By Larry McDonalds, author of The Bear Traps Report
The Coming Inflation Shock
Rents (surge) are about to impact PCE and CPI. A surge in PPI is flowing into CPI.
History will record that during the present time the most used word was “inflation” and the second most used word was “temporary.”
What isn’t in this life transitory? But if inflation lasts three years because of a demand shift caused by a zero-carbon emissions goal consensus, then call it what you will, we at The Bear Traps will allocate capital accordingly. It reminds us of Marty Zweig not caring if the down stock market was a correction or a bear market. Either way, he didn’t want to be long stocks. We don’t really care if inflation ends a year or three from now. We want to be long energy and metals.
By insisting on the word “transitory” all the Fed is signaling is that it is ignoring and will continue to ignore prices of goods and services. It’s brilliant in its own way because if six months from now prices are still going up, the Fed will merely say that, aha, now, surely, inflation is transitory. And it will play that game every six months for years if it can. It will only change its tune when things get so bad it has to change. As we have pointed out several times in the past, even Volcker didn’t fight inflation until he saw directly that inflation was increasing unemployment.
Some things are different now, of course than in Volcker’s day, the primary one being the Fed owns such a large portion of the treasury float that the treasury market has lost most, not all, of its signal value. This type of thing is not without precedent, by the way. The early 1930s devaluation of the dollar caused gold to go from just above $20 to $35, where it remained fixed into Nixon’s administration. That was a long time.
What is clear is that US bond yields have a negative real return. If you own treasuries, you are pretty much guaranteed to lose money in real terms. This should cause borrowing to increase, which in fact has happened. Mortgage debt is above $10 trillion, surpassing the pre-Lehman crash peak. An expansionary monetary and fiscal policy assumes that by extending credit, people will still by everything at increasingly higher prices no matter what. The reality is somewhat different. At first it goes along that way, true enough, but then comes a sticker shock pause, followed by a hoarding panic buying spree.
Normally this last phase causes a run on the currency which is akin to throwing nitroglycerin into a raging fire. At this point, central banks cave, raise rates, and accept the stock market selloff and economic recession. Unless, of course, yours is a reserve currency. That can, but doesn’t have to, change the game theory. Bottom line: Fed and Treasury probably figure they can get away with whatever they want to do. Of course, if they are wrong, it’s an unmitigated disaster. And yet, of course, something like a 9% weaker greenback would probably be welcomed by Fed and Treasury.
A further nuance is the fact that the Central Banks coordinate monetary policy. This is of necessity. When foreign banking systems are in trouble, it is the Fed that extends emergency swap lines to provide eurodollar liquidity to other Central Banks. Under such a circumstance, it would be unthinkable for monetary policy not to be coordinated on a global scale. So monetary policy is loose on a global scale, such that trillions of debt trade at negative nominal yields. Inflation just adds insult to that injury. But adding to inflation is supply constraint, not short term supply disruption, but long term supply absence altogether. There has been little mining activity to find new sources of metals for over a decade. As build local becomes the imperative, we note that not only has our industrial base not grown, it has shrunk, and in dramatic fashion. If any infrastructure bill passes, the drama will only become that much more accute. A negative supply shift away from China paired with a positive demand shift in infrastructure is the very stuff inflationary nightmares are made of.
Additionally, we have stressed the dawn of the age of the power of labor. Labor is harder to find and more expensive. And after decades of getting shafted, it is only fair the pendulum is finally swinging the other way. But labor inflation is difficult to cure for the simple reason that a majority of the voting population doesn’t see getting paid more money as a problem.
And finally, we have the problem of more money supply. At this point, money creation is no longer the immediate risk. No. The immediate risk is an increase in the velocity of the money that has already been created. Velocity has collapsed to such an extent that simply to mean revert to its downward regression line of old would be massively inflationary. But of course the velocity of money will increase as transactions increase in a global synchronized post Covid scenario. And finally, once the global economy kicks into high gear for several quarters, then, and only then, will banks start to aggressively lend thereby increasing the money supply magnificently.
So sustainable inflation seems fairly inevitable at this point even if years from now it proves “transitory.”
