Credit deflation and the reflation cycle to come (part 2)

[jamtomorrow]

45 minutes ago, JMD said:

For my sins i am a P2P investor - although hasten to add i am no longer active and am now divesting.

I'm curious @JMD, how are you finding the process of selling the loans? We pulled the experimental chunk we had in Zopa October time last year, but I was left with the impression their loan market was struggling for liquidity.

I still get their monthly emails because you have to hang onto the bad loans, and they say they've been bringing in "institutional" investors of late. I wonder what that really means.

[jamtomorrow]

45 minutes ago, DurhamBorn said:

Exactly,when consumers re-trench governments have to step in and governments drive inflation much more than consumers.

Is Rishi just going through the motions here, or (to borrow a cricketing metaphor) are they not quite getting up to the pitch of the ball yet? All seems a bit flat-footed for my liking.

https://inews.co.uk/news/politics/rishi-sunak-coronavirus-economic-recovery-fail-shops-541536

"Rishi Sunak: Covid-19 economic recovery will fail if public refuses to return to shops and restaurants"

[The_Doc]

From FT.

BP and Repsol are onto Jefferies’ “buy” list in a sector review:

Oil market fundamentals remain precarious but OPEC+ discipline and US declines should be supportive, and we raise our 2H Brent forecast to $43/bbl. We upgrade BP and REP to Buy and reinstate FP at Buy. Dividend risks are not off the table, but we believe valuation is supportive with the sector FCF yield at 8.3% on our 2021 estimates.

Balanced on the precipice. Oil market fundamentals remain precarious and in the near term we believe that oil price risk is skewed to the downside by COVID-19 demand risks and OPEC+ easing production cuts. Very high inventories and spare capacity approaching 11 mbd makes it unlikely that Brent can hold above $50/bbl until the latter half of 2021. However, OPEC+ has stared into the abyss of sub-$30 Brent, and we expect the group will take incremental oil off the market if prices move below $40/bbl. We also expect US production declines to continue given low activity levels and estimate that the exit rate of US liquids production in 2020 will be 2.8 mbd lower than 2019. We are thus raising our 2H20 Brent forecast to $43/bbl from $37/ bbl despite the near-term price risks. Our 2020/21 estimates are unchanged.

Risk on liquidity, if not dividends, lifted. The macro environment remains difficult but a prolonged period of sub-$30 Brent now seems unlikely. This does not mean that dividend risk is off the table, although liquidity risk likely is. The sector raised $80b in the capital markets in 2Q, and we update our proprietary company-specific liquidity analysis to reflect higher cash positions. Average net debt/capitalization will reach 27% at the end of the year, and the trade-off between dividends and balance sheet strength comes into focus. We are not including any dividend cuts in our forecasts, but we think there is a good chance that BP and ENI do cut; with BP, ENI and REP all yielding >10% we believe the market expects a cut.

Upgrade BP and REP. We have updated our price targets across the sector to now reflect a Brent price of $45/bbl in our terminal value calculations. We upgrade BP and REP to Buy and reinstate FP at Buy on valuation. On BP, this is the first time our team has ever upgraded a stock to Buy when the risk of an imminent dividend cut was possible, but we believe a cut of 65% is already priced into the stock. REP is the only company we expect to be cash generative this year, partially due to a ‘prefunded’ scrip dividend; we believe the 13% dividend yield is safe in the near term. FP, our top pick in Europe, has generated the most consistent results in the sector, and the FCF yield of 10.4% on our 2021 estimates provides strong coverage of the 7.8% dividend yield.

Messy 2Q. Our team has forecasted earnings for 72 quarters and 2Q20 seems the most difficult of them. Not only were price and margins depressed they were volatile which could mean big variances in realized prices depending on when a cargo was lifted in upstream, and negative inventory valuation swings in downstream. Upstream volumes were impacted by curtailments and OPEC+ production cuts, while downstream product sales and refinery utilization collapsed at the beginning of the quarter before recovering to still-low levels by the end.

[sancho panza]

7 hours ago, Harley said:

My canary just pegged it. 

The liquidity phase, then blow off phase, now the solvency phase commeth, starting with the upstream consumer.  But how will "they" deal with this, especially in an election year? Time for something new and new normal "kind"?  Jubilee, bad bank, etc?

