The Connectedness Cliché Is True
We cover a lot of ground in The Daily Reckoning Australia. Specific topics vary, but over time we’ll look at economic growth, central bank policy, inflation, deflation, currencies, gold, stocks, bonds, demographics, geopolitics, and a lot more.
All of this is done with a view to helping investors make the best choices for their portfolios and achieve the best asset allocation that includes those choices.
Of course, none of the topics listed above (and others we cover) are ever completely separate. They’re all part of one large complex dynamic system under the umbrella of finance and capital markets.
If inflation takes off, gold is never far behind. When bond prices rally, it means interest rates are dropping. That can be good for stocks in the short run, but then lead to market corrections or crashes as reality sets in — lower rates mean that monetary policy is tight, and recessions become more likely.
Exchange rates are not driven by trade balances or purchasing power parity. They still teach that in universities, but those ideas are stale leftovers from an age of gold standards and fixed exchange rates. Has anyone ever exported a Big Mac or imported a haircut?
Currencies are driven by capital flows, including so-called hot money. Those capital flows are driven by interest rate differentials, which are in turn driven by inflationary expectations. The capital surpluses can support imports until either exchange rates drop, or domestic savings increase — the reverse of the textbook explanation.
To use a cliché — it’s all connected.
That said, we do tend to tackle these topics one at a time. A quick look at past issues will reveal that we spent most of 2020 covering COVID and the presidential election. We have spent 2021 moving from inflation to asset bubbles to demographics and more.
One of my favourite topics I’ve written about was narrative economics. In previous issues, I explained how narratives (basically stories, sometimes referred to as anecdotal evidence) can drive markets more powerfully than fundamentals or technicals.
How narratives move markets
Narratives form a kind of background and scenery for a play that’s being performed by actors in the foreground. Most people focus on the actors. It’s important not to forget about the scenery. That’s where the villains hide.
That’s intuitive to most observers. What was surprising was that narratives can last for years in many cases and that they can turn on a dime. The first stage of the Great Depression (1929–32) was driven by a narrative that consumption was bad because so many were in financial distress.
It was bad form to buy a fancy car or expensive clothes even if you could afford it, because you were ‘showing off’ in front of the less fortunate. Of course, that just prolonged the depression because without consumption the US economy could not find a bottom.
That narrative flipped in 1933 when FDR became president. Suddenly, spending was good precisely because it could help the economy get back on its feet. FDR’s campaign theme was ‘Happy Days are Here Again!’.
The economy grew strongly from 1933–36, although it was still digging its way out of a very deep hole. Of course, the Fed blundered again and caused a second technical recession from 1937–38, which is why the Great Depression overall is dated from 1929–40.
Still, the narratives such as ‘consumption is bad’ and ‘consumption is good’ were more important drivers of recession and recovery than monetary and fiscal policy and the New Deal.
In addition to longevity and possible flip-flops, the other characteristic of narratives is that they can be completely false and still be powerful. We’re seeing examples of that today. The country has been in the grip of a strong inflationary narrative for the past six months.
It’s false. All signals from base effects to interest rates to velocity point to disinflation and possible deflation in the remainder of 2021 and into 2022. The stock market has been rising on the back of this inflation narrative. It will soon get a reality check.
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The bigger picture
So, yes, normally we look at a range of topics that affect markets and your portfolio. But we’re going to do something different in my upcoming issues. We’re taking two steps back and looking at all of these topics from a broader perspective. We’re going to take many of the major factors that drive markets and synthesise them into a big picture. Think of it as a landscape on a large canvas instead of the individual portraits we usually paint.
Our format will be a kind of Q&A. We’ll pose questions on topics investors are most interested in and use those questions as a platform for explanations of the key factors in markets today. As we move through the questions and answers, we’ll have the opportunity to connect the dots in ways that let readers see the bigger picture. The goal is not to provide a snapshot, but more of a movie that we can follow into the future.
In intelligence analysis, we call this ‘looking over the ridgeline’. It’s important to go beyond what’s seen and to anticipate the hidden and the unseen so that we’re not taken by surprise. The idea is to take a step back from sub-topics (inflation, deflation, growth, pandemic, demographics, fiscal and monetary policy) and give readers a sense of where the global economy is 20 months after COVID hit the world in an impactful way, and 18 months after the greatest recession since 1946. We’ll also look 16 months ahead through the rest of 2021 and all of 2022.
This will be a kind of intellectual macro-lifeline for the confused, anxious, and uncertain (which covers just about everybody these days).
We can’t promise that markets will always be smooth sailing. We will promise that in good markets and bad we’ll keep you ahead of the curve so you can preserve wealth and prosper despite adversity.
In my next issue, we’ll jump into the first of these questions. So stay tuned if you want to start getting a better understanding of our current economic landscape.
Until next week,
Strategist, The Daily Reckoning Australia
PS: This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events.