Dr Pippa Malmgren: Brace yourself for an inflation explosion

Stick to buying good brands, says asset management guru Dr Pippa Malmgren – and worry about your income.

Dr Pippa Malmgren
Dr Pippa Malmgren: presidential adviser

I’d wanted to meet Dr Pippa Malmgren for some time. I first had a go in 2010 when I was in the US. Then I hoped to see her in Glasgow at a conference last year. Next I thought I might be speaking at the same conference as her in Monaco later this year.

None of these worked out. So in the end we did something rather easier and met for a coffee at the Cadogan Hotel in Sloane Street (home of very, very strong espresso, by the way).

We start by running through Malmgren’s stunningly impressive career. Her father was the principal trade negotiator for the UK “under four different presidents: Kennedy, Johnson, Nixon and Ford”.

This meant that she “grew up in this world where talking about steel and auto parts and textiles at dinner was just completely normal”. That taught her that if you “want to work in the international arena you need to leave your own country first… you can never understand your own country until you leave it”.

So she went to the London School of Economics – the “best place in the world to study the politics of economic policy” – to do her PhD. She finished in 1991, took a job at rich country think tank the OECD, and looked for work at an investment bank. That took a while. Why? Maybe because she hadn’t grasped just how important greed was becoming in the financial world.

It is “crass to talk about money in Washington”, but when she told an interviewer at Bankers Trust that she wanted to make an “obscene amount of money”, she was in. She stayed for seven years, moving to Hong Kong to head the asset management business in Asia, before moving on to foreign exchange and ending up as chief currency strategist for the bank.

What made her good at that? Her understanding that no one really knows anything – most people are trading by guessing at what other people are guessing at. “For example, in Asia a lot of traders will keep a lunar calendar on their desk. If you ask them if they are actually trading based on the lunar calendar, they’ll say ‘no – but everyone else is’. This is really important.”

That insight encouraged her to focus on what everyone was thinking, rather than number crunching: while her rivals worked to out-forecast the Fed, Malmgren figured she’d “get on a plane and go talk to the board members of the Fed”.

As a result, she developed a reputation as someone who was both very well connected, but also “one of the few people in the market who could explain what was going on in plain English”.

Soon she was advising George W Bush on his election campaign, which led to a job “tailor made” for her skills – “being in charge of all financial market issues for the president of the United States”. Lucky, I say. Or very unlucky, she says. “In my first year we had seven of the largest bankruptcies in American history all occur in a single year… that’s the MBA you can’t buy.” Then there was 9/11.

I wonder, does she look back on that time as representing some kind of historical turning point in economics or finance?

She does. Before her team got to the White House they figured that the appropriate response to the dotcom meltdown was a tax cut, “which philosophically is where the Republicans are anyway”. But then came 9/11, the stimulus in response to that and the bankruptcies that “required yet more stimulus”.

Look at that chain of events and you start to see how – against all expectations – Bush’s government presided over “the largest Keynesian stimulus in modern American history”.

We move on to today’s monetary stimulus. When new Federal Reserve boss Janet Yellen spoke recently, the market wasn’t entirely sure what she had actually said – that interest rates would rise sooner than the market thinks, or not as soon as it thinks. What’s the real answer? “Here we come back to personalities,” says Malmgren.

Yellen believes that Japan’s first round of quantitative easing (QE) failed, because Japan “lost its nerve”. The authorities pulled it as soon as property prices started to rise (a “normal consequence of QE”), but that was too soon. That’s why Yellen doesn’t care where the property or stockmarket go in the US right now: she’s going to stick with QE until unemployment improves. She has effectively moved the unemployment target in the US from 6.5% to 5.5%.

But she’s also said that this isn’t enough of a target on its own, and so she “might be flexible” even on that. She has suggested that the inflation target should be not 2%, but 2.5%. She also effectively said that “we’ve been below average for so long that we can be above average for a while, and therefore we’re effectively abandoning the inflation target altogether”.

