The Sinister Plan to Ruin Your Wealth
With your regular weekend editor on leave at the moment, I am filling in.
But with a twist.
While Nick Hubble is away, I said I wanted to showcase some the writers we have in the global Agora Financial network.
But today’s contributor needs no introduction.
The main man himself, Jim Rickards, is your weekend editor for today.
Why? Because today is a deep dive into risky monetary practices.
The sort of wealth-eroding tricks and traps governments and central banks work on to engineer economic growth…knowing full well it may lead to economic failure.
Australia’s central bank is stuck in the same hole as the US Federal Reserve.
Minimal consumer inflation coupled with a disappearing consumer. The only difference here is that we pumped our money into houses rather than stocks.
The point is, traditional central bank techniques aren’t working anymore. Will our own central bank follow the Fed’s playbook?
We don’t know.
But nonetheless, it’ll be watching the Fed’s monetary policy moves.
So, you need to as well.
Read on for more.
The Fed’s Dangerous Inflation Game
Jim Rickards, Strategist
The US economy expanded at an annualised rate of 3.2% in the first quarter of 2019. That was reported by the Commerce Department last Friday morning.
That strong growth — coming on top of 4.2% in Q2 2018 and 3.4% in Q3 2018 — means that in the past 12 months, the US economy has expanded at about a 3.25% annualised rate.
That’s a full point higher than the average growth rate since June 2009 when the expansion began, and it’s in line with the 3.22% growth rate of the average expansion since 1980.
It looks as if the ‘new normal’ is back to the old normal of 3% or higher trend growth.
Or is it?
Bye bye, economy
The headline growth rate of 3.2% was certainly good news. But the underlying data was much less encouraging.
Most of the growth came from inventory accumulation and government spending (mostly on highway projects).
But businesses won’t keep building inventories if final demand isn’t there. That’s where the 0.8% growth in personal consumption is troubling.
The consumer didn’t show up for the party in the first quarter. If they don’t show up soon, that inventory number will fall off a cliff.
Likewise, the government spending number looks like a one-time boost; you can’t build the same highway twice. Early signs are that the second quarter is off to a weak start.
Dig deeper and you can see that core PCE (personal consumption expenditures — the Fed’s preferred inflation metric) cratered from 1.8% to 1.3%.
That’s strong disinflation and dangerously close to outright deflation, which is the Fed’s worst nightmare.
The data shows that the Fed is as far away as ever from its 2% target.
But why should it even have 2% as its target?
Common sense says price stability should be zero inflation and zero deflation.
A dollar five years from now should have the same purchasing power as a dollar today.
Of course, this purchasing power would be ‘on average’, since some items are always going up or down in price for reasons that have nothing to do with the Fed.
And how you construct the price index matters also. It’s an inexact science, but zero inflation seems like the right target. But the Fed target is 2%, not zero. If that sounds low, it’s not.
Inflation of 2% cuts the purchasing power of a dollar in half in 35 years and in half again in another 35 years.
That means in an average lifetime of 70 years, 2% will cause the dollar to lose 75% of its purchasing power! Just 3% inflation will cut the purchasing power of a dollar by almost 90% in the same average lifetime.
So again, why does the Fed target 2% inflation instead of zero?
The reason is that if a recession hits, the Fed needs to cut interest rates to get the economy out of the recession.
Got to go up…so they can come back down
If rates and inflation are already zero, there’s nothing to cut and we could be stuck in recession indefinitely.
That was the situation from 2008-2015.
The Fed has gradually been raising rates since then so that it can cut them in the next recession.
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But there’s a problem.
The Fed can raise rates all it wants, but it can’t produce inflation.
Inflation depends on consumer psychology.
We have not had much consumer price inflation, but we have had huge asset price inflation.
The US ‘inflation’ is not in consumer prices; it’s in asset prices. The printed money has to go somewhere. Instead of chasing goods, investors have been chasing yield.
Yale scholar Stephen Roach has pointed out that between 2008 and 2017, the combined balance sheets of the central banks of the US, Japan and the eurozone expanded by over US$8 trillion, while nominal GDP in those same economies expanded just over US$2 trillion.
What happens when you print over $8 trillion in money and only get US$2 trillion of growth?
What happened to the extra US$6 trillion of printed money?
The answer is that it went into assets.
Stocks, bonds and real estate have all been pumped up by central bank money printing. The Fed — first under Ben Bernanke and later under Janet Yellen — repeated Alan Greenspan’s blunder from 2005-06.
Greenspan left rates too low for too long and got a monstrous bubble in residential real estate that led the financial world to the brink of total collapse in 2008.
Bernanke and Yellen also left rates too low for too long. They should have started rate and balance sheet normalisation in 2010 at the early stages of the current expansion when the economy could have borne it. They didn’t.
Bernanke and Yellen did not get a residential real estate bubble. Instead, they got an ‘everything bubble’.
In the fullness of time, this will be viewed as the greatest blunder in the history of central banking.
Higher inflation to come
The problem with asset prices is that they do not move in a smooth, linear way.
Asset prices are prone to bubbles on the upside and panics on the downside. Small moves can cascade out of control (the technical name for this is ‘hypersynchronous’) and lead to a global liquidity crisis worse than 2008.
If the Fed raises rates without inflation, higher real rates can actually cause the recession and/or market crash the Fed has been preparing to cure.
The systemic dangers are clear. The world is moving towards a sovereign debt crisis because of too much debt and not enough growth.
Inflation would help diminish the real value of the debt, but central banks have obviously proved impotent at generating inflation.
Now central banks face the prospect of recession and more deflation, with few policy options to fight it.
I’ve discussed how Modern Monetary Theory (MMT) is becoming increasingly popular in Democratic circles, even though the Fed has disavowed it.
But it can’t be ruled out if Democrats win the 2020 election.
That means 3% or even 4% inflation could be coming sooner than the markets expect if it’s pursued.
But those who want higher inflation should be careful what they ask for.
From 2% to…10%?
Once inflation expectations develop, they can take on lives of their own.
Once it takes root, inflation will likely strike with a vengeance.
Double-digit inflation could quickly follow.
Double-digit inflation is a non-linear development.
Meaning, inflation doesn’t go simply from two per cent to three per cent, to four, five, six, etc.
What happens is that it’s really hard to get it from two to three, which is ultimately what the Fed wants. But it can jump rapidly from there.
We could see a struggle to get from two to three per cent, but then a quick bounce to six, and then a jump to nine or ten per cent. The bottom line is, inflation can spin out of control very quickly.
If people believe inflation is coming, they will act accordingly en masse, the velocity of money will increase, and soon enough the inflation will arrive unless money supply has been severely constricted.
That’s how you get the rapid inflation increases I described above.
So is a double-digit inflation rate within the next five years in the future?
Just to be clear, I am not making a specific forecast here.
But if it happens, it could happen very quickly.
So the Fed is playing with fire if it thinks it can overshoot its inflation targets without consequences.
It doesn’t seem like a problem now. But one day it might.
All the best,