Inflation at 4% in 2021 - Russell Napier
"Most investors just look at the narrow money aggregates and central bank balance sheets. But if you look at broad money, you notice that it has been growing very slowly by historical standards for the past 30 or so years. There were many factors pushing down the rate of inflation over that time, China being the most important, but I do believe that the low level of broad money growth was one of the factors that led to low inflation."
This has now changed.
"We are currently in the worst recession since World War II, and yet we observe the fastest growth in broad money in at least three decades. In the US, M2, the broadest aggregate available, is growing at more than 23%. You’d have to go back to at least the Civil War to find levels like that. In the Eurozone, M3 is currently growing at 8,9%. It will only be a matter of months before the previous peak of 11.5% which was reached in 2007 will be reached. So I’m not making a forecast, I just observe the data."
"Does the growth of broad money matter? Investors don’t think so, as breakeven inflation rates on inflation-linked bonds are at rock bottom. So clearly the market does not believe that this broad money growth matters. The market probably thinks this is just a short-term aberration due to the Covid-19 shock. But I do believe it matters. The key point is the realization who is responsible for this money creation.
This broad money growth is created by governments intervening in the commercial banking system. Governments tell commercial banks to grant loans to companies, and they guarantee these loans to the banks. This is money creation in a way that is completely circumventing central banks. So I make two key calls: One, with broad money growth that high, we will get inflation. And more importantly, the control of money supply has moved from central bankers to politicians. Politicians have different goals and incentives than central bankers. They need inflation to get rid of high debt levels. They now have the mechanism to create it, so they will create it.
What’s the timeline for your call on rising inflation?
I see 4% inflation in the US and most of the developed world by 2021. This is primarily based on my expectation of a normalization of the velocity of money."
Bruce Baker comments:
We are at a point in history, where some major disinflationary (and deflationary) forces of the last 3 decades in the process of reversing.
Globalisation has resulted in far more intense price competition as service providers and manufacturers in the emerging world, provided goods and services more cheaply to the West. We are now beginning to see deglobalisation (at least for manufactured goods) as a result of the COVID-19 crisis as well as the growing tensions between USA and China. This means that factors other than lower-cost have started to become more important.
Note: Deglobalisation will result in not only higher prices but also a lower standard of living (all things being equal) because of the Economic Law of Comparative Advantage. https://en.wikipedia.org/wiki/Comparative_advantage
Technology has been a major deflationary force by:
enabling much fiercer price competition via the Internet eg via Internet shopping.
Also because of Artificial Intelligence, far greater automation and robotisation.
Some are now arguing that the big tech giants like Google, Amazon and Facebook have become so dominant in their sectors that they are now seeking to monetise that dominance (monopoly power) by raising prices and killing off competition - hence higher prices than we should have to pay.
This is why the European Union and THE USA government are increasingly scrutinising the monopoly power of these tech giants.
China has been a major source of disinflation and deflation in the West. The growing tension between USA and China including tariff barriers, seems to be pushing the world into a new Cold War where countries and companies will have to choose sides - USA or China. This is inflationary - and an overlapping issue with deglobalisation China has also been
Massive growth of western M2 Money Supply, as governments supplement the role of central banks in controlling money supply. And now this is the argument presented by Russell Napier above.
The connected issue to the is the transition into an era of Modern Monetary Theory (MMT) economic policy and also Financial Repression.
I will add more to this discussion later.
That said, while not yet being prepared to accept Russell Napier's forecast on the timing of 4% inflation, coming inflation is DEFINITELY that we must now keep on our radar - because coming inflation will effect ALL other other prices - and hence it is a critical ingredient when considering investment strategy at this time.
Some Other References:
Economist Martin Wolf argues a somewhat similar case for inflation here.
This next article provides some useful context to the previous article - because a range of major deflationary (and disinflationary) forces of the last few decades are now in the process of reversing. http://puzzlefinancialadvice.com.au/2020/Articles/190409_AFR_Martin_Wolf_How_our_low_inflation_low_interest_rate_world_was_made.pdf
Ray Dalio Says 'Inflation Is Coming' - How To Prepare - 5/7/20
Why Our Economy May Be Headed for a Decade of Depression (and then inflation) - Nouriel Roubini 22/5/20
In September 2006, Roubini told the IMF of the coming Global Financial Crisis. "Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity."
