First Principles
Principles may be lacking in certain quarters, but we will start with the economics of inflation rather than Boris.
How much inflation and for how long?
Inflation is simply too much demand for the available supply, nothing more complex than that. So, you tame it by either less demand or more supply. So, unlike it seems most Central Bank economists, who it turns out are just statisticians, for ever looking back, we must project forward.
That tells us quite clearly that the inflationary imbalance will persist as long as demand stays artificially high and supply is artificially constrained. It is that simple. Forget the rest.
So as long as governments have fiscal laxity, along with negative real interest rates, they are pushing up demand. As long as workers wonāt or canāt work, it will reduce supply, as long as economic activity is made less efficient by government action and diktat, it will reduce supply; end of.
So, at the very least Central Bank balance sheets must start reducing, which is not happening, stimulus must be fully withdrawn, which is not happening, and the old workers and their old ways of working must resume, which is not happening. Fresh capital can certainly change some of that, but it takes time.
Putin, Oil, and Geopolitics
What about oil?
This is the one item that alone might distort the picture. Which is positive, as we see oil prices falling in the summer. We also donāt see the West has really grasped what Putin is up to; in all the cold war style hysteria, he is possibly just after what he says. This is for the West to stop fomenting rebellion in Russiaās sphere of influence, and to be clear about NATO expansion plans, where there are indeed none in existence. He might have higher hopes, perhaps of a deal on Crimea in exchange for the Donbas, but we doubt it (or his chances of getting it are low). As might we, less interference in our politics would be nice; but see previous answer.
Nor is it that clear he is actually rationing energy; it is telling that Russia is reported as not able to meet its OPEC + quota, which at these prices is crazy. His oil industry will have been hit by sanctions, and the loss of Western expertise, and the Russian economy will also have suffered under COVID. A loosening of sanctions would really help him, for all his bravado.
If that reading is correct, as the situation winds down and OPEC+ winds up production, oil prices will fall, I would expect quite substantially. Much of the energy spike is self-inflicted, with nuclear plant closing or offline in France and Germany, and reckless price controls, having made using UK gas storage unattractive. All of these things can be sorted out.
Any possible good outcomes on inflation?
So, to inflation, well it wonāt care much about the pinpricks inflicted by the likely interest rate rises now under discussion, especially if they creep up so slowly no one notices. It needs a unified 1% OECD jump to cool this lot down, and the ending of stimulus. Neither is likely. Closing the US printing presses, were it to happen, does also have interesting global impacts, as Andrew Hunt notes.
We see it all turning rather glacially, with a bigger slump in inflation, if energy prices fall, but then being generally persistent in the 3% area for the rest of the year. We expect to have both higher rates and inflation for a while.
All of this is mighty tricky for investors, but I donāt sense that just bailing out is right, nor that the actual interest rate rise will cause an enduring slump in all asset prices. Investors have to own something, or they will sit and be mauled by inflation.
And what of Johnson?
It is easy to read the current level of confusion from either sideās viewpoint. Yet to me, I see the normal factional infighting, the usual media exaggeration, some political mischief making, but still no reason to depose a Prime Minister with a very clear mandate and a large majority. Like any large party the Tories have the embittered and passed over, the Remainers and fans of state intervention and a volatile and raw body of new recruits in seats no one ever expected to win. Plus, no doubt a few opportunists who sense that the heavy lifting on COVID and BREXIT is done, and they can now seize all the prizes.
The Tories do need a reset; it would be nice if Downing Street left Ministers to govern and simply acted as a cheerleader. Not that I see that happening, leaders and their hangers on always lust after more and more centralization, more control. But until a compelling, unifying, plausible Tory opponent appears, I foresee no change.
And in a way with reform all but dead, with Goveās last hurrah on āLevelling Upā a damp squib, it may not matter who leads the Tories, they have very little real power.
It is quite odd how big majorities do so little good, and how poor party discipline is, when they have them.
Charles Gillams
THERE IS NO SANITY CLAUSE
Three big topics this week from three central banks, all of whom look to be in a muddle, with their knitting all jumbled up and highly implausible. Entirely predictable inflation meanwhile threatens to sweep them off their path, as they tinker with micro adjustments to interest rates.
Boris is diverting, but we doubt if it all matters; pre-Christmas entertainment. If he were logical or even vaguely numerate, he would change, but heās not, and he wonāt, but nor does he need to.
The Lib Dems win a by-election, that Labour fails to contest, but it makes no difference in Parliament, and it lets Boris look contrite mid-term. He will survive this with ease.
Which is not to say he should, or that heās not making a hash of COVID, the sequel. In keeping the NHS in its current format, Boris fails to ask, as many have before him, whether it is still fit for purpose. This remains an urgent question. It canāt simply collapse every year.