I agree,I look at the unemployment data out of the USA and it's horrific.AUstralia/UK/EU either gotten worse or heading there soon.

Headline figures hide a raft of udnerlying changes.As I was positing yesterday,I look at some shares in teh FTSE 100 and wonder who the hell is buying them eg Ferguson,BKGH,Ocado(£20 ffs) etc etc.

Key thing here is that teh confidence in the S&P 500 is fake news.

Whislt I'm long oil/gold/potash/utilies,I wouldn't touch much else.Interesting piece here

I'm going to say this but yesterday I was genuinely thinking about buying some out of the moeny puts on certain US techies.....

hattip Steve Kaplan

https://thefelderreport.com/2020/07/08/what-were-you-thinking-part-deux/?mc_cid=07c9487d74&mc_eid=f26c812ac8

A couple of years ago I wrote a blog post titled, ‘What Were You Thinking?’ in reference to a famous Scott McNeely quote from the aftermath of the Dotcom bust:

At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?

McNeely was the Founder and CEO of Sun Microsystems, one of the most popular and most overvalued stocks during the height of the stock market mania that peaked 20 years ago. He saw his stock price rise from $10 in the beginning of 1999 to over $60, and over 10-times revenues as he notes, at its peak just a year later and then fall back under $10 over the next two years. In other words, he had a front row seat in the roller coaster that was the Dotcom bubble and so his thoughts on the episode are especially interesting.

Even more interesting, however, may be the fact that only a few months ago there were even more companies within the S&P 500 Index that trade above this “ridiculous” valuation level than there were back in 2000 (thank you Tobias Carlisle and AcquirersMultiple.com for providing the data). What’s more, even as we find ourselves in the midst of the worst economic crisis in modern history, there are still more stocks that trade above 10-times revenues today (37) than there were in March of 2000 (30), the month the Nasdaq put in its infamous peak before falling 75% over the subsequent two years.

Now that we are entering earnings season, these numbers could get even more interesting. With the Nasdaq at new highs and sales for S&P 500 companies expected to fall 11.1% in the second quarter (according to Factset), there’s a good chance we could set a new record set for the number of components trading above 10-times revenues. And at some point, we will look back on this time and ask newbie day traders and passive investors alike, “what were you thinking?”

[sancho panza]

another kaplan tip shwoing all the liquity in the pipes as per @DurhamBorn predictions

https://thehill.com/opinion/finance/504702-the-feds-reckless-experiment#

'The quantity theory of money, the view that the money supply is the key determinant of inflation, is dead, or today’s mainstream economists tell us. The Federal Reserve is now engaged in a policy that will either put the nail in the quantity theory’s coffin or restore it to the textbooks. Sadly, if the theory is alive and wins out, the economy is in for a very rough ride.

The theory has had a long history of evidence in its support. In earlier times new gold discoveries, the source for old-fashioned money, produced inflation. Years later, in the early 1970s, Milton Friedman warned President Richard Nixon about expanding the money supply. His advice fell on deaf ears, and Nixon proceeded to pressure Arthur Burns, then chair of the Federal Reserve, to “goose” the money supply.

A horrendous decade of inflation followed as the Fed feebly applied its policy tools to avoid recession. Despite this, two recessions occurred, and the inflation rate worsened throughout the decade. It took Paul Volcker in 1980 to really slam on the money-supply brakes to get the inflation under control. Interest rates soared; the economy dropped into a serious recession, but inflation’s back was finally broken.

ADVERTISEMENT

After the inflation of the 1970s, economic thinking about monetary policy gradually started to change partly due to financial innovations such as money market mutual funds, which made identifying what counted as money unclear. The Fed shifted to setting interest rates as its preferred policy tool to manage national spending and inflation. Interest in measuring and watching the money supply waned.

The relatively low and stable inflation rate over the last four decades has given support for the Fed’s decision to focus on interest-rate manipulation. However, if we look at money-supply growth over the same period, using a traditional measure of money called M2, we observe that the money supply also grew at a modest and steady rate. Quantity theorists could claim that this supports their position. 

