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Targeting higher inflation is the new panic in town

The real median policy rate is now 2.5% below inflation. If it increases, the world debt bubble will explode.
Economies are bouncing back on high spending and ultra-low policy rates – but debt levels have shot up. Image: Shutterstock

The Covid-19 pandemic caused economies around the world to slump. Governments reacted by issuing stay-at-home orders that caused problems for many as their incomes and livelihoods were destroyed.

Governments spent money like crazy trying to help people weather the Covid storm – but in fact helped create problems with their lockdowns, and the fear and panic caused the biggest decline in a hundred years.

Worldwide, we added more than 20% to the debt burden in about 18 months.

It’s not over yet either, and policymakers have a new panic to worry about – and it could make Covid-19 seem like a cold.

Source: economists.co.za/Bank for International Settlements

While economies are bouncing back on high spending and ultra-low policy rates, debt levels have exploded. Never have so many central banks had negative real rates. At present 52 out of 59 large economies have negative real rates.

The message is clear. Your money is losing value in the bank, so spend.

The world debt-to-GDP ratio increased to a record high of 290% last year. It did drop back to 280% as the GDPs of many countries bounced back fast, but 280% is far higher than 240% before the pandemic.

Monetary policy normally fights inflation by increasing interest rates, but only a few central banks have done so – most have not. Some policymakers may have increased their rates, but interest rates are lower than inflation.

Read: SA rate-hike bets jump on upside risks to inflation

Savers are rather encouraged to spend. In many countries you can borrow money from the bank that is lower than inflation.

Inflation targeting is dead as the median real policy rate has been more negative over the last decade than before 2010.

Source: economists.co.za

The M2 money (cash and near cash) supply for about 75 countries raced ahead as governments, firms and households spent.

World inflation is now about 4.6% – the highest rate in 13 years. This is in addition to increasing food commodity prices, while the cost of oil and heating gas is also increasing rapidly.

Read: Global inflation spike seen posing near-term risks to economy

The world supply chain is severely disrupted.

Container rentals have increased 10-fold. Commodity prices are, in the main, heading up.

Assets like houses are seeing prices rise far faster than inflation.

By now under the normal policy guidelines such as the Taylor rule most countries should have increased policy interest rates. Surely central banks should have raised rates if they still want to bring inflation down as the typical forecast for inflation is that it is rising.

Inflation expectations will also rise the more inflation rises and the bad news of droughts in Brazil hits everything from orange juice to coffee.

The inflation show could get a lot nastier.

Remember, inflation takes money away from the salaries of the workers.

Negative policy rates with high inflation is the worst destruction of savings known to man.

Already Germans are buying gold while others pursue equity strategies or buy crypto currencies in the hope of preserving wealth. The assets that grow now are more risky as both stocks and bonds are at very high levels.

In my view, high inflation is now the accepted outcome from central bankers as they choose to help lower debt-to-GDP ratios rather than savers who have come to rely on real rates and low inflation.

For real-economy firms, planning for expansion is also about to get a lot more difficult as inflation increases. The old foe looks set to make a comeback.

Source: economists.co.za

Global GDP growth for this year is forecast at 6% while next year most forecasters see it at around 4.5%. After that forecasts are now 3% and lower.

At first central bankers said inflation is temporary and would decrease back below targets quickly. Since then, they have shifted the language to transitionary or ‘a period of mild medium-term’ inflation.

Perhaps inflation will fall back a little, but that is no longer assured.

Targeting lower inflation is dead; it was killed by the pandemic

This while the real median country has a policy rate that is now 2.5% below inflation. Higher growth and higher inflation – and we should be increasing rates, but that is not going to happen for a decade or perhaps even two.

Inflation targeting policy is buried so deep because of the debt mess the world is in.

Debt at 280% of world GDP tells one that the debt service costs are now the most important factor for central bankers.

Individual debt is over $300 trillion or about $39 000 (around R600 000) per person alive.

