Do Not Forget 1980, Inflation Is Not Gone

Authored by Bruce Wilds via Advancing Time blog,

The economic and financial puzzle has far more pieces to it than many people think. It is difficult to understand the market short-term let alone get any kind of picture of the long-term market. The market has been going up despite a number of formidable problems forming that we will have to face in the near future. Any one of these could derail both financial markets and economic growth.  

It is important to remember that inflation is not gone. In fact, it may be difficult to control several of the factors feeding into it. The debasement of currencies due to huge government deficits, a surge in energy prices, or a fall in food production could all push inflation much higher. This is why forgetting 1980 could be a big mistake. Higher interest rates are a key tool or shall we say weapon in controlling inflation. If needed to fight inflation, they will be used.

NASDAQ is at lofty levels. The New York Fed is now pricing in a 70.8% chance of a recession, the highest since 1982. This recession may be the “worst in our lifetime,” says Mike McGlone, Macro Strategist at Bloomberg Intelligence. McGlone is looking for more than a minor correction and he is not alone. 

We tend to give the central banks far more credit than they deserve as to how much they control. Over the years the “Fed put” has skewed true price discovery by coming in and saving the stock market whenever it gets into trouble. Yes, central banks heavily influence markets and interest rates but to say they control them may be an overstatement.

Adding to the current false Alice in Wonderland landscape is a whole lot of financial engineering and tax laws that have directed investment money into stocks and away from hard assets. The financial system is not a well-oiled machine, instead, it closely resembles a cobbled-together mess. How long the divergence in various markets can continue before assets revert to more historic valuations is questionable. The one thing that is certain is this can occur rather rapidly and catch many people off guard.

The case can be made that much of the financial markets are no more than a mirage. It is an illusion generated by hope, government spending, easy money, leverage, and hype. It has been created by those that benefit from convincing people with money that investing in such schemes will bring them more wealth. The problem is that this is a cycle that has played out time and time throughout history. Sooner or later true price discovery reasserts itself and reality raises its ugly head.

This becomes apparent when economic watchers trying to compare today with other periods in the past are stymied by the fact many comparisons have become “obsolete.” For example some point to proof of less liquidity due to a dropping M2 but fail to note the M2 does not include money that is still relatively accessible such as money funds. Today a great deal of money has not “gone away” but has merely been transferred to other places. 

An Exploded Bomb Gets Few Buyers

It is a bit simplistic to think the value of all assets moves in lockstep or last. Over time the growth in both credit and debt has outpaced the growth in hard assets. Also, many hard assets have a shorter lifespan than the debt supporting them. Please consider the possibility many of the important adjustments the economy must make are lagging far behind our current “financial culture” or that the economy has evolved in a way that simply no longer works.

It could be argued we are walking on thin ice. Like many market and economic skeptics, I contend we should prepare for a major shift in asset values. Hard assets may soar in value and at the same time many intangible investments fall in value. This view of the future can be difficult to wrap your head around. Most people tend to think of things going in one direction or the other and not in both.

If indeed inflation is not gone, this means that government bonds as an investment are still problematic with long-term bonds being the worse. Usually, such bonds do not yield a “positive return” over inflation. In the short term, they may bring you about even but in the long term it is very likely bondholders will be raped and plundered by the forces of inflation. 

When people called inflation peaking last June they did it using the base effect argument. Year-over-year comparisons are a big reason inflation appears to be ebbing. In short, it simply is not going up as fast. This system also promises less favorable comparisons in coming months which will reverse the impression inflation is no longer an issue.

Regardless of what some experts claim, the inflation, stagflation, or deflation debate is not over. It would be wise to remember this game does not end and it is impossible to escape. Decades of poor-quality growth have metastasized into an economic system that is unsustainable. It has also resulted in inequality that is eating away at society. Retiring with money does not guarantee a person a happy, healthy, and carefree life.

When is all said and done, the final stage of any country’s fiat money system has proven to be inflationary.