The game between prices and rates that ensnares America
The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds
If Rudolf von Havenstein, governor of the Reichsbank, had spent the last year of his life repeating that the German inflation that started in the summer of 1922 was a temporary phenomenon, he would have said a correct thing. He would also have had time (he died on November 20, 1923) to see the first effects of the monetary stabilization that started on November 12 with the divorce between the Reichsbank and the Treasury and continued on November 16 with the introduction of the new mark, equivalent to the old one but with 12 zeros less.
The German hyperinflation lasted only 18 months and everything returned relatively quiet in 1924. In 1925 a relief plan was decided for creditors who had seen the value of their assets practically zero. The holders of government bonds were reimbursed 2.5 per cent of the nominal. It went better for the lenders, for whom a new equivalent was established equal to a quarter of that initially agreed. It went very well for the borrowers and debtors in general, who were able to repay, in real terms, a fraction of the amount owed.
Havenstein had been forced to print paper marks to purchase the gold marks with which Germany had to pay war reparations. The German economy, he said, still needed more money, even after repairs. Havenstein was influenced by the Chartalist theories that had been circulating in Germany as early as 1905, the year in which Georg Friedrich Knapp's Staatliche Theorie des Geldes was published. Money, the Chartalists said, was not born as a practical remedy for the inconveniences of bartering, but was imposed by the sovereign. The sovereign gives value to paper money, fiat money, when he imposes it on his subjects for the payment of taxes.
MMT is a descendant of Chartalism and defines itself as a neo-Chartalist. Neither Chartalism nor MMT openly theorize inflation, but it is inherent in them the idea that money, as a pure legal creature, has nothing objective (as it happens in metallism) and can be freely used to achieve objectives. ultimately politicians. Inflation, and even more so hyperinflation, are an abuse of this freedom, which however remains extensive.
Returning to our times, we can say that inflation, beyond a certain level, is always temporary. When this level is exceeded, in fact, the economy first indexes and then dollarizes. In Argentina and Turkey it is allowed to hold dollar accounts to guard against inflation in the local currency. The state pays wages and accepts taxes in local currency, but allowing residents to hold dollar accounts avoids capital flight. In countries where holding dollars is illegal, the dollar is still a measure of value. If I sell a house in Venezuela, where inflation in Bolivares is 50 percent per month, the price is set in dollars. If I am paid in a year, the buyer will give me local currency at the exchange rate with the dollar at the moment when he pays off the debt. Inflation therefore exists only in the local currency. In dollars, inflation does not exist and there can also be deflation if the economy, as generally happens in hyperinflation phases, is in recession.
However, the fact that inflation is temporary does not mean that it is harmless. In recent weeks the idea of a short-lived anomalous wave is circulating a lot, after which the sea will return to calm. All right, then, and let's not be distracted by 4.2 percent year-over-year US inflation. However, even if we were certain that inflation will fall in the next 12 months, let's say, at the end of two years, we will have lost 7% of purchasing power on dollars. And it will be 7 percent lost forever, impossible to recover unless, in subsequent years, prices do not drop by the same amount in absolute value.
Investors will also have to take into account the pincer created by the combined effect of inflation on the one hand and the increased taxation on capital gains under discussion in many countries. With inflation of 5 and a total tax of 50, the portfolio should be made to return 10 per cent per year just to keep its purchasing power unchanged.
But what are the actual outlook for inflation in the next period? With the bottlenecks in supply chains and the rise in the price of raw materials, we can say that there is still a lot of tension to be gradually discharged downstream. Think of cars. Production reductions caused by semiconductor supply difficulties are driving up second-hand prices quickly.
In theory, firms could absorb the increase in costs by accepting a reduction in margins, but demand in reopening economies is very buoyant. Companies will therefore increase their list prices.
What about wage inflation? The very disappointing data on new employees in the United States has opened a debate. For some it is the fault of companies that are unwilling to offer more to attract workforce. For others it is the fault of federal and state unemployment benefits that discourage job seekers, especially for those who, returning to work, in addition to giving up benefits should also pay gasoline (higher) for travel and babysitting for their children.
For some, therefore, the subsidies must be reduced immediately (some republican states are already doing so) but for others the persistence of a high number of unemployed could justify their further extension, in order to push companies to increase the wages offered. In practice, the question is still open.
In Europe, inflation is still calm. Unemployment benefits are on average less generous and the reopening has just begun. We will also see some upward pressure in the coming months, but in a more limited form.
After the bad data on US inflation, the stock markets instinctively reacted with a fall. However, the relationship between inflation and stock exchanges is not direct, but passes through rates. Historically, rising inflation brings with it rates and, due to rising rates, causes a contraction of stock market multiples.
If, however, rates do not rise, because they are held down by the central bank, there is no reason, beyond a temporary discontent, for a structural decline in the stock exchanges. The Fed, for its part, is doing everything to find reasons not to touch not only rates, but also the level of purchases of securities, even at the cost of climbing on the glass and invoking the variants of the virus that could plunge us back into the crisis.
Furthermore, from the point of view of the stock exchanges, it is preferable for companies to pass on the increase in their costs downstream (even if this causes consumer inflation). The alternative, sacrificing margins, would be more penalizing for stock prices.
More inflation and firm rates should bring the dollar down. However, waiting for an anticipated US rate hike at the end of 2022 and the idea that European fiscal and monetary measures are not much less expansionary than American ones are holding back the decline. The real difference, moreover, is between America and Europe on the one hand and China on the other. China is the only region that is adopting both macro and micro orthodox policies. Ten-year Chinese stocks continue to perform better than all the others and are the only ones that will be able to offer capital gains in the coming months.
Rising inflation will lead us to suggest a reduction in equity exposure only when it brings interest rates or, at least, a reduction in central bank purchases of securities. For now, it is better to stay invested and bear the summer volatility without too much anxiety.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/primo-piano/prezzi-tassi-inflazione-stati-uniti/ on Sun, 16 May 2021 06:00:02 +0000.