That is way above world nominal per-capita income.

Data for about 31 countries shows the median debt-service-to-GDP for the private sector alone is 15.4%. It is increasing even with super-low interest rates. The real median policy rate is 2.5% below inflation now! If it increases the world debt bubble will explode.

Source: economists.co.za/Bank for International Settlements

That is because if interest rates rise from these ultra-low levels to combat inflation, total private sector debt-servicing-to-GDP will increase.

At 2.5% below inflation central banks would normally raise rates to about 2% or more above inflation.

Read: Kganyago: The Sarb also ‘came under attack’ from state capture

The debt service cost as a percentage of GDP for the typical country by my calculation would increase to about 25-30% of GDP.

The government sector interest-only payments also increase, so one would get a slow but sustained increase in government debt servicing costs too.

Suddenly borrowers would have to double their payments, and that will decrease expenditure by anything up to 20% as they pay back the banks.

Banks will not find new customers, and with the drop in demand GDP would shrink faster than debt. Houses and cars will not find buyers and the Middle East will be giving away oil for free.

Price deflation is very likely then, which will decrease nominal GDP even more and the debt burden will become even harder to manage.

That is the dilemma the world is in now.

Central bankers must know this and therefore the silent agreement is ‘talk inflation down so we can keep rates low’.

Let’s pray we get out alive of the debt dilemma.

Welcome back inflation

The one way to decrease the debt burden is to get inflation rising as it helps increase the world’s nominal GDP.

Say the 2% real growth happens and inflation rises 4%, then nominal GDP increases 6%. Hope that the debt level only increases, say, 4%.

That would lower the debt burden far quicker than through 2% inflation only. Of course, it also lowers the debt service costs, which again helps consumers to spend more, and that helps growth.

So stuff inflation – we need to get inflation to help nominal GDP grow.

Policy rates are allowing most countries to keep their debt service cost down, and quantitative easing helps keep government bond rates low – and governments can take their time paying back the debt, or make new debt to repay old higher-interest debt.

The fact that the median big economy has already seen an increase in the percentage of GDP that debt servicing costs – despite the same economies having the lowest median real policy rate – shows the dilemma.

If policy rates increase, the costs of serving debt will increase as a percentage of GDP for the private sector, including households and non-financial firms.

If inflation is high and interest rates low consumers would be crazy not to spend or at least not save in the bank. Inflation would eat your savings so why not spend it on something now.

Source: economists.co.za

Your debt we forgive by stealthy inflation

Negative real rates are also in effect a form of debt forgiveness.

People with loans are paying less than they normally would, as in some countries the prime rates are also below inflation, but lower rates destroy the value of savings, currencies and so on.

And if the whole world does this together, then all currencies decline with inflation and no one currency must fall out of bed. That is the tricky part for central bankers as this goes against their ethos.

So it makes sense to borrow to buy some assets like the house you intend to stay in. In the current scenario the value is likely to increase – and while your salary may not go up, low real rates will make paying it back affordable. If you are sure of the rental income that can help pay the house then bargain here too.

In some cases in South Africa people who bought houses after the great financial crisis are now paying less back to the bank than they are for rates and taxes!

As most central banks cannot afford to increase rates by much, the risk is all on the bank as your prime-minus rate is about to get overtaken by inflation.

Debt forgiveness is not that you do not pay the bank back, but that in real terms – that is, adjusted for risks like inflation and default – you pay back less.

Practical example …

Think of it this way: if you buy a house and rates are 1% but inflation (and house prices) are at 5%, you effectively pay back far less. On a loan of say R1 million, over 20 years you pay back R1.22 million – but the property value increases to R2.65 million.

Over 20 years the homeowner scores the difference of R1.43 million, or double the original value.

This is in effect ‘stolen’ from the saver; the saver who didn’t borrow the original amount actually lost out on R1.43 million.

This is the rising ‘inflation for debt reduction economics’ of the policymakers now. You may actually be enticed to borrow even more and the central banks will struggle to raise rates for far longer than they hoped to as the debt ratio will keep increasing.

