The Upshot of Inflationism

Doug Nolan

As a determined analyst, I’m as committed as ever to remaining “fiercely independent.” This must at least partially explain why I’ve tended to consider myself politically “independent.”

Political party ideologies undoubtedly engender biases and compromise objectivity. With the two major parties now in such a muddle, an “independent” affiliation almost wins by default. I recall years ago when I was first introduced to the notion of “the evil party and the stupid party” in a discussion about our two-party system. That conversation doesn’t seem as deeply cynical these days.

I’m left to daydream of a party committed to a smaller and less obtrusive federal government, strong national defense, fiscal responsibility, social tolerance and attentiveness to the environment. It doesn’t seem all that outlandish. Yet there’s one more thing – perhaps the most vital of all: I aspire to be associated with a political movement committed to sound money and Credit. Why all the clamor over guns when unbridled finance is so much more destructive?

This election cycle has been a national disgrace. It finally comes to an end Tuesday, when a deeply divided nation heads to the polls. I recall having a tinge of hope eight years ago that there was a commitment to more inter-party cooperation and less partisan vitriol. There’s not even lip service this time around. As an optimist, I would like to believe that a period of healing commences Wednesday. The analyst inside knows things will continue to worsen before they get better.

Our nation and the world are paying a very heavy price for a failed experiment in Inflationism. 


At this point, economic stagnation, wealth redistribution and inequality, financial insecurity and corruption are rather obvious consequences. “Money” and Credit have inflated, right along with government, securities markets, financial institutions, corporate influence and greed.

Along the way, there have been many subtle effects. To this day the majority still cling to the view that central bankers are essential to the solution - rather than the problem. But they are at the very root of disturbing national and international, economic, financial, societal and geopolitical degeneration.

For close to 30 years now, central bank policies have nurtured serial inflationary booms and busts. It’s a backdrop that has repeatedly forced investors, homebuyers and others into serious harm’s way. Buy or you’ll be left behind. Get aboard before it’s too late. It’s a system that systematically targets the unsophisticated and less affluent to take on a tenuous debt position to buy homes, cars and things in the name of promoting economic growth. It’s a system that devalues the wealth of savers. Somehow it’s regressed into a system with a policy objective to coerce savers and the risk averse, to ensure their buying power instead inflates the value of risky securities market assets.

We’re witnessing the repercussions of a prolonged bad cycle of playing with society’s psyche: inflating untenable expectations, only to see them crushed by the fist of bursting Bubbles. 


Central bankers then simply press on to the more egregious extremes necessary to reflate expectations. Apparently, big corporate “media” has been fine with all of this. Indeed, the “media” have been instrumental to Washington and Wall Street propaganda campaigns.

Ironically, it was free market ideologue Alan Greenspan that set in motion dynamics that evolved into Washington assuming commanding roles throughout the economy and financial markets. Every boom turned bust justified an even more “activist” reflation – fueling even bigger and more vulnerable Bubbles. Each Bubble begot even deeper structural impairment. 

And with each boom and bust the cumulative toll of victims expanded: lost jobs and careers; lost wealth along with insecurity; shrinking real incomes; repossessed homes and cars; bankruptcies and all the accompanying personal and family hardship.

Meanwhile, the fortunate and well-connected became millionaires and some even billionaires (helped if one operated a hedge fund). Over time, it turned more obvious the system was unfair (at best). Our government and central bank assured the discontents that they would redistribute wealth more equitably. Good times were right around the corner. Rest assured, the crisis was an aberration.

Propaganda went into overdrive – and the BS took on a life of its own: The economy, policymaking and the markets were fundamentally sound. Contemporary central banking was “enlightened.” Yet year after year the situation only worsened. Even with the stated unemployment rate back to 5% and stocks returning to record highs, disenchantment with the “system” grew. Interestingly, the “average” person seemed to better grasp the true merits of zero rates and money printing than PhD economists.

Today a strong majority of Americans believe the country is “moving in the wrong direction.”

A disturbingly large percentage no longer trust government, don’t trust “big business” or the media, and have little faith in the Federal Reserve or our institutions more generally. They fear our great nation is in terminal decline – and our leaders (govt, business, finance, academia, etc.) refuse to acknowledge there’s a serious problem, let alone do something about it. We fear an increasingly hostile world; we fear for the future. Insecurity – economic, financial and geopolitical – abounds. We worry our children won’t have same opportunities. And of course such a backdrop creates an incubator for anxiety, anger, racism and xenophobia. “When Money Dies.”