"A decade later, 'Dr Doom' is a bear once again."
"He foresees a slow, lackluster (i.e., 'U-shaped') economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts."
"Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade.
As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines.
Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression.
"My prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a 'Greater Depression.'" http://puzzlefinancialadvice.com.au/2020/Articles/The_coming_Greater_Depression_Roubini_.200428.pdf
"My argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen."
"We are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history." https://foreignpolicy.com/2017/06/09/the-thucydides-trap/
"When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. ... The corporate sector is ... going to respond by replacing labor with robots, automation, and AI."
"Hyundai .... told me that tomorrow, they could convert their factories to run with all robots and no workers."
"Any new factory in the U.S. (built as the US on-shores) is going to be capital-intensive and labor-saving. .... So reshoring means increasing production in the United States but not increasing employment ........ That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. And so consumption is going to be weak. That’s why you get the U-shaped recovery."
"The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. ..... That wasn’t even true during the global financial crisis when we were saying, 'We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.' "
"There’s a conflict between workers and capital. ..... There’s a conflict between small business and large business. ..... So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win."
"What policies would you (Roubini) enact to strengthen labor, and avert (or at least mitigate) the Greater Depression?"
"The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free."
What makes you (Roubini) confident that US deficit spending now will bring inflation now, when it has not done so over the years since the GFC?
“First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. …. monetary policy alone was insufficient and you needed fiscal stimulus.
What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus.
What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it ….. — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. This is because we’re going to see two big negative supply shocks.
For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock……. And … technology is going to gradually become a negative supply shock.
So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ….. What did you get? Stagflation.
I’m not talking about hyperinflation. …. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds ….. will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent.”
In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates? Yes
You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?
“I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. ……. So there is climate change. And its economic costs are becoming quite extreme.
And then there’s the pandemics. These are also man-made disasters.
Bruce Baker summary of 22/5/20 Nouriel Roubini article above: Roubini does not believe that there will be sufficient political will in the USA, to take the extreme monetised fiscal-deficit and redistribution measures required to avoid economic depression....even if Biden becomes president. Roubini also argues that negative supply-side shocks will bring inflation some time over the coming decade - maybe in 5 years time.
Inflation is coming.
" For the first time in 40 years, we believe we may now have to face up to the corrosive power of inflation. It is high time to prepare for this change and figure out what to look out for and how one might go about immunising investment portfolios against such an outcome. "
"A look at the chart below illustrates how benign inflation has been for the past 30 years. But as this chart from Advisor Perspectives illustrates this has not historically been the case:"
"It may seem like a strange time to be thinking about inflation – just as the world is in shut-down and deflationary signals abound. In our opinion it’s clear there are likely to be several quarters of deflation as a result of the supply shock instigated by the drop-off in consumer demand associated with coronavirus-related job losses and furloughing. But it’s precisely because inflationary signals are not yet fully visible that we need to be preparing ourselves now.
Over the coming months, these are the key signs that we believe investors can look out for to indicate the onset of inflation:
Talk of “inflation make-up” by central banks, an early-warning sign of governments allowing inflation to creep back into the system;
A move from ballooning central bank balance sheets to ballooning money supply: remember, financial QE alone didn’t move the money stock – fiscal QE can;
Increase in fiscal deficit and increased government spending plans;
Signs of greater protectionism/less globalisation;
Perhaps the most important signal of all: a change in the relationship between stocks and bonds. An increase in the correlation between the two asset classes – the extent to which they move together – has historically been a sign of a pick-up in inflation.
Attempting to protect portfolios could mean buying not-so-liquid inflation-linked securities and floating-rate bonds; pursuing value and momentum strategies in equities; and purchasing commodities, gold in particular. We are all going to have to learn to live – like Alice in Wonderland – in a world turned on its head, when after decades of a benign inflationary environment, the dominant story of the next decade becomes one of structurally higher inflation."
After trying for a decade, central banks might succeed at generating inflation 12/5/20
“The forces that will bring about inflation are aligning,” Chetan Ahya, chief economist at Morgan Stanley, said in a note. “We see the threat of inflation emerging from 2022 and think that inflation will be higher and overshoot the central banks’ targets in this cycle. This poses a new risk to the business cycle, and future expansions could also be shorter.”
Current chart of official US CPI (Consumer Price Index)