That means all real assets like houses, equities and commodities are the only real game in town.

I would be very afraid of my pension fund, which has to keep at least 25% in interest-paying assets. That part was delivering reasonable returns, now no longer. (One could hope for a commercial property boom but alas, we left the office and the mall for the delivery from the warehouse.)

Hang on to your donkey – it’s going to be a wild ride.

(But borrow the money to buy the donkey.)

Source: economists.co.za

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And Numsa was offered a 4.28% increase by Neasa.

How can anyone blame the unions for striking last week, to receive a 8% increase, in a high inflationary environment.

The steel industry needs to step-up and meet the workers reasonable demands.

Affordability, mr Commissar, employers also struggle to keep afloat. It is not only workers, or only employers, but a combination of demand and supply. Currently the demand for products are low in our economy, simply because of policies creating this false narrative that employers will always be in a position to pay more. Our economy is in dire straights and your policies of burn it down, break it down or threatening it down will only escalate this situation for the worse.

You are following the popular narrative regarding wages and inflation. The general understanding is that the employer pays the wage. This is not the whole story though. The employer is entirely at the mercy of the consumer, who buys his products, for the cash flow to pay wages. The consumer is the ultimate employer in a free market economy and consumers do not care about labour laws and wage demands. They simply choose the best product at the best price. The law does not prohibit imports. The consumer will simply import the best product at the best price if he is not satisfied with the local offering.

This implies that labour laws and wage demands from organised labour confiscate the rights of consumers and hands them over to union members. The law takes the spending power away from the consumer, who is an average citizen and hands it over to the union members. The labour laws also expropriate the job opportunities of the unemployed masses and hand them over to union members in the form of protected positions and exorbitant wages.

This brings us to the question- Why would voters support such a coercive act? Why would voters, as consumers, enslave themselves to socialist labour unions? It s because they fail to connect the dots.

This brings us to the reality that the strength of labour unions is built upon the economic ignorance and stupidity of the average voter. The ignorance and stupidity of voters empower militant labour unions all the way into Luthuli House, from where they control the law-making process in parliament to enslave all of us.

My dear Mr Commissar, it’s very elementary the workers are free to offer their labour to the highest bidder. So if employer A won’t give them what they demand they can just go off to employer B, see! Or if there is no employer B they can just go and sit at home because there must be other people who would rather take what is on offer than sit at home and get nothing!

Now go back and play quietly in your sandbox.

I love reading your comments… such a good laugh.

me too, Cat. I love reding the drivel and I get a good laugh each time. I strongly suspect commissar is one of my in laws…..

@EFF CommieSar.

4,28% offer is more than reasonable. What corresponding PRODUCTIVITY INCREASE does workers give to employers?

No, the only thing that will “step up” is the rate of unemployment.

The few that has a job, they can afford to strike *lol* Bizarre!

I have noticed Pref shares going up quite dramatically over the last week or two.

Maybe in agreement that interest rates should have been raised at the last MPC meeting. They are dragging their feet.

No wonder Bitcoin and crypto is becoming so popular. The traditional financial system is broken and the same “people” that broke it cant fix it. It will be crypto and DeFi that will have to come to the rescue. Will be a “regulation” fight though. They will blame terrorism or something. Yet it is these very people that are the problem.

Very well written article Mike, which shows the mess created by the central planners mainly starting 2008 when they bailed out banks that should have failed.

The Ponzi scheme is now seemingly out of control and the crony capitalists are rushing to buy real assets with all that cheap money they are so close to.

Inflation is nobody’s friend.
Nobody’s!

This is an excellent article from the master of his trade.

There is a strong correlation between levels of government debt and the long-term trend of share indexes. Contrary to the general perception, that correlation is positive.

