Imminent Inflation?

Stocks had another big rally week.  The major indices have now gained nearly 6% over the past two weeks.  A pullback in price after such a big up move would be typical.

As I noted on the Headline Roundup Webinar last week (replay available on the app, search YourRLA at the app store), gold prices declined to the long-term, uptrend line and I expected they may stabilize.  To this point, that is what has happened.  I’ve reprinted the chart here.

This past week, the topic of inflation began to appear frequently in the news headlines.  Even many mainstream media sources noted that inflation seems imminent.

US Government debt saw yields increase which means bond prices fall.  This is a phenomenon that is observed when investors fear that inflation is on the horizon.

This from “Bloomberg” last week (Source:  https://ca.finance.yahoo.com/news/treasury-yields-surge-test-key-104318569.html) (emphasis added):

Treasuries tumbled anew Friday, sending 10- and 30-year yields to their highest since early 2020, amid growing concern stimulus will fuel an explosion in economic growth that ignites price pressures. Expectations for inflation over the next decade lurched to a seven-year high.

Yields on the 10-year benchmark rose as much as 10 basis points to reach 1.64% in U.S. morning trading, a level unseen since February 2020. The 30-year rate advanced almost 11 basis points to a session high of 2.40%, edging toward a January 2020 peak. Rates leaped across notes and bonds, with the biggest moves in the long end, steepening the yield curve. The 10-year rate has failed to close above 1.60% since early 2020, though it has surpassed that level in volatile intraday trading several times in recent weeks.

“We’re talking about a fair amount of stimulus — both fiscal and monetary — going forward,” BTG Pactual Asset Management’s John Fath said, referring to the $1.9 trillion pandemic-relief bill and prospects for more, along with the Federal Reserve’s pledge to stay accommodative. “We potentially could grow a lot faster and inflation could come into the horizon a lot quicker,” which begets higher rates.

The breakeven rate on 10-year notes, a measure of market expectations for annual consumer-price gains based on the yield gap to inflation-linked debt, topped 2.30% in early New York trading Friday, a level it hasn’t breached since early 2014. An equivalent measure for the five-year note touched its strongest level since 2008.

In our managed portfolios, we remain bearish on bonds as we have been since January of this year.  An Exchange Traded Fund that tracks the price of the US Treasury long bond has declined more than 10% since that time.

Reuters had this to say on the topic last week (Source:  https://www.msn.com/en-gb/money/other/us-consumer-prices-rise-underlying-inflation-muted-for-now/ar-BB1esatq) (emphasis added):

U.S. consumer prices increased solidly in February, with households paying more for gasoline, but underlying inflation remained tepid amid weak demand for services like airline travel and hotel accommodation.

The mixed report from the Labor Department on Wednesday did not change expectations that inflation will push higher and exceed the Federal Reserve’s 2% target, a flexible average, by April as declining COVID-19 infections and a faster pace of vaccinations allows the economy to reopen.

Inflation is also seen accelerating as price decreases early in the coronavirus pandemic wash out of the calculations. Many economists, including Fed Chair Jerome Powell expect the strength in inflation will not stick beyond the so-called base effects and the reopening of services businesses.

“Base effects and one-time price increases stemming from the reopening of the economy and some pass-through of higher prices from supply chain bottlenecks should lift core inflation to 2.5% in the spring,” said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics in New York.

To put these inflation conversations in context, we need to understand that the methodology used to calculate the inflation rate has been changed over the years to make the rate of inflation seem more subdued.

This is a topic that is not often discussed nor widely understood.

For example, there are now adjustments for hedonics and substitution and the weighting of the items in the basket of goods used to calculate the inflation rate are changed.  All these adjustments reduce the reported inflation rate.

A hedonic adjustment is an adjustment for convenience or literally for ‘pleasure’.  As items that we buy are improved, if prices go up some of that price increase is arbitrarily removed from the inflation rate calculation since the item has made our life more pleasurable.

I’ll give you an example that will give away my age.  Some of my earliest television memories were of three working channels on a black and white set, with no remote control.  If you wanted to change the channel, you had to get out of the chair and walk across the room and turn the knob on the set.