So who is right? The Fed’s latest policies should put the issue to rest. But this may be a very costly experiment.

In the 49 days ending June 8, the money supply (M2) has increased by $1,018.6 billion. To put this into perspective, the money supply grew by $921 billion in all of 2019. The Fed is “goosing” the money supply at rates previously thought foolhardy by any quantity theorist worth their salt. When will the wait for evidence in the experiment end? Milton Friedman would have said to give it six months to a year or even more. The lags are long and variable, he noted.

The Fed has taken a recession caused by a government-forced shutdown and applied its traditional demand-management tools to stimulate employment. This amounts to beating a dead horse. As the shutdown eases, employment will recover, as the early evidence suggests. The Fed’s wild purchase of financial assets, the cause of the exploding money supply, is great for financial markets in the short term, but its effect on employment is likely to be negligible if labor supply restrictions persist. Rather, if the Fed’s experiment reignites inflation, we can expect a long and difficult path forward. 

ADVERTISEMENT

There is still time for the Fed to reverse course, throttle back the money printing press, and hold down inflation. But this is a presidential election year, and cooling the financial market boom would not sit well in certain government circles. On June 10, Chairman Jerome Powell announced that the Fed would do “whatever we can for whatever it takes” to support the economy. Reversal may be a long time coming. 

 

Is the quantity theory dead? Did the Fed go too far for too long? Stay tuned.'

[Chewing Grass]

13 minutes ago, sancho panza said:

I agree,I look at the unemployment data out of the USA and it's horrific.AUstralia/UK/EU either gotten worse or heading there soon.

We have swept it under the carpet by rebranding it as furlough and giving the can a big kick.

[Errol]

56 minutes ago, jamtomorrow said:

Is Rishi just going through the motions here, or (to borrow a cricketing metaphor) are they not quite getting up to the pitch of the ball yet? All seems a bit flat-footed for my liking.

https://inews.co.uk/news/politics/rishi-sunak-coronavirus-economic-recovery-fail-shops-541536

"Rishi Sunak: Covid-19 economic recovery will fail if public refuses to return to shops and restaurants"

They aren't going to return because the pandemic isn't over. We are still in it. People are now getting ready for the winter when phase 2 starts.

The virus causes serious long-term conditions even for some mild sufferers and very little is known about it. Until there is a vaccine there will be no return to any normality.

[Bricks & Mortar]

Russell Napier.  Seems to be a 'straight to inflation' sort of guy.

https://themarket.ch/interview/russell-napier-central-banks-have-become-irrelevant-ld.2323?mktcid=smsh&mktcval=Twitter

[stoobs]

In terms of tax generation tools, reducing contribution allowances for ISAs has been mentioned, but a more radical approach would be to completely scrap them. You still own everything you did yesterday but the tax wrapper has vanished.

Depends how much the Government is struggling to make the sums work.

[jamtomorrow]

1 hour ago, Errol said:

They aren't going to return because the pandemic isn't over. We are still in it. People are now getting ready for the winter when phase 2 starts.

The virus causes serious long-term conditions even for some mild sufferers and very little is known about it. Until there is a vaccine there will be no return to any normality.

Agree. And therefore wondering why our Chancellor is wasting precious time, opportunity and political capital on empty gestures and dead ends.

This is one of my overriding concerns with DB's thesis - it assumes some basic competence in statecraft and, specifically, for UK Treasury to get to the pitch of the ball on industrial policy. Whereas we seem to be charging the resuscitator to 11 ready to give the corpse of the consumer yet another jolt (with apologies to SP for the professional outrage!)

[kibuc]

Is anyone here using Investing.com portfolio for price tracking, and has anyone noticed some bonkers reporting of daily price changes? It's been another day in the row when I'm watching SILJ posting +2% ish while most or all of it's top 10 constituents are down on the day. It's only after clicking into details when I can see that it's +2% over some arbitrary level that is netiher the yesterday's closing price nor the price 24h ago (which would be little use anyway).

Right now it reports a price of $13.21 for +1.69% (+$0.21) gain over the "previous" price of $13. The current price is correct, but the yesterday's close was at $13.27 and the index is currently down 0.38%, which Google correctly reports. $13 is just a red line on the chart that seems to have been placed as a point of reference for no reason.

