I’ve noticed lately that inflation continues to “surprise” to the downside, to a small degree here in the US but mainly overseas (notably Europe, Australia and Canada), creating expectations of further monetary easing. This is leaving many people who have been calling for hyperinflation and the collapse of fiat currencies scratching their heads. They say that Central Banks can’t just expand their balance sheets by trillions of dollars (essentially print money at will) without suffering the consequences of hyperinflation. We have to look at the whole picture to understand why this isn’t happening.
Let’s use the US as our example (it’s basically a very similar case in the other developed nations as well). The Fed has expanded its balance sheet by approximately $3 trillion dollars since 2008. However, consumer credit declined in both 2009 and 2010, and didn’t really pick up until 2012. So, a large portion of Fed printing has basically offset the contraction in consumer credit while the rest has allowed the banks to recapitalize their reserves.
The key issues still remain unemployment, confidence and taxes, all of which are being effected by politics. Until businesses have the confidence to invest in future growth, they won’t hire and they won’t expand, and we’ll most likely see a continued focus on creating value through financial alchemy with share buybacks, higher dividends and restructuring (splitting companies because the sum of the pieces is greater than the whole).
Global tax rates continue to rise – the US raised the highest income tax bracket as well as adding the Medicare surplus tax, Japan just agreed to raise their consumer tax in April, 2014, and many European nations have been raising both income and VAT rates. This is a problem because it has very deflationary effects as people have less to spend and try to shelter the rest. With most Western governments accumulating debt like it’s their job, deflation is not a good thing because if you can’t inflate away your debt and growth is anemic, the only option left is to continually roll the debt until you default or nationalize private assets to cancel the debt.
Europe continues to make the problem worse by forcing austerity measures on the Southern nations when it’s actually Germany that needs to rebalance, despite the image of a strong economy running trade surpluses. German policies in the 1990’s created the trade surpluses and have forced unemployment and deficits on its Southern neighbors. When they formed the Eurozone in 1998 with its current structure of one currency while each country maintains its own debt/budget, Spain, France, Greece, etc. sealed their fate. The best solution is to break up the Eurozone but doing so will admit it was a mistake so it’s unlikely to happen anytime soon. Things are not going to end well there which is why my clients own virtually no developed nation government bonds. The current “recovery” that their political leaders and the media are pointing to is a cyclical blip that will not last long because they fail to address the structural problems.
This brings us full circle, back to Central Bank balance sheet expansion through the purchase of government bonds. I think the Fed’s statement last week that they’re comfortable with rates at current levels is part of their transition to cutting back, even while other Central Banks are still ratcheting higher. As long as governments continue their deflationary policies, Central Banks will have to continue to buy government bonds in an effort to counter the effects and repress interest rates, and money will continue to pour into the stocks and bonds of private companies.
-Nick