When I was old enough, my Dad had me serve as the remote, telling me what channel to put on.  Fortunately, there were only three choices so it didn’t take too long.

Then, a television manufacturer developed a remote control.  Even though it cost more to buy a television with a remote control, that increase in cost would not have been factored in when calculating the inflation rate due to an adjustment for hedonics since the remote control made television viewing more pleasurable.

Then there is the adjustment for substitution. 

This adjustment is made when an item that is included in the basket of goods and services that is used to calculate the inflation rate increases in price dramatically.  Because of this dramatic price increase, a bureaucrat arbitrarily determines that no one will buy that item any more and another lower cost item is substituted for the first item.

Finally, there are the adjustments for weighting.  These weightings are also arbitrarily determined.  For example, as of January 2021, health care was given a 7% weighting in the Consumer Price Index calculation even though healthcare consumes about 20% of Gross Domestic Product.

My first point is simply this:  you should discount any source that uses the Consumer Price Index as the measure of inflation.

Past radio program guest, Mr. John Williams, calculates the inflation rate using prior methodologies.  You can check out his fine work at www.ShadowStats.com.  The chart on this page taking from Mr. Williams’ website shows that using the 1980’s inflation calculation methodology, the real inflation rate is in the 10% range.

The red line on the chart is the official CPI and the blue line is Mr. Williams’ alternate calculation.

My second point is that the real inflation rate is much higher than the reported rate but even those analysts who report on inflation using the lower, manipulated official inflation rate are now warning of impending inflation.

The Associated Press reported (Source:  https://apnews.com/article/business-prices-inflation-producer-prices-c084f9d40c972f3e6269f4e6c672e563) that energy prices increased 6% in February after a 5.1% rise in January.

The same piece reported that food prices jumped in February as well.

Jeff Gundlach, CEO if Doubleline Capital sees headline inflation (the official inflation rate) potentially reaching 4% by summer.  (Source: https://www.thinkadvisor.com/2021/03/10/gundlach-watch-out-for-inflation-topping-4-bond-fallout/)   

 Mr. Gundlach stated that he believes the Fed is not concerned about inflation; in fact, he believes the Fed will welcome higher inflation.  It’s easier to pay off existing debt with discounted dollars.

If you know of someone who could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

“Evolving Wealth Preservation and Storage”

In my view, the manner in which wealth is stored, preserved and grown is changing radically presently.

Many who are not paying attention to financial and economic developments remain unaware of these changes.  However, anyone who chooses to be a serious observer of these developments can see that fiat currencies are weakening, and alternate wealth management strategies are quietly becoming more mainstream.

Driving these changes is wildly evolving monetary policies.

Central bankers around the world set money policies and they’ve painted themselves into the proverbial corner.  They have few options left.

While the country and the world are focused on the impeachment trial and the coronavirus, wealth preservation and storage are changing before our very eyes.

After the financial crisis, central banks resorted to printing money after reducing interest rates to zero failed to produce the desired result of another boom cycle.

In the fractional reserve banking system under which we operate, as money moves from one bank to another money is created.  Here’s a quick example.

I deposit $100,000 in my bank.  Under the current reserving rules of 10%, my banker must reserve $10,000 and can loan out the other $90,000.  In other words, money is created as money is loaned.

If money is moving fast and the velocity of money is high, more money is created.  The $90,000 that my banker loaned to a home buyer was paid to the home seller who deposited the $90,000 in her bank.  That banker reserved $9,000 and loaned out $81,000.

By reducing interest rates, borrowing becomes more attractive, borrowing activity increases and more money is loaned into existence.  After the financial crisis, due to the level of private-sector debt that existed, borrowing did not pick up despite interest rates of nearly 0%.

So, the Federal Reserve embarked on a path of “quantitative easing” or money printing.  Since money was not being loaned into existence because private sector debt levels were too high and consumers weren’t borrowing money, the Federal Reserve decided to just print it.

Whenever you hear or read that the Fed is expanding its balance sheet, it simply means the Fed is printing money.