[AWW]

2 hours ago, Errol said:

They aren't going to return because the pandemic isn't over. We are still in it. People are now getting ready for the winter when phase 2 starts.

The virus causes serious long-term conditions even for some mild sufferers and very little is known about it. Until there is a vaccine there will be no return to any normality.

I just don't see a second wave happening.

1. We've had the BLM protests and the pubs have been open for getting on for two weeks. The first thing you'd expect to see to indicate a second wave is an increase in calls to NHS 111.  However, enquiries to NHS 111 haven't budged: https://digital.nhs.uk/dashboards/nhs-pathways
   
2. The original SARS pandemic was largely over within three months. Covid-19 is 70% the same virus:
   
3. New research shows that T-cells, rather than antibodies, provide long-term protection from a number of coronaviruses, Covid-19 included. Early indications are that around half the population are already carrying immunity thanks to T-cells. From https://www.nature.com/articles/s41586-020-2550-z 

   Quote

   "We then showed that SARS-recovered patients (n=23) still possess long-lasting memory T cells reactive to SARS-NP 17 years after the 2003 outbreak, which displayed robust cross-reactivity to SARS-CoV-2 NP. Surprisingly, we also frequently detected SARS-CoV-2 specific T cells in individuals with no history of SARS, COVID-19 or contact with SARS/COVID-19 patients (n=37)."

   This isn't the Spanish Flu. It's not influenza. There won't be a second wave.

[janch]

1 hour ago, Bricks & Mortar said:

Russell Napier.  Seems to be a 'straight to inflation' sort of guy.

https://themarket.ch/interview/russell-napier-central-banks-have-become-irrelevant-ld.2323?mktcid=smsh&mktcval=Twitter

Thanks for posting and ties in well with this thread:

..... broad money growth is created by governments intervening in the commercial banking system. Governments tell commercial banks to grant loans to companies, and they guarantee these loans to the banks. This is money creation in a way that is completely circumventing central banks. So I make two key calls: One, with broad money growth that high, we will get inflation. And more importantly, the control of money supply has moved from central bankers to politicians. Politicians have different goals and incentives than central bankers. They need inflation to get rid of high debt levels. They now have the mechanism to create it, so they will create it.

He maintains that governments are now in control rather than the banks.

[sancho panza]

1 hour ago, kibuc said:

Is anyone here using Investing.com portfolio for price tracking, and has anyone noticed some bonkers reporting of daily price changes? It's been another day in the row when I'm watching SILJ posting +2% ish while most or all of it's top 10 constituents are down on the day. It's only after clicking into details when I can see that it's +2% over some arbitrary level that is netiher the yesterday's closing price nor the price 24h ago (which would be little use anyway).

Right now it reports a price of $13.21 for +1.69% (+$0.21) gain over the "previous" price of $13. The current price is correct, but the yesterday's close was at $13.27 and the index is currently down 0.38%, which Google correctly reports. $13 is just a red line on the chart that seems to have been placed as a point of reference for no reason.

Yeah,use it many multiple times a day.I've noticed reporting of ETF's relating to PM miners has become virtualy worthless of late such that I only looked because you psoted on the matter..See below todays HUI

[JMD]

4 hours ago, jamtomorrow said:

I'm curious @JMD, how are you finding the process of selling the loans? We pulled the experimental chunk we had in Zopa October time last year, but I was left with the impression their loan market was struggling for liquidity.

I still get their monthly emails because you have to hang onto the bad loans, and they say they've been bringing in "institutional" investors of late. I wonder what that really means.

I'm in several p2p's, but mostly in AssetzCapitol. Its slow going, but I could speed things up by taking an optional say 10% haircut (actually you decide the level of discount depending on how quickly you want to shift the loan) when selling, but i haven't done that yet. The institutional money moving into this space is an interesting phenomena, and i'm hoping it is 'smart-money' as opposed to 'dumb-money', and will help stabilise the loan paltform market in the very short-term.

