The Maradona Theory of Interest Rates at Play

The year 1923 was the one of galloping inflation when a kind of madness gripped Germany’s financial authorities and economic disaster overwhelmed millions of people. It was the year of astronomical figures, of ‘wheelbarrow inflation’, of financial phenomena that had never been observed before. The death of the mark in November 1923 came as a merciful release, for the events of the preceding eight months had ensured that the old mark could never recover.

Adam Fergusson, When Money Dies

In Weimar Germany in 1923, hyperinflation hit so hard that people were getting paid by the hour. As soon as they received the cash, they would rush to buy things that would hold its value.

It’s why many resorted to bartering instead of using money.

Paper money was so abundant and had such little value that people had to carry it in suitcases or bags. They used it to light fires, as wallpaper, or even as something to entertain children with. In fact, here is one of my favourite photos from that time:

Fat Tail Investment Research

Source: Rare Historical Photos

[Click to open in a new window]

The kids in the photo have stacked up 100,000 German papiermarks, or the equivalent of about US$1 at the time.

While there seemed to be lots of money everywhere, there were actually shortages of it.

Something similar happened in Argentina when it was hit with rampant inflation in 1989. The money at the time, the austral, was losing value faster than the government could print it. At one point, they even had to issue emergency notes of 500,000 australes to keep money circulating…people literally turned into millionaires overnight.

Of course, that was a vicious cycle. The more money the government printed, the more it lost its value.

Much like the Argentinean austral, the German papiermark only lasted a few years. It went on a downward spiral with no hope of recovery. Such is the destructive power of inflation.

I’ve often spoken about Argentina and hyperinflation, but this is a phenomenon that’s also hit developed countries like Germany.

The way things are looking at the moment, inflation is on the rise around the globe.

Prices are rising on the back of supply side problems. The pandemic has increased production costs and we’re seeing higher prices in commodities, transport, and energy.

Free Report: Economist reveals five stocks he believes you should sell today. Download now.

Prices are also going higher due to more demand from consumers. The pandemic has hit service industries like restaurants and travel, so locked-up consumers have instead turned to buying more goods, which has hit supply chains.

And then, of course, there’s been an increase in money supply along with pandemic stimulus.

Central banks are now indicating that they’ll start to wind back stimuli.

On Wednesday, the US Fed also said they’ll be starting to taper stimulus to fight back inflation pressures. They’ll be reducing its US$120 billion in monthly bond purchases by US$15 billion a month, starting this month.

As Powell said, he wouldn’t hesitate to raise rates if inflation picked up:

For now, (the risk) appears to be skewed toward higher inflation. We need to be in a position to act in case in case it becomes necessary to do so or appropriate to do so.

If they stick to the plan (and that is a big if), bond purchases would end up in June. The Fed is willing to wait and see on rates. Their view is that high prices will likely go on until next summer and then slow down after that.

It’s something that was echoed by US Treasury Secretary Janet Yellen.

In a recent interview, she said the US is not losing control of inflation and that she expects inflation will remain high until the middle to end of next year.

But believe me, central banks aren’t in control of anything. And as I wrote last week, by the time they admit they’ve lost control, it will be too late.

Is the Fed running the Maradona theory of interest rates play? It’s something I’ve written about before, where they try to influence expectations towards their target without having to move rates.

Expectations that rates may be rising sooner than expected may dim the stock and housing market.

Of course, that’s in theory. Expectations can get out of hand if enough people lose confidence in the central bank’s handle of inflation.

At the moment, my expectation is that inflation will continue to rise and central banks won’t do much about it.

I mean, inflation in the US is at a 30-year high, but the Fed is keeping the interest rates at zero…

You see, the worry is that at first, the bout of inflation feels good, especially if there is high debt around. Inflation shrinks debt, it feels like you have more money.

But at the end of the day, inflation benefits governments and reduces your purchasing power.

So start getting ready for it.


Selva Freigedo Signature

Selva Freigedo,

For The Rum Rebellion

PS: The Rum Rebellion is a fantastic place to start your investment journey. We talk about the big trends driving the Australian Economy. Learn all about it here.

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.

The Rum Rebellion