The Best Way to Profit From Low Inflation


Seven days into the new year and the records are rolling in. West Texas oil has gone under $50 a barrel for the first time since 2009, the euro is hitting nine-year lows, and inflation in Germany is at a five year low too. Oh, and a mainstream economist finally said something worth paying attention to. Impossible, you say? Stay tuned to find out!

Of course, the first three items above are all connected. Lower oil prices — not to mention copper, iron ore and agricultural commodities — are bringing down the general price level. That’s keeping inflation down. Why do you care?

In a nutshell, the problem for the central banks is that they want inflation to go up. They have a target of 2%. The latest reading on inflation in Germany was 0.1%. That’s a problem for the head of the ECB, Mario Draghi. To boost inflation, he may resort to inflating the money supply, weakening the euro.

That move, coupled with a stronger US dollar, would also make the yield on US debt look attractive and drive demand for US Treasuries. In fact, bond expert Jeffrey Gundlach told Barron’s magazine that yields on 10-year Treasuries could drop from the current 2% to take out their ‘modern era’ low of 1.38% yield — levels last seen in 2012. That could stoke another juicy bond rally.

It’s also part of the ongoing shift in market perception. You may recall that not so long ago US Treasuries were often compared to the value of confetti, paper cups, Christmas wrapping or cheap toilet paper.

The story for a long time was that former Fed Chairman Ben Bernanke’s money printing was readying all 18 trillion dollars worth of US Treasuries to be torched in an inflationary fire. The result would be the gold phoenix rising from the fiat currency ashes.

Markets never do what you expect. The relentless deflationary forces have — for now at least — allowed Bernanke to get away with prodigious money creation. Gold investors might take heart from the fact that it’s holding around the US$1200 mark. But it’s a long way from the big rerating many have been waiting for.

Even our northern neighbours in Asia — the world’s biggest gold bugs — have tempered their buying. The Wall Street Journal reported Perth Mint’s sales of gold coins were down 28% from 2013 and the US Mint was even worse, down 39%.

Of course, there are plenty of people prepared to tell you the price of gold is being manipulated. Personally, I have my doubts about that. But what is clear is interest rates can stay a lot lower for a lot longer than people expect.

Over in the United Kingdom, the Guardian reported last Friday on a fresh mortgage price war and ‘what may be the lowest ever two-year fixed rate home loan, priced at 1.29%.

Of course, the caveat to the deal is a big one: you need a 40% deposit. Few people will have this, so it looks more like an advertising stunt than anything else, but it’s indicative of the trend.

Banks just love lending against real estate. Back here in Australia, Digital Finance Analytics crunched some handy numbers for us.

According to DFA, ‘Total credit grew by 5.9% in the year to November 2014. Housing lending grew at 7.1%, business lending at 4.6%, and personal credit by 1.1%.’ The home lending numbers now have investment loans at a record figure of 34.2%.

The outcome of this, in time, is that wealth inequality in Australia will continue to widen. It’s baked into the economic cake, and sanctioned in Canberra.

Why? Enter economist Joseph Stiglitz. While not speaking directly about Australia, in a recent interview, the Nobel Prize winner debunked the notion that the massive wealth and income gap in the world was due to the accumulation of capital, as French economist (and guru author of 2014) Thomas Piketty argues.

Instead, Stiglitz said:

…you cannot explain what has happened to the wealth/income ratio by that analysis. A closer look at what has gone on suggests that a large fraction of the increase in wealth is an increase in the value of land, not in the amount of capital goods…

What has happened repeatedly in recent years is that we’ve had monetary authorities allowing — through deregulation and lax standards — banks to lend more. But this lending has not gone for creating new business, not for capital goods. Disproportionately it has gone to increase the value of land and other fixed resources (buildings, real estate, etc)…

When you deregulate, you allow more lending against collateral. Then those who have the assets that can be used for collateral see those assets go up in price, like land. And so those who hold wealth become wealthier. The workers, who have no wealth, don’t benefit from that expansion. So the link is that credit affects land prices and fixed asset prices, and those go disproportionately to the rich. And that is a major part of the increase in the wealth.

¬Or, as we say over at Cycles, Trends and Forecasts, the choice is yours: renter or rentier. To make sure you know how to be on the right side of the equation, start here. It’s the only place in the world where the right choice will be clearly explained to you.


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Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.

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