Will Biden’s stimulus package fuel global inflation – and how can you protect your wealth?
Joe Biden’s latest stimulus package threatens to fuel inflation around the globe. What should investors do?
Assuming all goes to plan, the US economy is about to get another huge cash injection. American president Joe Biden’s $1.9trn stimulus package, which looked set to become law this week, includes an extension of nationwide unemployment benefits alongside $1,400 cheques being sent to most American adults (the payments are means-tested, but the thresholds are well above the average US income). As Bloomberg notes, the scale of the stimulus has seen various analysts upgrade expectations for US growth this year, from already high levels. Investment bank Morgan Stanley reckons growth will now hit 7.3%, a level unseen since 1951, while the OECD group of wealthy countries “doubled its own estimate” to 6.5%.
The payouts are undoubtedly popular with the electorate, with strong support regardless of political persuasion (voters are split on lots of topics, but free money doesn’t seem to be one of them). However, the big question for investors is: will the stimulus combine with huge levels of pent-up demand to create an inflationary surge once Covid-19 is truly behind us? And will that surge be more than temporary? And if so, what might that mean for markets that have grown used to disinflation?
How much is too much?
On the inflation point, there are signs of nerves even among those who wouldn’t traditionally be viewed as overly cautious on public spending. For example, economist and Bill Clinton-era Treasury secretary Larry Summers reckons the stimulus goes “way beyond what is necessary”, meaning that “we risk an inflationary collision of some kind”. Economist and opinion columnist Paul Krugman on the other hand, who debated the topic with Summers in a Princeton University-hosted video call last month, basically conceded that while it’s possible, inflation is not as big a risk as Summers fears – and in any case it’s worth a shot to shore up the economic recovery.
MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
As Paul Ashworth of Capital Economics makes clear, no one really knows the answer. Economists favour a concept known as the “output gap” to try to put a figure on how far an economy is from running at full capacity. But it’s always been a controversial measure and it’s of virtually no use in helping anyone in practical terms (in other words, it’s useful for justifying decisions on a spreadsheet after they’ve been made, but hopeless in terms of predicting inflation).
One thing, however, is for sure. Due to a combination of earlier stimulus packages and extended benefits, US “households have a lot of money set aside that could boost consumer demand later this year”, says Ashworth. As Chetan Ahya at Morgan Stanley points out in the Financial Times, “US households have lost $490bn in income, but received $1.3 trn in transfers”. That’s all before the latest stimulus.
From an investor’s point of view, the concern about inflation at this stage is that it might make central banks – led by the US Federal Reserve – tighten monetary policy. The Fed keeps arguing that it will let inflation rise above the 2% target level, with its main focus now being a return to full employment. However, Ahya argues that the risk is “inflation could overshoot the overshoot level the Fed is comfortable with”. That might force the Fed to act more quickly than it currently expects, which could hit markets hard.
Great Rotation, then Great Inflation?
We’ve already seen bond yields rising and tech stocks falling this year, but so far it all falls into the category of a “rotation”. Investors are selling the assets that were popular during the long slide in interest rates and the low-growth era that followed the financial crisis. They’re now shifting that money into stocks that should benefit from stronger growth and rising inflation. In other words, as an investor, you shouldn’t panic. The tech-heavy US Nasdaq index has had a tough year, because it’s the home of all the most expensive and popular stocks over the past year. But the broader-based S&P 500 has gained over the year, while the more value-focused FTSE 100 in the UK has outperformed both (if only a little).
What of the longer run? So far, markets only seem to be pricing in a return to something approaching “normal”, rather than a long-term rise in inflation. However, with central banks likely to be highly reluctant to tighten monetary policy and risk crashing the economy, we suspect that longer-term inflation might well be what we get. If that’s the case, bonds will struggle (though they may be propped up by various “financial repression” strategies – such as regulations forcing pension funds to own them, for example) first. Stocks will probably be fine up until inflation hits about 4% (and the UK markets is likely to do better due to the high weightings towards financials and commodity stocks). But if inflation really does take off, it would be wise to be holding some commodities and specifically, some gold.
-
Energy, healthcare and utilities: how to tap into AI in the real economyAI promises to add to the productivity and profitability of much of the economy beyond tech. Here’s two themes to tap into AI in the real economy.
-
How Junior ISAs could help with inheritance tax planningLooming inheritance tax changes will limit how much pension wealth can be passed on but more people may be maxing out their loved ones’ JISA allowance instead
-
Rachel Reeves is rediscovering the Laffer curveOpinion If you keep raising taxes, at some point, you start to bring in less revenue. Rachel Reeves has shown the way, says Matthew Lynn
-
The enshittification of the internet and what it means for usWhy do transformative digital technologies start out as useful tools but then gradually get worse and worse? There is a reason for it – but is there a way out?
-
What turns a stock market crash into a financial crisis?Opinion Professor Linda Yueh's popular book on major stock market crashes misses key lessons, says Max King
-
ISA reforms will destroy the last relic of the Thatcher eraOpinion With the ISA under attack, the Labour government has now started to destroy the last relic of the Thatcher era, returning the economy to the dysfunctional 1970s
-
Why does Trump want Greenland?The US wants to annex Greenland as it increasingly sees the world in terms of 19th-century Great Power politics and wants to secure crucial national interests
-
Nobel laureate Philippe Aghion reveals the key to GDP growthInterview According to Nobel laureate Philippe Aghion, competition is the key to innovation, productivity and growth – here's what this implies for Europe and Britain
-
'Investors should brace for Trump’s great inflation'Opinion Donald Trump's actions against Federal Reserve chair Jerome Powell will likely stoke rising prices. Investors should prepare for the worst, says Matthew Lynn
-
The state of Iran’s collapsing economy – and why people are protestingIran has long been mired in an economic crisis that is part of a wider systemic failure. Do the protests show a way out?
