Most people associate ‘inflation’ with rising prices, but the disease goes much deeper than that. Inflation is a phenomenon wherein money becomes so abundant it disrupts relative price formation and hence interferes with the vital transmission of information about the state of the countless interactions of supply and demand, plenty and scarcity, which take place on the market. As the fever rises, mistakes accumulate, conflicts intensify, timings clash, finances become stretched, and coherence is lost. A rising price is one thing. Prices -plural- rising at varying speeds and in an ever less predictable manner is a much more dangerous pathology.
An uneasy calm has descended on the markets since the end of the first quarter put a stop to the heavy liquidation in bonds and some gained the sense that commodities were perhaps a little overcooked. The rebalancing and retracements those two entailed could yet run further, but we very much doubt that we’ve seen the last of the inflationary wave.
The sell-off in Treasuries is causing a few conniptions and simultaneously provoking a spate of bearish comments. The higher the markets go without some sort of correction or consolidation, the riskier they get, but we don’t think bonds, per se, are yet enough to trigger a reversal
Though a lot of hot money was poured into the trade in the last quarter of 2020, there is still much reluctance on the part of economists – always prone to a spot of Under-consumption fallacy – to wholly embrace the idea that prices are beginning to rise and that the path ahead is likely to be an inflationary one. That path will inevitably not be smooth, nor its ascent uninterrupted, but it is hard to see where we slow the climb or take a different turning – or even that sufficient will exists to choose that alternative were it ever to come up on our satnav.
Inflation, Milton Friedman famously said, is a monetary phenomenon. But it is also one given the readiest of outlets through recourse to what we call ‘fiscal’ policy – i.e., by spendthrift governments borrowing money created at their call and forced into the system by means of warfare, welfare, contracting, cronyism, bureaucratic expansion and plain old boondogglery. Arguably, this is where we find ourselves today, in a world where supply is no longer likely to meet demand as abundantly and as effortlessly as has been the case these past twenty years.
China’s ports are humming, its exports booming to the point that it is causing evident stress in maritime trade. Freight rates are soaring and dockside space is becoming limited, threatening production and raising costs across the board. Despite the macro strength – and the vote of confidence this has received from forex and equity markets – the last few weeks have been testing ones in credit. Once more the nation’s vast superstructure of debt has creaked and groaned – but just about held firm, once more. One of these fine days…
Markets seem happy for now to focus on the carrot of a vaccine while ignoring the stick of the further severe restrictions to life and liberty being implemented while we await its delivery. Whether or not it offers a release from bondage, the state’s rediscovered taste for authoritarianism will, however, take some good time to dispel, while its corollary – the move toward taking an ever greater role amid the wreckage of the private economy – is being pursued with relish. Whatever the sloganizing, this is very unlikely to Build anything Back Better – only dearer and scarcer.
We ended the summer by saying that – barring another disastrous, COVID19-inspired, mass governmental embargo on everyday economic activity – the miners, makers, movers, and merchants of the things we need to run our lives when we are not scrolling through Instagram or pretending to pay attention to a yet another pointless Zoom conference would begin to make up ground lost in lockdown to the providers of such diversions. State interference would henceforth take other, more chronic forms of hindrance: tending deliberately to boost demand while making its satisfaction progressively more difficult. So far – broadly speaking – so good.
The ink has not even dried on the US ballot papers (!) but the Market already thinks it knows what this will all mean. And then there’s Pfizer’s vaccine announcement – perhaps similarly preliminary in nature – but, hey, the Herd will always take every silver lining it can find. Some of the themes we touched upon at the end of the Summer are still in play: Japan has been attracting money, non-oil commodities are rallying, gold has lost some lustre, bond yields are creeping higher, and Value may just be topping out at last v Growth.
On the eve of what is shaping up to be a particularly momentous US election, we offer our view of what is at stake – both in the markets and out in the real world, far beyond the flickering screens of the trading room.