Back to the Future: 1980s Inflation Repeat
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Posted 05/07/2023
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In the vast, intricate jigsaw that is our economic and financial landscape, there are far more pieces than many can imagine. The riddle isn't just about understanding the transient shifts in the market, it's about making sense of the long-term trends that will invariably shape our financial future. As of late, the market has been experiencing an upward surge, even in the face of looming issues that have the potential to completely upheave our financial markets and the economic growth we've been witnessing.
You must not forget the ghost of inflation. Yes, it's been quiet, but it's not vanished. In fact, several factors could make it notoriously hard to rein in. From the debasement of currencies resulting from substantial government deficits, and spikes in energy prices, to a dip in food production, any of these could drive inflation much higher. The spectre of 1980 is one we cannot afford to ignore. Higher interest rates are a crucial tool - a weapon, if you will - in battling inflation. Rest assured, if the need arises, they will be summoned to the frontlines.
Currently, the NASDAQ is perched at impressive heights. The New York Fed has projected a 70.8% chance of an upcoming recession, the highest forecast since 1982. According to Macro Strategist at Bloomberg Intelligence, Mike McGlone, we might be on the cusp of the "worst recession in our lifetime". He foresees more than just a small correction, and he is not the only one.
We often attribute an enormous amount of power to central banks, assuming they hold full control over the market's movements. Over the years, the 'Fed put' has distorted true price discovery by swooping in to rescue the stock market every time it stumbles. Yes, central banks exert significant influence on markets and interest rates, but to say they have complete control is perhaps a stretch.
The current market landscape, bizarrely reminiscent of Alice's Wonderland, has been shaped in part by a flurry of financial engineering and tax laws that have nudged investment funds towards stocks. Far from a smoothly operating machine, our financial system resembles a ramshackle contraption held together by duct tape and wishful thinking. The question looming over us is, how long can this divergence in various markets continue before assets revert to their more historic valuations? The answer is not clear, but one thing is certain - the shift can occur with startling speed, leaving many unprepared and caught off guard.
The task of comparing today's economic conditions with those of the past is further complicated by the fact that many comparisons have become "obsolete." Some point to reduced liquidity due to a falling M2 but fail to acknowledge that M2 does not include money that is still relatively accessible, like money funds. In reality, much of our money hasn't "disappeared" - it has simply been transferred elsewhere.
In a world where growth in credit and debt has surpassed the growth in hard assets like gold, it's simplistic to assume that the value of all assets moves in tandem. Many of these hard assets have a shorter lifespan than the debt supporting them. There is a high possibility that many of the key adjustments our economy must make are significantly lagging behind our current "financial culture," or that our economy has evolved into a structure that simply no longer works.
We may be skating on thin ice. It is prudent to prepare for a major shift in asset values. Hard assets like gold may soar in value as many intangible investments plunge.
If inflation is truly not gone, this means that government bonds as an investment remain problematic, especially long-term bonds. Often, such bonds do not yield a "positive return" over inflation. In the short term, they might break even, but in the long run, bondholders may find themselves victimised by the destructive forces of inflation.
When people declared inflation peaked last June, they used the base effect argument. The slowing pace of inflation led many to believe it was ebbing. However, the system promises less favourable comparisons in the coming months, which will reverse the notion that inflation is no longer a concern.
Despite the claims of some experts, the debate over inflation, stagflation, or deflation is far from resolved. We should remember this is a game with no end, and escape is not an option.
It's important to remember that the final stage of any country's fiat money system has historically proven to be inflationary. And in such a stage, the value of hard assets like gold has typically held steady, or even increased, as a reliable store of value.