10/29/2016 - The Roundtable Insight – Alasdair Macleod & John Butler On Rising Inflation & Gold
FRA is joined by John Butler and Alasdair Macleod of Goldmoney in discussing the impact of stagflation on the global economy, along with the effects it would have on equity markets.
John Butler is the Vice President and Head of Wealth Services for Goldmoney, Inc, the world’s leading provider of savings, payments and other financial services all fully backed by physical, allocated gold. Prior to joining Goldmoney he had a 15-year career as a macro investment strategist at Deutsche Bank and Lehman Brothers, among other firms. He is also the author of The Golden Revolution, a book analysing the causes and consequences of the 2008 financial crisis and exploring ways in which gold could re-enter the international monetary system.
Alasdair Macleod writes for Goldmoney. He has been a celebrated stockbroker and Member of the London Stock Exchange for over four decades. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy.
THE EFFECT OF PRINTING MONEY
Theory would have told you, years ago, that all the money printing during the crisis of 2007/2008 would eventually turn into rising price level. There tends to be a relationship – albeit a very unstable one – between expansion of the money supply and a rising nominal price level. It can’t be modeled precisely, which is why the bulk of the economic profession doesn’t bother to even think about it.
We’re finally starting to see that the vast expansion of money supply that happened in all major economies in 2008/2009 is following through into a general consumer price inflation. We’re seeing in commodities, which have bottomed, and in wages. Wages are picking up.
We have passed an inflection point with growth generally weak in most economies around the world. This combination of CPI inflation rising and growth that is weak or slowing further makes for a stagflationary mix, which is a horrific environment for investors as it implies a potential under-performance of both stocks and bonds.
The fact that the fiscal profligates are talking about fiscal stimulus spending more aggressively than they have been for a while, is clear evidence that the inflation inflection point is behind us. They simply want to inflate their way out of the massive debts they have created for their own political reasons. That is the world we’re now living in. It’s amazing, in a way, how openly they are discussing helicopter money.
There is an assumption among the Keynesians and Monetarists that if the state expands the quantity of money in circulation, it will stimulate the economy. As a one-off, it is certainly possible as it fools people into thinking there is real extra demand in the economy. The payment for that extra money is a tax on all the existing money in circulation that gets realized gradually over time, so you find that prices start rising when that new money is spent, and then the price rises gradually ripple out from that point. There is a gradual wealth transfer because the purchasing power of an individual’s wages and savings is being debased by price rises which are emanating as a result of this extra money being injected into the economy. What you’re doing, in effect, is making a few people wealthier by printing money and giving it to them first, but making the vast majority of people impoverished. To do this continuously guarantees that there is no economic recovery at all in the economies that suffer from this money printing. Stagflation is essentially the early stages of a price inflation that risks morphing into a hyperinflation. We have a situation today where there is so much debt around that it is impossible to conceive of a situation where the central banks could raise interest rates to a level that can slow down the switch in preference away from money and into goods.
A RISING CPI
There is going to be a huge reluctance on the part of central banks to tackle the situation. The CPI deliberately understates the increase in the general level of prices in the economy. If you had a true representation since the Lehman crisis, you would find that as a deflator on GDP, we would be showing negative growth since the Lehman crisis. Everyone is getting poorer from the wealth transfer effect resulting from printing money and credit.
The trend toward rising consumer prices is the legacy of all the stimulus we have seen today. It’s almost as if central bankers love the smell of inflation. They have this obsession with it, even though it’s destroying the middle class’ purchasing power.
Since Brexit, the Sterling has weakened considerably. If you look at producer prices, falls in producer prices have now reversed due to higher commodity prices and because of lower sterling. It reversed from -20% to +25% BPI inflation in Sterling. What will that do to the inflation rate in the UK in 2017? Businesses will go into recession, unemployment will rise, and we will likely to have headline inflation rates in excess of 5%.
EFFECT ON EQUITIES AND ASSETS
At the moment, bond markets are controlled by central banks because they can’t afford for there to be a bear market in bonds. At some stage, the market will win, and that would cause a very substantial rise in bond yields and a very substantial fall in equity prices. The UK has routinely 80% loaned value mortgages, so all the assets that have been puffed up and sustained since the Lehman crisis are at risk. When that market rigging starts cracking, it could be extremely expensive for anyone who has invested in conventional assets.
Since gold is an asset that cannot possibly default, prices tend to rise with inflation. Stagflation is an even better environment for gold because it will outshine equities dramatically. It is the best environment for gold outright, in price terms, and relative to stocks and bonds. Stagflation only occurs in the occasional economic cycle, and then those cycles that tend to be those that follow major crises. As an investor, you cannot responsibly create a portfolio for a stagflationary environment that does not have a material allocation to gold in it.
When you get inflation, you do get conventional markets being destabilized, and the social ramifications are extremely unsettling. We mustn’t look at this stagflation scenario in just the narrow terms of the financial effects; there are also social effects and it is the interplay of the social effects and the financial effects that make it worse for conventional assets.
HOW IS THIS TREND AFFECTED BY KEY ISSUES?
We need to understand how distressed the European banking system really is. It never materially recapitalized deleveraged anything after 2008. There have been all kinds of accounting shenanigans that have been deliberately engaging in structured transactions whose only purpose is to disguise the fact that they are under-capitalized vis a vis regulatory requirements. There is overwhelming but circumstantial evidence that even the biggest banks in Europe are in even worse shape than they were in 2008. The market is kind of telling you that they’ve figured this out, but the problem is that in a global economy, if one financial over-leverages and not capitalize itself properly, then you have these cross boarder linkages. It happened in the 1920s and 1930s, when an Austrian bank catalyzed a cascade of solvency issues and defaults across the entire world. If it could happen then, it could happen now.
If you look at the Italian situation, Italian non-performing loans, which are all in the private sector, are officially admitted at 40% of private sector GDP. It’s a very clear indication of the underlying state of the Italian economy and why almost 50% of youth are unemployed in Italy. The banks will go under, but the underlying situation is impossible as well.
Abstract by: Annie Zhou <a2zhou@ryerson.ca>