So will QE ever end? Can the Fed ever actually exit its position? “I have from the start had the view that it won’t be able to” – not without causing huge upset in the markets as it starts to sell. The best the Fed can do is to slow the pace at which it buys assets – as it is now. The Fed is not removing the punch bowl. It is, as Jeff Lacker of the Richmond Fed puts it, just “spiking the bowl less rapidly”.

Remember, the Fed is still adding $55bn a month. This would be market-moving “headline news under any other circumstances”. So if the Fed (and the Bank of England) can’t actually exit QE, how can this end? The debt stays on central banks’ balance sheets and just “slowly rolls off through duration” (in other words, as it matures). Otherwise there is a clever idea doing the rounds whereby the QE debt just morphs into a sovereign wealth fund, and is then spent domestically. That then provides a “huge stimulus” to the economy.

This brings us to inflation. Today Malmgren runs Principalis Asset Management, a consultancy that works with big institutional asset managers on their asset allocation, “focusing on the risks they can’t quantify” in geopolitics and policy. One of the things she is well known for talking about is the coming explosion in inflation. There are, she says, lots of signs that the velocity of money is “definitely returning to the system”. Such as? “Crowdsourced financing.”

Our central banks only measure how fast money is moving around an economy by looking at bank lending. But “the market is finding ways to connect investors with deals and with lending opportunities and they are meeting one another in all kinds of ways”.

Other non-bank finance is coming in to the equation too. Think about huge companies that can raise millions in the capital markets at the drop of a hat, but whose suppliers can’t get an overdraft. They lend direct to them.

“Money’s like water… it will always find a way to where the profits are.” There will “be false starts with the crowdfunding platform structures… but that doesn’t mean it won’t work or that it won’t permanently displace bank lending”.

What other signs of inflation does she see? “Shrinkflation” – where the packaging and price of a product are the same, “but what’s inside is smaller”. Input costs are rising globally – look at wages in emerging markets and at the fact that the prices of most major proteins are at “all-time record highs”.

And what of the cost of land and feed stock around the world? Then there is the cost of farming equipment, which is “going through the roof” and the oil price – oil may have come down from its record highs, but at “anything over 100 bucks it’s still expensive to move things from A to B”.

You also can’t ignore that “even in the industrialised world” workers are “screaming for wage hikes and getting them” in many cases. Add that to the rising cost of living, and “I just hate to think what will happen”. We’re talking about a “good old-fashioned wage-price spiral, “of the kind you are already seeing in emerging markets” and “I think we have every prospect of seeing in the industrialised world too”.

So what do MoneyWeek readers do? First make sure their wages keep up. The quick and easy answers to inflation “are never going to work” – governments “expropriate your gold”. The real answer is to “invest in your own personal skill set” so you can “generate more income at a time when your cost of living is rising”.

As for stocks, it’s still about brands, says Malmgren. Generic suppliers “get crushed before the big guys” in inflationary times, so stick with firms that can raise prices.

We’ve both finished our coffee and Malmgren has other meetings. But as I know that MoneyWeek readers never forgive me if I let an interviewee go without getting a view on house prices, I chuck the question in. Is the value of all of our houses going to rise?

“In the UK the answer is yes.” Everyone massively underestimates foreign demand (“the Chinese are buying £125,000 flats sight unseen in Birmingham”) and also refuses to recognise that it is still cheaper to live in London than in Mumbai and Beijing.

But what happens when real interest rates rise? They won’t.

“Everybody assumes that if inflation goes up then interest rates will go up. Really, why? What governments everywhere – the Fed, the Bank of England – are doing is basically removing the brakes from the bond market. Normally the bond market can sell off in response to higher growth, higher inflation risks… But if [central banks] are buying most of the bonds [then] you just took the brakes away. There are no brakes. In fact there isn’t even really any radar in the old sense. You snapped the antenna off once you start doing quantitative easing.”

That, says Malmgren, is why the bond market can’t show inflation with rising yields as it always has done in the past. And why we have to look for it in other places.

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