The Law of Parsimony

Greetings from the edge of the Great Plains, where the Rocky Mountains loom up to the west and the wind never stops blowing in the winter. It’s not even winter yet and the wind is blowing. But life goes on. And we’re one day closer to the inevitable end of the most absurd financial experiment in human history.

Am I exaggerating? Consider the evidence. Consumer price inflation in the US rose at an annualised rate of 6.2% last month. Producer prices rose even higher, at 8.6%. Food, fuel, rent…it’s all getting more expensive. And why?

The clowns, charlatans, Marxists, and morons in charge of US fiscal and monetary policy will tell you that inflation is ‘transitory’. They’ve claimed that people saved up during the pandemic, banked government cheques and cash splashes, and are now spending that money. The supply chain can’t keep up. Hence, rising prices. But look at the chart below:

Up…up…and away!

Federal Reserve Economic Data

Source: US Federal Reserve

[Click to open in a new window]

Follow the money. And use Occam’s razor, which states that the simplest explanation for something is usually the best. The chart above shows the growth of ‘broad money’ in the United States, or M3. It includes cash and coins in circulation (only about US$2.2 trillion). But it also includes liquid and less liquid forms of cash — things like time and savings deposits and certificates of deposit (CDs). Notice anything?

The monetary base exploded after the Global Financial Crisis in 2009. In the United States, it’s gone up 35% — from US$15.4 trillion to US$20.9 trillion. You’ve got a lot more money chasing goods and services. Inflation is the obvious result.

And then there’s the Fed. It added US$1.4 trillion to its balance sheet in the last 12 months. At US$8.6 trillion, the Fed’s assets have more than doubled from US$4.1 trillion at the beginning of the pandemic. It also held its target Fed Funds rate at effectively zero. So what?

This unprecedented buying of bonds and mortgage-backed securities has kept interest rates down (real rates, adjusted for inflation, are negative on both 10-year and 30-year US government bonds). That’s pretty important for a government with almost US$30 trillion in debt. If interest rates were allowed to rise, the cost of servicing outstanding US debt would quickly go up too.

Amazingly, the Fed’s balance sheet is ONLY 37.5% of GDP. It was 20% before the pandemic binge. But the Bank of England’s ratio is 41%. And the European Central Bank — a heavy buyer of corporate bonds — has a balance sheet-to-GDP ratio of 80.5%. That means the Fed is still lagging its global brethren in boosting asset prices.

Don’t get me wrong, zero rates plus quantitative easing have been rocket fuel for growth assets (tech stocks, cryptocurrencies, digital assets). The five largest companies in the S&P 500 now make up close to 25% of the index’s total market capitalisation. That’s Apple, Amazon, Microsoft, Facebook (Meta), and Google (Alphabet).

And speaking of the S&P, it’s up nearly 25% year-to-date. It’s been up double digits in eight out of the last 10 years. The two exceptions were in 2018 when it was down 5%, and 2015 when it was up 1%. So what?

So you’ve been warned. Massive asset price inflation preceded massive consumer price inflation. But both are ultimately unsustainable.

Dan Denning Signature

Dan Denning,
Editor, The Rum Rebellion

PS: The cash conundrum is upon us. On the one hand, it’s mildly surprising to me that there’s only US$2.2 trillion worth of cash and coins in circulation. I like having cash on hand — or stuffed under the mattress — if the payment system goes down. Also, you don’t want to be queuing up for cash in a crisis. It’s not safe.

On the other hand, the investment hand, a massive allocation to cash when inflation is becoming entrenched in the psychology of consumers isn’t great either. In that sense, the soaring prices of digital assets are understandable. It’s people getting out of cash and into something that’s going up much faster than the official rate of inflation.

Our goal in The Bonner-Denning Letter is to beat inflation without exposing ourselves to the risk of assets that don’t generate cash flows. You can’t price those assets. You can only speculate and try to sell them to a greater fool.

We live in a world full of fools — or at least people who act like fools as part of a crowd/mob mentality. That means a lot of people have gotten wealthy — on paper, and in dollar terms — selling to fools. Our advice is not to get greedy and mistake your P/L for your IQ. When the losses come, they will be swift and merciless.

Dan Denning is the co-author of The Bonner-Denning Letter.

Dan was a founder of Port Phillip Publishing back in 2005, which quickly became the leading publisher of its kind for independent financial research and insights. In 2014 he left to head up Southbank Investment Research in the UK. Dan is also the author of the 2005 book, The Bull Hunter. Today, he’s based in his home state of Colorado. Each Monday in The Rum Rebellion you’ll get Dan’s unique contrarian thinking to provide insights you won’t find anywhere else.

Dan Denning’s belief in free markets, sound money, personal liberty, and small government have underpinned everything he’s done during his 23 years in the financial publishing industry.

The Rum Rebellion