Bailey - Bank Governor and historian
But perhaps Andrew Bailey, Governor of the Bank of England, understands the extraordinary risks Boris poses to the economy, and has hiked rates to show that. A Cambridge (Queens) historian, with a doctorate on the impact of the Napoleonic Wars on the cotton industry of Lancashire, he will know full well the impact of a French orchestrated trade war backed up by a dodgy pan European monetary system.
A consummate insider, via the LSE, he moved on to the ascending ladder of the Bank, which did include a slightly unfortunate move into the FCA. This turned out to have rather more real villains than he was used to. Married to the head of the Department of Government at the LSE, he will be very well aware of the political game and the current mood in Whitehall.
Heās seen enough inflation and has decided the Bank must pretend to act. Not only is the rate rise trivial, but it also coincides with a continuation of Government bond buying (QE), an odd call. That the last thing the economy needed was still more liquidity, has surely been obvious for eighteen months now.
Christine Lagarde and Jerome Powell
In Europe the same mishmash exists. We have been hearing Christine Lagarde explain why the ECB is now accelerating one asset buy back (APP) while ending another one (PEPP). She was winging it with the phrase āutterly clearā in answer to a pertinent question, when it was clearly anything but. Still, she did seem to have her ear rather closer to the ground on wage inflation, at least compared to Jerome Powell.
He by contrast has been caught with his pants on fire, trying to weasel his way out of the Fed failing to spot inflation, by saying that most market commentators agreed. Remind me, which is the canine, and which the wagging appendage?
Basic economics - why inflation arises
We called it on inflation as soon as that stock market rally took off, and for the simplest of economic reasons: the pandemic had reduced global productive capacity, so absent a change in price levels, the economy was less productive, profits were therefore lower, competition would therefore be less (unless prices rose), and total production must fall. Less output, same demand will always mean inflation.
Forget the energy issue, forget supply chains, less capacity, more demand always means trouble. True based on that one schoolboy error, the dopey measures to reduce capacity further by more regulation, hiking the minimum wage, paying people not to work and so on, plus embarking on accelerated decarbonization and a few new trade wars, was not going to help much either. But please no more āsurpriseā inflation, it was baked in. (See extract from my book, Smoke on the Water, blog dated July 2020, title re-appearing shortly on Amazon)
After the interest rate rise
However, we have also long felt that interest rates canāt rise enough to stop inflation, but that as governments have to back off fiscal stimulus, as they are already overborrowed, the lower productive capacity will itself shrink demand, and in the end cause inflation to fall. But we see that as taking years, not months.
Why are interest rates not rising to combat inflation? No political will for a start, and any one country that gets too far out of line will find currency appreciation itself addresses the problem. So, do we believe the US ādot plotā suggesting three rate rises in 2022, while the Euro zone does nothing? We struggle to.
Powell is still clinging to the lower workforce participation rate (which matters) as a signal to defer rate rises and not the unemployment rate (which is more closely related to vacancies) and hence of less fundamental relevance. While employment is great, it will still be unattractive if inflation (and fiscal drag) takes off, thereby holding the participation rate low.
This does still suggest dollar strength, while sterling like other smaller currencies always needs to be wary of getting too far out of line with US rates. But also, a need to fathom out the new look economy. To us, it does not seem service industries that rely on cheap labour are operating in the same world they grew up in. Certainly not if it is onshore.
There is a forced change in government consumption patterns (and hence employment), and this will also be telling. We are heading into quite a different market, when all this shakes down.
Sitting on high cash levels over Christmas, as we are, is pretty cowardly, but if you canāt see the way ahead, slow speeds are usually safer.
We do also rather agree with Chico Marx, this year at least.
Charles Gillams
Monogram Capital Management Ltd
Some Big Calls
First posted on 7th February 2021
US Markets: The āno-Trumpā response
We may learn a little about markets from the curious absence of Trump.
We had been confidently told that without him the US stock markets would fold, and as US markets collapse, these days so do global ones. Indeed, not just relying on the US, has become the fund management challenge of the last decade.
Well, he went, admittedly in a two-stage collapse, but he and the Republicans are out of office, yet the apparent upset in Georgia passed with barely a market ripple. Markets just went on up, unconcerned. Now some of that is their appetite for short term debt fueled spending, which even if you know makes little sense, it is folly to stand in the way of.
But beyond it, higher taxes and lower growth must be the consequence, if you are buying stocks on a 6 times multiple of earning the next two years matter a lot, but when buying them on the current S&P 500 forecast of 25.35 times earnings, that implies those later high tax years must surely be in the equation too.
Has the market priced in the downside?
