Inflation Sprouts — Remember The Good Old Days?

The big story this week has been the surge in US inflation.

From the BBC:

US inflation surged in April from a year earlier as the economic recovery picked up.

Consumer prices jumped 4.2% in the 12 months through to April, up from 2.6% in March and marking the biggest increase since September 2008.

The report from the US Labor Department comes amid fears that rising consumer prices could push up interest rates.

The culprits were food and used cars. As they continued:

Prices of second-hand cars increased by 10% in comparison with March — the biggest monthly increase since records began. The Labor Department said that accounted for more than one-third of the overall jump.

People are buying used cars in a bid to avoid public transport.

But it’s not just in those areas that inflation is showing up. Last week I wrote about how inflation was already showing in commodities.

The idea of higher inflation has dragged stocks down this week…and if there’s anything that can pop things, it’s the possibility of higher interest rates with so much debt in the system.

The Fed isn’t worried, they say they see this inflation as transitory. They don’t seem in a rush to raise interest rates anytime soon, even with inflation rising and real interest rates at negative.

Remember the good old days when we would rely on interest rates as an income stream…or salary increases?

We would exchange our time for working in exchange for a salary…we would save up…buy a home…build a portfolio. Everything we buy costs us our time. But the value of our time doesn’t get us as much anymore.

The income stream of building wealth through work and salary increases is pretty much gone. Salaries are stagnant, and your savings move you backwards. Instead, it’s assets who have been seeing all the price increases.

You can definitely see this in property. Property prices have been rising quicker than salaries for decades now. So have the stock markets…asset prices appreciating faster than salaries force people into getting into more debt to buy a home. Deposits are a huge hurdle for young families.

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Money is mostly coming out from asset appreciation instead of salary growth. There is a real disconnect from the real economy.

And more recently, speculation is rampant. There’s clearly an appetite for risk with interest rates at close to zero to take on higher amounts of debt to increase wealth.

But these distortions are mostly the consequence of years of central bank manipulation of the economy.

When property prices collapsed in 2008, central banks lowered interest rates and started quantitative easing.

It didn’t create inflation but it affected asset prices and created a sort of wealth effect.

And then when the real crisis hit last year, central banks threw everything they had to stop the fallout.

I mean, take a look at the chart below. It shows the US money supply in circulation for the last 60 years along with checking and savings accounts (with less than US$100,000) in banks and money market mutual funds.

US Money Supply in Circulation

Source: US FRED

[Click to open in a new window]

The policies propped up asset prices once again. Even with a once-in-a-century pandemic asset prices didn’t collapse.

For a while now that has been the name of the game.

That is, printing and stimulating through unconventional policies like quantitative easing and lower, close to zero interest rates. Growth in the US has mostly come from these policies instead of from economic growth.

The problem with this game is that as soon as liquidity and access to debt stops, prices collapse, much like they did in Spain or the US in 2008.

On that note, my colleagues Ryan Dinse and Greg Canavan say there’s an alternative financial system starting to emerge, with two systems now operating in tandem. You can find more about that here.

We’ve had a record-long boom. Markets are at a high and so is property…even with a pandemic raging we’re starting to see some signs of inflation picking up.

Is this transitory?

Who knows. No one has a crystal ball here, not even the Fed.

With real interest rates at negative, in my mind it’s a good idea to invest in real things, like gold. Or commodities key for the renewable energy transition that could benefit from inflation.


Selva Freigedo Signature

Selva Freigedo,
For The Rum Rebellion

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Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

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