Weekly Comment - November 23, 2021

November 23, 2021 | Nick Foglietta


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It appears that 2021 is going to challenge central bankers on their “no bad days” thesis

To set the tone for this week’s editorial let’s begin with a quote from US Federal Reserve former Vice Chair, Stanley Fischer:

Last week’s comment generated quite a number of responses. The theme of the responses was mostly anecdotal examples of where the prices of things had shot up significantly. Two readers asked: “Why is inflation so bad? The value of my assets are going higher…I feel good about my net worth today” (paraphrased).

The following chart pictorially explains what these two readers are sensing. The chart shows the ratio of American net worth relative to American GDP.

The ratio was stable after the WWII, and then started to decline moderately to bottom in 1978/1979.

Not coincidentally, this was near the time of the last peak inflation and interest rate cycle. As interest rates declined, productivity increased. Technological advances sped the increase in productivity. The net worth/GDP ratio started higher.

The monetary response to COVID in 2020, was like gasoline on the fire of asset inflation. Nothing in history compares, the chart shows the magnitude of the response.

The early years of wealth increase was mostly a real and healthy. It remained that way until 1998-2001. This is when the central banks stepped in and changed the economic inputs via overreaching monetary policy to avoid a normal recession. These were the seeds being sown for the asset inflations were are presently experiencing.

Much like the drug addict who feels good for years on ever-increasing doses, the central bankers believed they cheated inflation critics out of their claims that monetary stimulus was going to result in “bad” inflation outcomes. It appears that 2021 is going to challenge central bankers on their “no bad days” thesis.

The next chart requires some thought. There is no way to confidently say that 2020 was the bottom of the deflationary cycle, but each month that passes leads me to believe it will turn out to be the bottom.

That said, the evidence is growing that 2020 was the bottom! If that turns out to be true, then this chart might be important to consider.

With all of the debt/liquidity created in the present time, the peak inflation rate could turn out to be much higher than the 1980 peak.

The question for investors is staring back at us, but we continue to avoid answering it for fear of what it might mean: If the inflation cycle is building for the long term, how can interest rates stay low?

The answer is that I doubt they can stay low.

If interest rates rise, how do asset prices stay inflated?

Assets will struggle under higher interest rates and higher inflation.

Since September, stock markets have started a pattern seen near many stock market tops in history. The core company shares stay elevated, but a lot of weakness around the perimeter.

Stock markets are in the strongest quarter of the calendar year. Let’s see how this progressed between here and the end of the year.