Every government intervention creates unintended consequences, which lead to call for further government interventions
- Ludwig Von Mises
The main thought bubble for this outlook is that the gargantuan current effort by policymakers to simultaneously solve the three major generational challenges: inequality, the green transformation and infrastructure, will come at a high price in the shape of inflation, a higher marginal cost of capital, and the realisation that they need to be prioritised separately.
The big change in economics and politics since the pandemic has been that, to a greater or lesser degree, governments globally recognise that we have transitioned to an era of fiscal stimulus forever. This sits in diametric opposition to the “frugal 2010s” where most government and central banks fooled themselves into believing that fiscal deficit and monetary policy normalisation were possible. In short, the days of believing that the economy can revive on credit creation through tinkering with the price of money and relying on the banking system and a focus on mere financial stability are over. Monetary heroin has nearly killed the real economy patient while making financial assets as high as a kite. After years of neglect, the real economy now needs a proper dose of steroids. This means we are undergoing a violent switch in focus by policymakers away from financial stability and toward social stability. Monetary policy is now the mere lapdog of what some have dubbed “fiscal dominance”.
Fiscal dominance is the response to democracy under attack after decades of rising inequality that has broken the social contract. The Covid pandemic was the straw that broke the previous paradigm’s increasingly vulnerable back, as the response supercharged the “K-shaped” tendency in every recovery since the 1980s, in which the wealthiest and the highest-earning incumbents reaped the lion’s share of the rewards. In the recovery from here, policymakers will focus the bulk of their efforts and stimulus toward rewarding the lower half of economic K, in an attempt to flip the K into a mirror image of itself and close the gap. This has enormous consequences for society and for markets.
We can call it the Social Stability Paradigm: the model for saving democracy – this is particularly true in the US, where the K-shaped distortions are the worst in the developed world. Simply put, the new mantra is to print and spend as much money as possible while rates and inflation are low. It seems so easy at first, but we need to make sure to reflect on the consequences of this new policy, particularly the unintended ones, like galloping inflationary risks.
Sometimes being old has its advantages, as no one under 50 can even recall what it is like to live in an inflationary world, and no investment professional under the age of perhaps 70 can recall the same.
I was young back then and can vividly remember the Car Free Sundays in Denmark during the OPEC crisis, how my parents struggled to make their payments on their 18% mortgages, and (less so in Denmark than in the US) how the government was constantly raising pay and devaluing the currency. And the income taxes! The marginal tax rate was still 70% in the US until Reagan’s changes in the early 1980s, once inflation was subsiding and the public debt had been devalued by inflation. In Sweden it reached an amazing level of 102% (Astrid Lindgren) in the same time frame.
‘We are getting close to the abyss’ became a cry to action.
The 1970s also saw the end of Bretton Woods, which began breaking down when Nixon fully removed the USD-gold peg in 1971. This moved the world to a fiat money system dominated by the US dollar, which was overvalued. The 1970s inflation ended in the early 1980s with Chairman Volker hiking rates to the moon. Today, there is no such central bank alive who is willing to do that, as it would instantly trigger an enormous reset of asset prices and the real economy, which can only survive at its current level on zero or near-zero rates. So the market will have to do it for them instead. That’s our main message for investors: you are living in a different world now relative to anything you have known in your lifetime.
The ability of low interest rates to help the real economy stopped many years ago, even as it helped pump asset prices to the moon. Now the inequality is becoming a dangerous political problem as greater portions of the population are left behind. Asset inflation will no longer be the name of the game from here, simply because at present, everything that has a cash-flow or even the distant promise of delivering one (think no revenue tech start-ups, etc.) is priced to infinite value because of a zero denominator.
We have no way of turning back now.
To ensure social stability, the focus will now turn to increasing the income for labour (salaries, redistributive benefits) relative to capital. This will mean higher wage inflation and lower equity returns over time.
Tangible assets will outperform non-tangible ones, and assets with positive convexity will win (those assets that benefit from rising yields and a global demand in resources) and ultimately we are in the final round of pretending we can solve a productivity/solvency crisis by creating more debt.
Rising supply constraints and excess demand from government into basic resources, driven by the agenda of dealing with the generational challenges of climate and inequality, is the Kryptonite of this “free market”.
Next comes marginally higher interest rates, higher volatility, but also the best macro environment in my lifetime.
We are into the epilogue of this failed model of pretend and extend, and to make sure we go out with a bang the governments have fired up the engines of helicopter money while fooling themselves into thinking there won’t be any unintended consequences.
King Monetary Policy is dead, long live King Fiscal.
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