Initially, money printing creates the illusion of prosperity.  In many areas of the economy today, this prosperity illusion exists.  But, in other parts of the world, new and even crazier monetary experiments are being executed.

In much of the world, bonds now have negative yields.  A negative-yielding bond gives you back less than you invested at maturity.

This Negative Interest Rate Policy, or NIRP as it’s known by, is changing the dynamics of wealth storage, preservation and growth.  This from “Zero Hedge” (Source:  https://www.zerohedge.com/markets/negative-rates-are-forcing-german-banks-hoard-cash) emphasis added):

In the era of NIRP, “cashless societies” like Sweden are at a clear disadvantage. When banks are charging wealthy customers additional fees for storing their cash on deposit, the option to transition a chunk of one’s fortune to cash suddenly makes sense. And as Bloomberg reported Friday, this phenomenon hasn’t been lost on German banks.

(Editor’s Note:  Bloomberg story here- https://www.bloomberg.com/news/articles/2020-01-31/german-banks-are-hoarding-so-many-euros-they-need-more-vaults)

To help them keep as little money in reserve accounts as possible, banks in Germany are reportedly stuffing vaults with euro banknotes in to keep them handy for customers (and avoid the additional NIRP tax on deposits). Some banks have hoarded so much cash that they’re running out of room and are searching for more storage. This behavior has been going on for years, practically since Draghi introduced negative rates almost six years ago.

But the trend has gotten so out of hand German banks are running out of space to stash the notes.

The physical cash holdings of German banks rose to a record 43.4 billion euros ($48 billion) in December, according to Bundesbank data published on Friday. That’s almost triple the amount at the end of May 2014, the month before the European Central Bank started charging for deposits and raising the pressure on Germany’s already beleaguered banks.

By the end of last year, German banks were holding a record amount of physical cash.

            Andreas Schultz, who runs a German savings bank had this to say, “These days it’s better to keep funds in cash rather than park them at the ECB.  That’s despite the risk, insurance costs and logistical hassle involved. It’s a ludicrous demonstration of the consequences of the ECB’s interest-rate policy.”

            Frank Schaeffler, a member of the German Parliament commented, “This is just the beginning.  If it continues, we’ll see a boom for vault makers and security companies.”

            In my view, negative interest rates could become a worldwide phenomenon.  If it happens, consumers and banks alike will look for alternative ways to store and grow wealth, likely outside the banking system.

            Former Federal Reserve Board Chair Alan Greenspan stated fairly recently that it was his view that US interest rates could go negative.  In a CNBC interview, Mr. Greenspan said, “You’re seeing it pretty much throughout the world. It’s only a matter of time before it’s more in the United States.”  (Source:  https://www.cnbc.com/2019/09/04/alan-greenspan-says-its-only-a-matter-of-time-before-negative-rates-spread-to-the-us.html)

            Demand for secure storage and alternate assets is exploding in Europe.  Markus Weiss, managing director at Degussa Goldhandel which sells gold and offers clients space to store their valuables said, “We’re seeing increased demand for our safe deposit boxes, frequently for storing cash.  That high demand has lasted for months now and we’re continuously expanding our capacities.”

            Looking ahead to the next monetary experiment, it’s quite possible that we will see helicopter money in my view.  While no one knows for sure, the advent of helicopter money could likely be the last money experiment before the reset.

            Helicopter money was once proposed by former Federal Reserve Chair, Ben Bernanke, earning him the moniker “Helicopter Ben”.

            Helicopter money is money that is printed but rather than using the newly printed money to buy assets from banks, it is distributed directly to the public.  It could come in the form of a direct bank account deposit or a tax credit.

            Treasury Secretary, Steve Mnuchin recently stated that the administration is working on tax cuts for the middle class.  A CNN article (Source:  https://www.cnn.com/2020/01/23/politics/mnuchin-trump-tax-cuts-2020-election/index.html) quoted Mr. Mnuchin, “ They’ll be tax cuts for the middle class, and we’ll also be looking at other incentives to stimulate economic growth.”

            Helicopter money may indeed be on the way.

            That will mean the way wealth is stored will continue to evolve.  When doing your planning for 2020, think tangible for some of your assets.