So, what seems to have happened, is the downside of future years has been calmly offset against the short-term gains of a stimulus package: is that logical? It seems unlikely, if nothing else a big corporate tax rise is due, to notionally pay for it all, plus a fair slice of traditional āstick it to the richā revenge legislation.
The assumption seems to be that the winners in the higher consumption aisle will be neatly offset by those who suffer from the new regulations. We are less sure and do feel the ultimate impact will inevitably be lower US growth.
Of course, tech might solve all, but then it is very richly valued already. It might solve the growth problem, but could still be loss making for investors, at these levels.
That is not to say that Biden put on a poor show in his advocating a āgo bigā package, he did it lucidly and with passion, a good speech.
For all that, when a new leader arrives and confidently asserts lots of economists (but notably not including The Economist this week) think heās doing the right thing, it means trouble ahead. While his near certainty that the US would consequently be back to full employment by Christmas was touching, but absurd. The excess stimulus might get growth back to pre-pandemic levels, but thatās really not the same as employment.
The China issue remains big.
Another really big asset allocation call:
We are hearing ever more gruesome tales about East Turkmenistan, following on from decades of horrors from Tibet, both sovereign states seized by China in the political chaos after WWII.
If you see them like the other nations seized by Maoās fellow imperialist Stalin, at much the same time, you will understand the repression. Although as ever with China, with a big dose of racism, against the 7% of their population who are not ethnically Han Chinese, plus of Communism, which still stands against any form of religion, be it Buddhist (Tibet) or Islam.
Will Biden care more or less than Trump about human rights? Well obviously, he will care more, as something is more than nothing. But will he be more effective than Trump, indeed do the Chinese find an unpredictable enemy with a penchant for sudden tariffs, harder to deal with, than a believer in the international order and gentle fireside chats?
Well here cynicism prevails: these are nations caught between empires, like Poland was for centuries; any tension in the international order will always see a land grab by their bigger neighbours.
I also believe Biden will find the proposed attacks on American consumption through both higher taxes and the removal of cheap energy and labour, can perhaps withstand also keeping Trumpās price rising tariffs in place. As notably he has done just that, to date. Indeed, he seems to be out-Trumping Trump on Federal procurement and protectionism.
But I still donāt think cutting China out of global trade, however barbarous their actions have been, is a runner. I think the vile abuses of power can go on, just as the EU has already handed a free pass to Chinaās torture chambers to plough on, by agreeing a new trade deal with no human rights teeth. So, in time, realpolitik will triumph with Biden.
It was I suppose nice to see China (after a pause for thought) suggesting locking up elected politicians in Burma, after the Army grew tired of holding all the cards, but getting no thanks for it, was a poor move. But there was a long enough pause to just tell the junta they didnāt mean it and were really rather pleased. A little more discord, more repression of the ātribalā areas along their shared border, more sanctions to exploit, a few less pesky journalists, all are very much in Chinaās interest.
So, I see a curious dichotomy, in the Han Chinese areas, Tesla car plants, Apple phone stores, Starbucks a plenty, for a sophisticated technologically advanced middle class, will all thrive. While the minority non-Han areas will be pillaged for resources and labour and if they are good, be re-settled and re-educated and polished up for tourists. A bit like California in the 19th Century. So perhaps Xi is right, only China can split China, but then history suggests, it will, one day.
But not any time soon; you can take a moral position on Chinese racism, or an economic one on Chinese dynamism, but I am fairly sure the market will easily favour the majority.
This of course does create another ESG contradiction, the US high flyers rely on selling to the Han Chinese but are keen to exploit minority Chinese labour forces and natural resources. We can look forward to a great deal of sophistication in somehow disconnecting the two.
Efficacy of the Astra Zeneca / Oxford vaccine
Finally, I should mention the battering the EU and even perhaps the Euro (at a nine month low) has taken from the principled resistance to fudging the data exhibited by German scientists. The scientists are right, the evidence base for efficacy in the over 55 age group is indeed absent. Excitable politicians, including the normally precise Macron, have said it means it is ineffective, which it does not, only that proof is lacking.
Now that is presumably in part to cover the arrogant and inflexible EU procurement process, so full of checks and balances it strangles itself.
Borisās vaccination stance
While Boris (faced with the same data) decided to wing it, correctly seeing that to save the NHS and his own electoral chances in May, he would rather give a potentially useless but harmless jab to millions of elderly disease vectors, than talk about due process. For once his disdain for the experts paid off.
The opposition in the meantime pleaded for a longer deprivation of our liberty by a longer pointless lockdown. Thank you for that suggestion.
Call it luck, if you will, but Boris has spent a long time practicing that ex tempore talent.
Proof might have been lacking, but it looked a jolly good bet. It sure was.
Charles Gillams
Monogram Capital Management Ltd