The two main candidates espouse two polarized views of the world. There’s the anti-establishment movement tapping into widespread frustration. The system is broken. And there’s the establishment candidate that takes a more promising view: “We are from the government and we’re here to help you.” One sees Washington as a corrupt swamp that needs draining. The other espouses the view that Washington must right the wrongs of an unjust world.

The fact of the matter is that “the establishment” has made an incredible mess of things – and that’s Republican and Democrat alike, (too often difficult to differentiate). Over the years the media has performed dismally, failing to hold our policymakers accountable. For too long the media has succumbed to historical revisionism, content to whitewash festering problems. 


Where were the tough questions for Greenspan, Bernanke and Yellen? Where was tenacious investigative journalism with regards to Fannie and Freddie? (Why did no one go to jail?) Why no vigorous scrutiny of all the Wall Street nonsense – until after the Bubble burst and it was too late?

Even after decades of one boom and bust cycle after another, the media retain a strong bias in support of central bank activism. History is clear: inflation is problematic and, in the end, unethical and terribly destructive. Yet, amazingly, to this day the vast majority of journalists remain pro-inflationism.

I argued that with “mad as hell…” having finally reached a majority, Brexit could be viewed as an important inflection point. Power had swung decisively away from the so-called “establishment” (government, media, securities markets, etc.). No matter Tuesday’s outcome, this dynamic is gathering momentum at home and abroad.

For the record, I have already voted for one of the two deeply flawed candidates. I cast my vote for change. An an analyst of Bubbles, I am absolutely convinced that the sooner problems are recognized and addressed the better. There’s never a convenient time to rein in monetary inflation, and it’s extremely unfortunate that this dangerous ideology has gone unchecked for so long. At this point, there will no easy way out of history’s greatest global financial Bubble. 


The inflationists will continue to claim that they just need additional time – and that the costs of staying the course are low. Nonsense. One can’t overstate the costs associated with more of the same.

This week’s trading seemed to confirm that markets have again entered a high-risk period. “Risk Off” has gained momentum, with global risk markets closely correlated on the downside. 


Stocks suffered almost across the board - the U.S., Asia, Europe and EM. Japan’s Nikkei fell 3.2%, as the yen rallied 1.6%. Notably, European equities came under heavy selling pressure. 

Italian stocks (MIB) were slammed 5.8%, and Spanish equities lost 4.5%. Germany’s DAX dropped 4.1% and France’s CAC 40 fell 3.8%. UK stocks were under pressure as well, with the FTSE 100 sinking 4.3%. European bank stocks sank 4.9%, led by the 8.9% decline in Italian banks.

Italian 10-year yields surged 17 bps to a 13-month high 1.75%. Moreover, the Italian to German 10-year bond spread widened 20 to a two-year high 162 bps. Heavily indebted and economically fragile Italy remains vulnerable to risk aversion and any tightening of global finance. With “Risk Off” taking hold, the last thing Italy needed was a group of earthquakes to go with heightened political uncertainty surrounding their December 4 referendum. Also, this week saw Italy’s jobless rate increase to a seven-month high 11.7%.

“Risk Off” heavily impacted EM this week. EEM (EM equities ETF) dropped 2.7% this week, trading to its lowest level since mid-September. Bloomberg: “Erdogan Crackdown Has Turkey on Edge as Kurd Leaders Jailed.” Turkish stocks were hit 5.2%, as the lira dropped 1.6% to another record low. Stocks fell 4.2% and 2.7% in Brazil and Mexico. Indian stocks were down 2.4%.

Bloomberg: “U.S. Stocks Post Longest Slide Since 1980…” A bit dramatic, but some fear (and a lot of hedging) has returned to U.S. equities. The VIX traded to the highs (22) since June. Selling was broad-based – big-, medium- and small-caps. And while Treasuries enjoyed a modest safe haven bid, it did not reverse selling pressure overhanging the beloved dividend stocks. The Nasdaq 100 (NDX) fell 2.9%, as the Crowded technology space begins to unravel.
According to Lipper, junk bond funds suffered $4.1bn of outflows this past week (largest since August 2014). Credit spreads widened meaningfully this week. And while spreads are not yet at alarming levels, increasingly it appears a widening trend has taken hold.

Tuesday evening – and likely late into the night – will be fascinating history in the making. 
 
Odds remain firmly in favor of a Clinton victory (as they were against Brexit heading into the June 23 vote). Unless the Democrats surprise with a clean sweep, there will likely be a relief rally partially fueled by an unwind of bearish hedges. But the race is clearly tightening. A Trump win would stun the markets at home and abroad, perhaps with that problematic combination of sinking stocks, rising yields, widening spreads and currency market instability. 
 
That would spell serious liquidity issues.

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