The Real Inflation You Need to Worry About — Inflation Concerns Increased

Inflation has markets all a jitter.

US stock market opens mixed with inflation concerns

Biden’s $1.9 trillion relief package has increased concerns that inflation could increase in world’s largest economy

AA News Broadcasting, 8 March 2021

…prospects of more government spending and a growing economy have stoked fears of an inflation spike, sending the benchmark 10-year Treasury yield to near one-year highs and weighing on technology shares that rely on cheap funding for growth.

Reuters, 8 March 2021

…people are making an argument that we’re headed toward the kind of sustained inflation we saw in the ’70s

The Hill, 4 March 2021

And this conceited and typically hubristic comment from US Treasury Secretary (and former Fed Chair) Janet Yellen should heighten investor concerns…

I’ve spent many years studying inflation and worrying about inflation, and I can tell you, we have the tools to deal with that risk if it materializes,

Janet’s smug assessment of her academic prowess and ability reminds me of Bernanke’s assurance on subprime being ‘contained’.

Thankfully, we’ll be spared from Janet’s theoretical solutions. Solutions, that in practice, only create far bigger problems…which then require even bigger ‘solutions’, leading to even bigger problems.

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We are not going back to the 1970s or likely to have high inflation.


Ironically, because of PhD central bankers like Yellen…and their slavish adherence to the spluttering debt-fuelled economic growth model.

In 1970, US M2 money stock was US$600 billion. Over the course of the decade, M2 expanded to almost US$1,500 billion…a 150% increase.

During this same period, the velocity of money (the speed with which the money stock changes hands) increased slightly from 1.77 times to 1.87 times.

More money moving a little quicker through the economy created inflationary pressures.

Federal Reserve Economic Data

Source: Federal Reserve Economic Data

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In 2010, US M2 money stock was US$8.5 trillion. A decade later, M2 has expanded to US$19.5 trillion…a 130% increase.

However, the speed with which all this money moves through the economy has fallen from 1.7 times to 1.1 times…people are not playing the same game of ‘hot potato’ as they did in the 1970s.

Federal Reserve Economic Data

Source: Federal Reserve Economic Data

[Click to open in a new window]


Back in the 1970s, US total debt (as a percentage of GDP) started the decade at 170%.

By the end of the decade, debt-to-GDP was 160%.

Federal Reserve Economic Data

Source: Federal Reserve Economic Data

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Whereas in 2010, debt-to-GDP started at 373% and ended the decade at 400%.

Federal Reserve Economic Data

Source: Federal Reserve Economic Data

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The sheer weight of debt (requiring more money to be allocated to principal and interest payments) is why the velocity of money has fallen. Society is using money for repayments and/or savings.

The other missing ingredient from the 1970s is the first wave of boomers entering the labour force.

Now they’re exiting…having to make ends meet from government and private pension plans.

This is why, in spite of the headlines, I think inflation expectations are not all that different from where they were before COVID-19.

Real Economy - Estimates of Inflation Expectations During Pandemic

Source: Real Economy

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The REAL inflation will deliver deflation

The REAL inflation investors should be focused on is asset price inflation.

In The Gowdie Advisory on 21 January 2021, I wrote:

US$15.6 trillion at risk from souring market

The Buffett Indicator — which measures US share market capitalisation against GNP (Gross National Product) — is one of many valuation metrics used to determine whether a market is over, under or fairly valued.

Here’s the January 2021 Buffett Indicator reading of the Wilshire 5000 Total Market index to GNP.

For those not familiar with Wilshire 5000 index, this is from Wikipedia…

“The Wilshire 5000 Total Market Index, or more simply the Wilshire 5000, is a market-capitalization-weighted index of the market value of all American-stocks actively traded in the United States.”

Advisor Perspectives - A Buffet Indicator Variant

Source: Advisor Perspectives

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There’s a couple things to note about this chart.

1. The current reading is in a zone all of its own.

2. The “mean” is 78%…which means fair value for the index is 78% of US GNP.

To illustrate why the market cannot continue to outgrow the economy — especially one that is struggling with significant underlying damage — let’s do some numbers.

US GNP is — for rounding purposes — US$19 trillion.

Trading Economics - United States Gross National Product

Source: Trading Economics

[Click to open in a new window]

At present, the Buffett indicator — also for rounding purposes — is at 160%.

US$19 trillion x 160% = US$30.4 trillion.

If you believe the broking fraternities PR, then, the market is destined to grow at 6% per annum over the next five years (some even say we’ll have a Roaring Twenties-type bull run — but let’s stick with the more conservative 6%).

If the US economy is stuck in the low growth zone of (say) 2% per annum, then this is what the Buffett Indicator looks like in 2026…

Port Phillip Publishing

Can this happen?

Well, to answer that question, here’s an extract from the Forbes interview in 2001 when Warren Buffett said the Market to GNP ratio was “probably the best single measure of where valuations stand at any given moment…”

In his example, Buffett used GNP growth of 5% and market growth of 10% — the principle is still the same…

“For investors to gain wealth at a rate that exceeds the growth of U.S. business, the percentage relationship line on the chart must keep going up and up. If GNP is going to grow 5% a year and you want market values to go up 10%, then you need to have the line go straight off the top of the chart. That won’t happen.

If (or, more likely when) the Market to GNP ratio reverts to the mean, what sort of dollars are we talking about?

GNP of US$19 trillion x 78% = US$14.8 trillion…a loss of US$15.6 trillion from the current value of US$30.4 trillion.

And that’s just the number from mean reversion. What happens if it overshoots on the downside? Possibly US$20 trillion (2/3rds) of current value could be vaporised.

That’s the equivalent of one year’s GNP.

What was once soaring, will become souring…leaving a very bitter taste in people’s mouths.

Further economic contraction would be all but assured.

Asset price inflation has created the illusion of wealth.

Which has been a welcome distraction from the real problems in the economy…too much debt, an ageing population and the accelerated adoption of AI and robotics stunting job and wages growth.

Why else do you think the Fed is so keen to keep the market propped up? They are using Wall Street as a proxy for the economy.

When the overly inflated asset bubble pops, it will also burst all those thought bubbles on future inflation.

While the ‘wealth effect’ does NOT trickle down, the LOSS of wealth effect does flow through the economy.

Deflation is by far the greatest threat.

Should that happen, we might see Biden give Bernanke the job of flying the Fed’s helicopter…the one filled with money for him to drop.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

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