As investors, we should align our interests with that of the largest governments. When the debt is above 80% of GDP( currently 280%) it is impossible to service or repay. Governments will default, without a doubt. It is the shape of the default that matters. Defaults come in different shapes and sizes. Reserve Banks have the power to engineer a stealth default through currency devaluation. Controlled inflation through negative real bond yields is the most politically acceptable form of government default because it leaves the financial system intact.

Under these circumstances, step one for investors is to protect purchasing power by buying assets that rise with inflation(not bonds). Step 2 is to finance those purchases with debt. Step 3 is to manage the risks inherent to gearing. This will put the investor in a position to benefit from the process as Keynes describes below.

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.” – John Maynard Keynes

I agree with everything you say Sensei.
But there is one more thing. Bitcoin.
Currency debasement is happening all across the globe causing an ever increase in asset prices. The scarcer the asset, the larger the increase.
The scarcest asset of them all is bitcoin.

Bitcoin is one of the thousand assets on my watchlist. I invest in those that show the best relative strength over the selected timeframe. I have no favorites among them. I simply take the buy signal when I get it, and take the stop loss when it is time to do so. Life is simple and uncomplicated this way.

Isn’t RSA debt/GDP above 80% ?

It’s doubtful anyone in the ANC fathoms that

Debt at 280% of GDP? Not if you bring the unfunded liabilities of governments on medicare and social security into account.

Then it’s much bigger. More like 10x.

Clearly it will never be repaid. So, in our future there lies a massive default. Either by inflation, or worse deflation.

I’m going with inflation and so is every central banker.

Very good points you made. Unfortunately I do not have enough experience to fathom the buy signals of individual companies. I spend a lot of time analyzing performance of the top asset managers. Hopefully these guys will get things right. Most of them do not.

Great article. The global economy is doomed either way. Raise rates and debt bubbles will explode, together with asset classes (houses, equities, cryptos). Not raising rates will just postpone the pain: Risk of hyper inflation and even bigger asset bubbles, which will lead to stagflation and even worse scenario for asset classes. Monetary instruments are there for a reason. Not using it for its intended purpose will have catastrophic consequences. Central banks have become gamblers. I don’t care about negative real return. I wait patiently in cash for opportunities when the monetary experiment fails! It is a matter of when, not if.

An invitation to get into debt in a property market in SA which is notorious for its volatility? Did you buy a property in Sandton 15 years and expect to sell it (including all costs) and buy an apartment in Clifton where a parking space on the roof of a block of flats is on the market for R1.5 million?

There’s a thingy called a Gold 1oz Kruger Rand ….

Pensioners or those nearing retirement are the net investors and cannot realistically just SPEND MONEY anyhow. Obviously their funds are held in Pension Funds not in banks where they can draw willy nilly. They are on the receiving end whichever way you look at it. Low rates decimate their savings. High inflation combined with taxes put them at the disadvantage in terms of affording necessities of life.

See how the inflation antidote of gold is being pathetically stepped upon by the western CB cartel as it wastes its energy. More power to the crypto core so long as it is not also undermined. For as long as the crypto game is useful to the tax dodging and greedy elite then it will be the major beneficiary. Follow the very big money.

“…. crypto game is useful to the tax dodging and greedy elite then it will be the major beneficiary”

Well when taxes are thrown about by governments like confetti to pay for exorbitant salaries and personal expenses, its time “real” money, accessible to the minions emerged

Crypto / Bitcoin is like sticking a finger in the eyes of the elite

You can buy a fraction or the whole coin and banks / central banks cannot stop you taking it anywhere in the world…to spend or trade as you please. If one thinks the global powers can just stop the internet…well thats like sticking your head in a bucket of something smelly

Crypto is not omnipotent. As the globalists increase their grip then the purpose of central control, China style, increases. There will be no freedom of any kind for any but the very few elite. Its just human nature being assisted by the beast of inadequately controlled capitalism. Not to worry because its far too late to do anything. The sheeple have succumbed to the media mind control machine long ago.

Should we be investing in Kruger Rand coins?

End of comments.

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