     

[sancho panza]

3 hours ago, Bricks & Mortar said:

Russell Napier.  Seems to be a 'straight to inflation' sort of guy.

https://themarket.ch/interview/russell-napier-central-banks-have-become-irrelevant-ld.2323?mktcid=smsh&mktcval=Twitter

Sorry for the full repost but this is too good to remain behind a link..Napier has a fan base on here.Either that or @Harley has a jock accent and a beard.More support for DB's inflation via the govt thesis(at times you'd think Napier has been reading it)

Also @MrXxxx and @jamtomorrow that he sees the main driver of infaltion as a return of velocity which has been discussed on here since the first pages.

In bold is the questions,underlines are my highlights.

 

 

 

'Mr. Napier, for more than two decades, you have said that investors need to position themselves for disinflation and deflation. Now you warn that we are in a big shift towards inflation. Why, and why now?

It’s a shift in the way that money is created that has changed the game fundamentally. Most investors just look at the narrow money aggregates and central bank balance sheets. But if you look at broad money, you notice that it has been growing very slowly by historical standards for the past 30 or so years. There were many factors pushing down the rate of inflation over that time, China being the most important, but I do believe that the low level of broad money growth was one of the factors that led to low inflation.

And now this has changed?

Yes, fundamentally. We are currently in the worst recession since World War II, and yet we observe the fastest growth in broad money in at least three decades. In the US, M2, the broadest aggregate available, is growing at more than 23%. You’d have to go back to at least the Civil War to find levels like that. In the Eurozone, M3 is currently growing at 8,9%. It will only be a matter of months before the previous peak of 11.5% which was reached in 2007 will be reached. So I’m not making a forecast, I just observe the data.

Why is this relevant?

This is the big question: Does the growth of broad money matter? Investors don’t think so, as breakeven inflation rates on inflation-linked bonds are at rock bottom. So clearly the market does not believe that this broad money growth matters. The market probably thinks this is just a short-term aberration due to the Covid-19 shock. But I do believe it matters. The key point is the realization who is responsible for this money creation.

In what way?

This broad money growth is created by governments intervening in the commercial banking system. Governments tell commercial banks to grant loans to companies, and they guarantee these loans to the banks. This is money creation in a way that is completely circumventing central banks. So I make two key calls: One, with broad money growth that high, we will get inflation. And more importantly, the control of money supply has moved from central bankers to politicians. Politicians have different goals and incentives than central bankers. They need inflation to get rid of high debt levels. They now have the mechanism to create it, so they will create it.

In the aftermath of the Global Financial Crisis, central banks started their quantitative easing policies. They tried to create inflation, but did not succeed.

QE was a fiasco. All that central banks have achieved over the past ten years is creating a lot of non-bank debt. Their actions kept interest rates low, which inflated asset prices and allowed companies to borrow cheaply through the issuance of bonds. So not only did central banks fail to create money, but they created a lot of debt outside the banking system. This led to the worst of two worlds: No growth in broad money, low nominal GDP growth and high growth in debt. Most money in the world is not created by central banks, but by commercial banks. In the past ten years, central banks never succeeded in triggering commercial banks to create credit and therefore to create money.

If central banks did not succeed in pushing up nominal GDP growth, why will governments succeed?

Governments create broad money through the banking system. By exercising control over the commercial banking system, they can get money into the parts of the economy where central banks can’t get into. Banks are now under the control of the government. Politicians give credit guarantees, so of course the banks will freely give credit. They are now handing out the loans they did not give in the past ten years. This is the start.

What makes you think that this is not just a one-off extraordinary measure to fight the economic effects of the pandemic?

Politicians will realize that they have a very powerful tool in their hands. We saw a very nice example two weeks ago: The Spanish government increased their €100bn bank guarantee program to €150bn. Just like that. So there will be mission creep. There will be another one and another one, for example to finance all sorts of green projects. Also, these loans have a very long duration. The credit pulse is in the system, a pulse of money that doesn’t come back for years. And then there will be a new one, and another one. Companies won’t have any incentive to pay back these cheap loans prematurely.

So basically what you’re saying is that central banks in the past ten years never succeeded in getting commercial banks to lend. This is why governments are taking over, and they won’t let go of that tool anymore?

