Control of the US budget is about to be taken over by a former central banker. Given that central banks around the world have been calling for governments to start using all the money they’ve printed to boost their economies more aggressively, that suggests we can expect a lot more spending. In turn, that implies a more inflationary economy.
That makes sense to me. But today I want to have a look at if there are any potential flies in the ointment.
Yellen seems highly likely to spend, spend, spend
Janet Yellen, the boss of America’s central bank, the Federal Reserve, before current governor Jerome Powell, is going to be sworn in as US Treasury Secretary today (for UK readers, that makes Yellen the American version of Rishi Sunak).
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
While Yellen was at the Fed, she followed the script that was written during the Alan Greenspan days. In effect, there’s no problem so big that throwing more money at the system won’t solve it. Or at least patch it over. However, following the 2008 crash, throwing money at the system wasn’t enough. Because quantitative easing (QE) just pushed up asset prices. That created as many problems as it solved.
So the new central bank mantra became: “We can provide the money – but now the government needs to step up and get it into the economy”. And now the central banker who printed the money is the person in charge of spending the money. That’s not someone who’s going to be scared of a bit of deficit spending.
Yellen has already confirmed this: her speech today apparently acknowledges “the country’s debt burden”. However, she says, "right now, with interest rates at historic lows, the smartest thing we can do is act big. In the long run, I believe the benefits will far outweigh the costs, especially if we care about helping people who have been struggling for a very long time."
For what my view is worth, at this stage I believe that erring on the side of spending too much is indeed the right course of action. Coronavirus is not the result of colossal mal-investment or rampant moral hazard (that was 2008). It’s a natural disaster whose impact – combined with the effect of the containment measures – has shut down many otherwise viable businesses. It’s right to support them and to support individuals, because if you don’t, we’ll be a lot longer getting out of this hole than we need to be.
But from an investment perspective, my view is irrelevant (as is yours). This is the path of least resistance. This is the path that will be followed. This is what we’ll get. So it’s no wonder that a lot of people think we’re going to see an inflationary dénouement to this bubble – even if not this year, then very soon.
There’s a column in this morning’s FT from Wharton professor Jeremy Siegel, headlined: “Higher inflation is coming and it will hit bondholders”. Siegel has a fondness for equities and so his column is more of a bearish call on bonds. I suspect he thinks that inflation will only get to the point where it hurts fixed income, but won’t get to the point where it hurts equities significantly (which history suggests starts when inflation gets to about the 4-ish percent mark and rising).
I think he’s right on inflation rising, but perhaps a little too optimistic about the idea that bond yields can rise without really giving certain parts of the equity market a painful shoeing.
But I digress. We’ve been talking about inflation for a while here. What I’m wondering about today is what could derail this scenario?
One key risk to the inflation scenario
The most obvious risk that I can see to the inflation scenario comes from the one economy to have already rebounded. China’s GDP growth for 2020 came in at its customary level of 6.5%. Everyone is entitled to treat Chinese GDP figures with even more scepticism than you’d treat the average set of official statistics, because when Chinese officials miss targets, they are at risk of losing their jobs, their liberty, and on occasion, their lives.
Yet in this case, it looks about right. China rebounded strongly in the second half of last year, having both entered and exited the coronavirus disaster earlier than everyone else (because, of course, it started there). Note, by the way, that China did this without a vaccine.
On the one hand, this is good news. If China had this strong a rebound without a vaccine – and arguably, with a much more threadbare welfare system propping up the population – you’d think the return to confidence in the rest of the world would be commensurately greater. So China’s strong recovery bodes well for the rest of the world in 2021 (eventually, at least). That in turn, suggests the inflation story is a good bet.
On the other hand, as John Authers points out in his Bloomberg newsletter today, China’s recovery does give some cause for concern. The rally has been driven by pretty much the same thing as China’s 2008 recovery. That is, a focus on selling goods abroad (demand for kit for working from home has helped) and building property and infrastructure.
The problem is that it’s this focus that has led to China’s economy being so unbalanced in the first place. And it looks as though China might try to rein it all in. It’s interesting, for example, to note that China hasn’t really been fazed by the ongoing strengthening of its currency, the yuan, against the US dollar in the last year or so. Until very recently, China had seemed to favour a weaker currency.
If China tightens monetary policy, it may not matter. After all, the US and most other big economies are going to be spending heavily. That’s plenty of replacement demand right there, and I suspect it’ll be enough. However, it could lead to a few bumpy moments in the shorter term, as Authers notes, “as China had recently been contributing to the liquidity gushing through the world”.
This is something we’ll be keeping a close eye on in MoneyWeek magazine. If you don’t already subscribe, get your first six issues free here.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
Trading terms: The Santa Rally
Glossary Will the Santa Rally result in its traditional December effect on global markets?
By Dr Matthew Partridge Published
Lock in high yields on savings, before they disappear
As interest rates peak, time to lock in high yields on your savings, while they are still available.
By Ruth Jackson-Kirby Published
UK wages grow at a record pace
The latest UK wages data will add pressure on the BoE to push interest rates even higher.
By Nicole García Mérida Published
Trapped in a time of zombie government
It’s not just companies that are eking out an existence, says Max King. The state is in the twilight zone too.
By Max King Published
America is in deep denial over debt
The downgrade in America’s credit rating was much criticised by the US government, says Alex Rankine. But was it a long time coming?
By Alex Rankine Published
UK economy avoids stagnation with surprise growth
Gross domestic product increased by 0.2% in the second quarter and by 0.5% in June
By Pedro Gonçalves Published
Bank of England raises interest rates to 5.25%
The Bank has hiked rates from 5% to 5.25%, marking the 14th increase in a row. We explain what it means for savers and homeowners - and whether more rate rises are on the horizon
By Ruth Emery Published
UK wage growth hits a record high
Stubborn inflation fuels wage growth, hitting a 20-year record high. But unemployment jumps
By Vaishali Varu Published
UK inflation remains at 8.7% ‒ what it means for your money
Inflation was unmoved at 8.7% in the 12 months to May. What does this ‘sticky’ rate of inflation mean for your money?
By John Fitzsimons Published
VICE bankruptcy: how did it happen?
Was the VICE bankruptcy inevitable? We look into how the once multibillion-dollar came crashing down.
By Jane Lewis Published