics may contend that these guys are lagging indicators which is kind of true but they lag a lot longer than what the crowd is implying now and the career risk for painting a true picture is high so..Those into multi-dimensional models will recognize the typical pattern in (debt) addiction with a declining trend being associated with diminishing returns on renewed enthusiastic episodes.

 

When comparing to what happened after WW2, sure, total debt was quite high compared to economic potential but private debt was low and there was significant growth potential …ahead. When comparing to the 70s, the same relatively-low-private-debt-some-growth-potential also applied. Since Bretton Woods, things have slowly been going downhill. Just like the Dutch Disease for exporting countries or the silver windfall from Spanish conquests, the USD currency privilege is a curse in disguise. Of course, this has been ‘known’ for a while. But this too shall pass. An interesting aspect is the concern with creeping taxation without adequate restraints which is exactly my concern with rising debt levels. But of course, the two ‘issues’ are joined at the hip.

The above was released in 2011 so it's not as if the recent trends should come as a surprise, viral or otherwise.

 

The bankruptcy-related gradual-and-then-sudden theme is interesting for inflation but the misery index that’s been associated with the 70s had roots going deep in the 60s, way before and inflation numbers had been creeping up for years.

 

Also, in the 70s, the labor force was consistently growing above 2.0% and this growth is firmly below 1% now (and decreasing, likely going negative in this decade).

 

In a contrarian way, the deflation risk remains the most significant in this ‘reflation’ environment.

 

[John Hjorth]

...The 99% of you who don’t care about this stuff should STOP READING NOW...

 

wabuffo,

 

This is not a nice line of posting, viewed from a fellow CoBF member perspective. Appreciated anyway for my part - in these weird times - personally, I think every investor pay a lot of attention to these issues [i may be wrong about that though].

 

Thank you for sharing your thoughts and thinking.

[wabuffo]

This is not a nice line of posting, viewed from a fellow CoBF member perspective.

 

You are right.

 

I forgot that ALL CAPS means shouting.

 

I was worried that I'm posting too much about this macro stuff and it was meant more like "oh boy, there goes that boring guy again - skip ahead to the next post."

 

Thanks for the feedback - I'll just let'er rip from now on with no ALL CAP warnings  :D

 

wabuffo

[ANP301191]

Looking at this from a completely different perspective - both the EU and Japan are actively buying corporate bonds. Just this week the ECB basically restated that last week. I think the BoJ is still buying equity ETFs (can't verify it as the last articles I found were from Jan). Yet both countries don't seem to have much (if any) inflationary fears. I understand that the US economy is bigger/far more robust/has a more diversified core than either the EU or Japan. However, I think the current causes of inflation (as far as I have read) seem to be raw material prices which lead to higher prices of manufactured products leading to general inflation. The EU and Japan import the same sorts of things that the US does, from the same countries, with the same raw materials prices. So if inflation does strike the US, shouldnt the market just weaken the dollar versus its trading partners and reregulate itself? And a little bit of inflation would probably help the US government and the average American with 92K of personal debt (https://www.cnbc.com/select/average-american-debt-by-age/).

 

I am not so much a student of economics as you can see from above, but logically, with declining labor and automation making things cheaper, shouldnt the fear be stagflation? In fact, just speaking anecdotally, I know of tons of businesses who are relooking at their workforce requirements (mine included) because the pandemic proved that we can work from home/automate certain roles, without much disruption.

 

I appreciate the concern about rampant or high-inflation, but honestly, dont see it happening today with the mentioned risks above (maybe being a little bit stupid or naive).

[maplevalue]

This is exactly what concerns me--that inflation will not be something that occurs gradually, but in a highly nonlinear fashion that is "unpredictable", black swan like. A lot of economic phenomena occur like this thanks to lots of interconnectedness and feedback loops existing in our modern system.

 

I say it's better to prepare for it than to ignore the risk due to extreme asset price sensitivity to rates at these levels.

 

Agree with you here. One interesting thing to think about is that in response to a rapidly changing economic situation in 2020, the Fed conducted monetary policy in an 'emergency' fashion (i.e. inter-meeting cuts, cuts larger than 25bps). Given the nature of the COVID shock, and the potential for inflation dynamics to rapidly change in 2021/2022, it is not too crazy to think about the possibility they need to react in an emergency fashion to raise rates.

 

Probably a low-probability event, but given it is not priced in at all it's interesting to think about.

[JRM]

I hear all of the arguments for deflation and increasing the money supply to match demand and I nod my head and generally agree.  But there are things that just don't pass the smell test.  For one, the case-schiller housing index is at an all time high while the housing component of the CPI is flat to down.  The C-S index is looking at actual home prices whereas the CPI housing component is calculating an "implied rent" which I can't figure out how it is determined.  The fed makes excuses for prices of things which are going up as supply side, so the market will work out supply issues?  Really?  How does that work, exactly, with natural resources? 

 

I also can't get past the idea that the dollar only has value if people have confidence in it.  Last year there was a run on toilet paper.  Part of the reason for the shortage was supply chain driven (people going to the bathroom more at home vs work or restaurants).  However, a large part of the shortage was due to people hoarding unnecessary amounts of toilet in fear that they would run out.  What happens if a critical mass of people (or foreign countries) lose faith in the dollar as a currency?  To me that's where all of this fancy money supply logic falls apart.

 

The fed can create as much money supply as it wants, but at the end of the day there is a risk of supply side inflation if not enough goods are produced in the real economy.