Exactly. Don’t forget: These are politicians. We know what mess most of the global economy is in today. Debt to GDP levels in most of the industrialized world are way too high, even before the effects of Covid-19. We know debt will have to go down. For a politician, inflation is the cheapest way out of this mess. They have found a way to gain control of the money supply and to create inflation. Remember, a credit guarantee is not fiscal spending, it’s not on the balance sheet of the state, as it’s only a contingent liability. So if you are an elected politician, you have found a cheap way of funding an economic recovery and then green projects. Politically, this is incredibly powerful.

A gift that will keep on giving?

Yes. Treason May made a famous speech a few years ago where she said there is no magic money tree. Well, they just found it. As an economic historian and investor, I absolutely know that this is a long-term disaster. But for a politician, this is the magic money tree.

But part of that magic money tree is that governments keep control over their commercial banking system, correct?

Yes. I wrote a big report in 2016 titled «Capital management in the age of financial repression». It said the final move into financial repression will be triggered by the next crisis. So Covid-19 is just the trigger to start an aggressive financial repression.

Are you expecting a repeat of the financial repression that dominated the decades after World War Two?

Yes. Look at the tools that were used in Europe back then. They were all in place for an emergency called World War II. And most countries just didn’t lift them until the 1980s. So it’s often an emergency that gives governments these extreme powers. Total debt to GDP levels were already way too high even before Covid-19. Our governments just know these debt levels have to come down.

And the best way to do that is through financial repression, i.e. achieving a higher nominal GDP growth than the growth in debt?

That’s what we have learned in the decades after World War II: Achieve higher nominal GDP growth through higher rates of inflation. The problem is just that most active investors today have had their formative years after 1980, so they don’t know how financial repression works.

Which countries will choose that path in the coming years?

Basically the entire developed world. The US, the UK, the Eurozone, Japan. I see very few exceptions. Switzerland probably won’t have to financially repress, but only because its banking system is not in the kind of mess it was in in 2008. Government debt to GDP in Switzerland is very low. Private sector debt is high, but that is mainly because of your unique treatment of taxation for debt on residential property. So Switzerland won’t have to repress, neither will Singapore. If Germany and Austria weren’t part of the Eurozone, they wouldn’t have to repress either. Of course there is one catch: If the Swiss are not going to financially repress, you will have the same problem you had for a long time, namely far too much money trying to get into the Swiss Franc.

So we will see more upward pressure on the Franc?

Yes. But financial repression has to include capital controls at some stage. Switzerland will have to do more to avoid getting all these capital inflows. At the same time, other countries would have to introduce capital controls to stop money from getting out.

The cornerstones of the last period of financial repression after World War II were capital controls and the forcing of domestic savings institutions to buy domestic government bonds. Do you expect both of these measures to be introduced again?

Yes. Domestic savings institutions like pension funds can easily be forced to buy domestic government bonds at low interest rates.

Are capital controls really feasible in today’s open financial world?

Sure. There are two countries in the Eurozone that have had capital controls in recent history: Greece and Cyprus. They were both rather successful. Iceland had capital controls after the financial crisis, many emerging economies use them. If you can do it in Greece and Cyprus, which are members of the European Monetary Union, you can do it anywhere. Whenever a financial institution transfers money from one currency to another, it is heavily regulated.

What’s the timeline for your call on rising inflation?

I see 4% inflation in the US and most of the developed world by 2021. This is primarily based on my expectation of a normalization of the velocity of money. Velocity in the US is probably at around 0.8 right now. The lowest recorded number before that was 1.4 in December 2019, which was at the end of a multi-year downward trend. Quantitative easing was an important factor in that shrinking velocity, because central banks handed money to savings institutions in return for their Treasury securities. And all the savings institutions could do was buy financial assets. They could’t buy goods and services, so that money couldn’t really affect nominal GDP.

What will cause velocity to rise?

The money banks are handing out today is going straight to businesses and consumers. They are not spending it right now, but as lockdowns lift, this will have an impact. My guess is that velocity will normalize back to around 1.4 some time next year. Given the money supply we have already seen, that would give you an inflation rate of 4%. Plus, there is no reason velocity should stop at 1.4, it could easily rise above 1.7 again. There is one additional issue, and that is China: For the last three decades, China was a major source of deflation. But I think we are at the beginning of a new Cold War with China, which will mean higher prices for many things.

