If you can't see inflation, you're looking in the wrong place
Inflation is very much alive.
It’s been skyrocketing for at least a decade.
It’s in plain sight, but you can’t see it if you’re looking at consumer prices.
It’s not there.
But it can be seen in the NASDAQ Composite which has gone 6x since the GFC.
And here as well, in U.S. 2 year bond yields which have cratered from ~5% prior to the GFC, to ~0% today.
In other words, massive credit creation since the GFC has found its way into assets, not consumption, as a result of monetary policy converging with technology.
The proof?
Consider the following.
Inflation (increasing flation) largely exists because of increasing credit from banks and accommodative economic guidance from central banks, some of which are independent of government, and some not. In countries where they are not, add in government ideology.
If you have large amounts of credit being created by banks (following central bank accommodative policies and/or government jawboning, policies and/or edicts) and that credit goes into GDP related activities, you typically get consumer price inflation and high employment. We’ve seen this in the past.
But what if the credit goes into shares, bonds, and other investment assets, and not GDP?
Yep, like the past decade, where a lot of credit has been assigned to buy-backs, structured credit products, negative gearing of investment portfolios and other investment assets. This is where new credit is applied to old products and services, i.e., diverted into secondary markets and trading platforms.
Well, the result of that is share price growth, lower bond yields/higher prices, and supercharged returns/higher prices for structured products. In other words, you get GDP-under-productive debt, plus asset bubbles that no one seems to want to call.
As I’ve previously written, the ~$70 trillion in new debt created between the GFC and April last year produced $14 trillion in incremental annual GDP over that period. In other words, only around 20c in the incremental debt dollar was productive. The rest is caught in a blocked chimney, parked with central banks, stuck in the external banking system, lost in unproductive government spending, corporate defaults, and forgiveness, used for buybacks, negative gearing and structured debt products sold by banks. Most of all, fuel for asset prices.
If we then add the recent $10 trillion plus of estimated debt being pumped into the global debt lakes (it’s probably double this, but let’s be conservative at $10 trillion), this makes $80 trillion of leverage since the time of Lehman.
And, if as predicted by the IMF, GDP falls by 3% this year, incremental growth in GDP since the GFC would be only $11 trillion, give or take. This can be seen in the table in the second last column.
In turn this means only 14c in every incremental dollar of credit created since the GFC has gone to productivity (GDP). Essentially, a 30% decrease in credit productivity, just in the last year.
The rest has found, or will find its way into underground tanks of rocket fuel for investment assets.
Other key consumer price inputs have been muted.
With the advent of the cloud, the global economy is pivoting to a services economy spurred on by technology innovation.
Technology is driving down prices. Even food, alcohol and beverages are being produced, packaged, and sold with the aid of technology and advances in these areas, and this benefits prices. Juggernaut marketplaces have delivered massive price savings in many consumer good categories. I’ve written about the amazon effect in the past and the work done by the U.S. Fed on the more frequent price decreases for consumer products sold in locations where amazon products/services are available.
Converging forces have forced inflation to jump to assets.
So, we have a convergence of some debt diverted from GDP activities to investment assets. We also have significant decreases in consumer prices largely resulting from disinflationary innovation and the cloud.
That’s why you can’t see any material inflation in consumer prices after all of this credit creation. Government ideology, central bankers, banks, the credit virus and the rise of the fintech have all caused it to jump from consumer prices to investment assets.
If it had returned to infect consumer prices, you know exactly what the central banks would have done well before now - sell bonds, taper or run-off the balance sheet and in so doing manipulate interest rates up to cool things down.
So why should it be any different when it comes to asset prices?
Well, there’s little will in the White House to see asset prices fall. It’s a scorecard for the President, part of keeping up appearances within a China context, a present for retiring baby boomers and collateralising fuel for the fractional banking system.
Equally, with the Fed jawboned and painted into its corner and the virus on the march, the Fed will find it difficult to taper and normalise asset buying and interest rates. And this is unlikely to happen to any material extent until the economic engine takes over from the shock absorber.
Plus, any material increase in the real interest rate, directly by central bank open market operations, or indirectly through deflation (if that plays out) would mean serious debt defaults. That’s where Guarantee Infinity comes into play.
Just when you think the roof is about to fall in, governments usually step in to kick the can down the road and avert a crisis. That will probably happen again. In this case it seems it will be extensions to PPP, JobKeeper and their equivalents in other countries, albeit perhaps smaller chunks and more targeted.
Of course that can’t last, but for the moment, inflation has jumped to assets. When it will jump (or slingshot) back to consumer prices remains an unanswered question.
Mike.
NextLevelCorporate is a leading independent strategic corporate advisory firm with a multi-decade track record of delivering transformative corporate finance solutions, in and out of Australia.
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