Most economists say there is such a huge output gap, inflation won’t be an issue for the next three years or so.

I don’t get that at all. You can point to the 1970s, where we had high unemployment and high inflation. It’s a matter of historical record that you can create inflation with high unemployment. We have done it before.

The yield on ten year US Treasury Notes is currently at around 60 basis points. What will happen to bond yields once markets realize that we are heading into an inflationary world?

Bond yields will go up sharply. They will rise because markets start to realize who is controlling the supply of money now, i.e. not central banks, but politicians. That will be the big shock.

For a successful financial repression, governments and central banks will need to stop bond yields from rising, won’t they?

Yes, and they will. But let me be precise: It will be governments who will act to stop bond yields from going up. They will force their domestic savings institutions to buy government bonds to keep yields down. The bit of your statement I disagree with is that central banks will put a cap on bond yields. They won’t be able to.

Why not? Even the Fed is toying with the idea of Yield Curve Control, an instrument they successfully used between 1942 and 1951, when they capped yields at 2.5%.

I think this is a bad parallel, because from 1942 to 1951, we also had rationing, price controls and credit controls. With that in place, it was easy for the Fed to cap Treasury yields. Yield Curve Control is easy when everyone is expecting deflation, which the current policy of the Bank of Japan shows. But once market participants start to expect inflation, they will all want to sell their bonds. The balance sheet of the central banks will just balloon to the sky. They would be spreading fuel on the fire, given that their balance sheets would expand with rising inflation expectations. Yield Curve Control in an environment of rising inflation expectations is not going to happen.

You are saying that governments now control the supply of money, and it will be governments who will make sure policies of financial repression are successfully implemented. What will be the future role of central banks?

They will be sidelined. They will become more a regulatory than a monetary organization. The next few years will be fascinating. Imagine, you and I are running a central bank and we have a 2% inflation target. And we see our own government print money with a growth rate of 12%. What are we going to do to fulfill our mandate of price stability? We would have to threaten higher interest rates. We would have to ride a full-blown attack on our democratically elected government. Would we do that?

Paul Volcker did in the early 80s.

Yes. But Paul Volcker had courage. I don’t think any of today’s central bankers will have the guts to do that. After all, governments will argue that there is still an emergency given the shocks of Covid-19. There is a good parallel to the 1960s, when the Fed did nothing about rising inflation, because the US was fighting a war in Vietnam, and the administration of Lyndon B. Johnson had launched the Great Society Project to get America more equal. Against that background of massive fiscal spending, the Fed didn’t have the guts to run a tighter monetary policy. I can see that’s exactly where we are today.

So central banks will be mostly irrelevant?

Yes. It’s ironic: Most investors believe in the seemingly unlimited power of today’s central banks. But in fact, they are the least powerful they have ever been since 1977.

As an investor, how do I protect myself?

European inflation-linked bonds are pretty attractive now, because they are pricing in such low levels of inflation. Gold is obviously a go-to asset for the long term. In the next couple of years, equities will probably do well. A bit more inflation and more nominal growth is a good environment for equities. I particularly like Japanese equities. Obviously you wouldn’t buy government bonds under any condition.

How about commodities?

In a normal inflationary cycle, I’d recommend to buy commodities. There is just one complicating factor with China. If we really enter into a new Cold War with China, that will mean big disturbances in commodities markets.

You wrote in the past that there is a sweet spot for equities up to an inflation rate of 4%, before they tip over. Is this still valid?

Yes, this playbook is still in place. But once governments truly force their savings institutions to buy more government bonds, they will obviously have to sell something. And that something will be equities. Historically, inflation above 4% hasn’t been too good for equities.

How high do you see inflation going?

If we’re taking the next 10 years, I see inflation between 4 and 8%, somewhere around that. Compounded over ten years, combined with low interest rates, this will be hugely effective in bringing down debt to GDP levels.

In which country do you see it happening first? Who will lead?

The one I worry about the most is the UK. It has a significant current account deficit, it has to sell lots of government bonds to foreigners. I never really understood why foreigners buy them. I wouldn’t. Now we have Brexit coming up, which could still go badly. I don’t think it will, but it could. So we would see a spike in bond yields in the UK.

What will it take for an investor to successfully navigate the coming years?

First, we have to realize that this is a long term phenomenon. Everyone is so caught up in the current crisis, they miss the long term shift. This will be with us for decades, not just a couple of years. The financial system is a very different place now. And it’s a very dangerous place for savers. Most of the skills we have learned in the past 40 years are probably redundant, because we have lived through a 40 year disinflationary period. It was a period where markets became more important and governments less important. Now we are reversing that. That’s why I recommend to my clients that they promote the people from their emerging markets departments to run their developed world departments. Emerging markets investors know how to deal with higher levels of inflation, government interference and capital controls. This will be our future.

Russell Napier

 

[sancho panza]

1 hour ago, AWW said:

I just don't see a second wave happening.

1. We've had the BLM protests and the pubs have been open for getting on for two weeks. The first thing you'd expect to see to indicate a second wave is an increase in calls to NHS 111.  However, enquiries to NHS 111 haven't budged: https://digital.nhs.uk/dashboards/nhs-pathways
   
2. The original SARS pandemic was largely over within three months. Covid-19 is 70% the same virus:
    

   This isn't the Spanish Flu. It's not influenza. There won't be a second wave.

Good psot AWW

I'm not even sure there's been a pandemic.If we go a year out and look back at average excessdeath rates going back 20 years and adjsut for population,I think we might be surprised by lack of a big hike in 2020 compared to tohters.

Reasons for this are numerous,not least that many deaths have been certified as covid when they weren't.

Also that previous flu years have seen a lot more deaths-there are some that argue the main differnce between covid and a bad flu year is that the covid peak was march/April rather than the normal Dec/Jan.

Also that a large part of the increase in deaths currently(and likely going forward) is down to the rahter questionable policy of emptying hospitals of sick people who promptly were sent home and died.

I won't even start on the stopping of cancer treatments and testing.

Gotta go and start cooking kids dinner.Interesting turn of converstaion.

 

 

@kibuc, sold top ladder in NCM today and used the proceeds for some Fiore.Jsut a FOMO trade,I won't add any more unless they pull back big time.You did well there to be fair.

 

[Chewing Grass]

10th of August 6 a.m.

Its a Saturday to give people two days to straighten their knickers.

[Hardhat]

Interesting article there @sancho panza

Question: if I wanted to buy 2030 index linked bonds, what should I search for in AJ Bell?

[reformed nice guy]

1 hour ago, Chewing Grass said:

10th of August 6 a.m.

Its a Saturday to give people two days to straighten their knickers.

uh?

[Chewing Grass]

4 minutes ago, reformed nice guy said:

uh?

Was waiting for that, -20%.

[AQUAMAN]

netflix just tanked 10% apparently

[Errol]

6 hours ago, AWW said:

I just don't see a second wave happening.

We haven't dealt with the first wave yet. US cases totally out of control. India - totally out of control. Russia - barely controlled. Spain - reports steepest rise in cases in months (https://www.theguardian.com/world/live/2020/jul/16/coronavirus-live-news-fauci-says-us-must-stop-nonsense-south-africa-cases-top-300000) etc etc.

UK will see a gradual and then large increase in cases as lock down eases. Health Secretary already admitted to dealing with 'hundreds' of outbreaks that they forgot to tell the media about.

2nd Wave will come in late October/November.

Covid also has horrendous long term impacts even for those who have had mild cases in may instances. You simply don't want to catch this.

[AWW]

7 minutes ago, Errol said:

UK will see a gradual and then large increase in cases as lock down eases.

But we've already eased lockdown and haven't seen any increase whatsoever, using the proxy of NHS 111 calls. Obviously, there is the possibility that deaths will start to tick up over the next fortnight or so. Do you think 111 calls are now a poor indicator, that people just won't bother calling and just assume they have Covid-19?

I'm not a virologist, so please point out any false assumptions I've made. It would also be good for people to share their own indicators. I'm only really interested in the UK picture.

[logana]

Every virus mutates, it is part of a virus life cycle. This means corona will become less deadly. So there will be a second wave but not as many serious cases or deaths.

That is what a doctor friend told me; his hospital have already prepared for the second wave, they are just waiting for the damn PPE