Inflation Watch 

Doug Nolan


August Personal Consumption Expenditures (PCE) inflation rose to 4.3% y-o-y, the largest gain in 30 years. 

The S&P CoreLogic National Composite National Home Price Index posted a 19.7% y-o-y gain in July – the strongest housing inflation in data back to 1987. 

Zumper data show national apartment (two-bedroom) rent inflated 13.1% y-o-y, with Zillow national rental prices rising 11.5%. 

The Bloomberg Commodities Index ended the week with a year-over-year rise of 44.6%. 

A benchmark United Nations food index inflated 33% over the past year. 

University of Michigan consumer one-year inflation expectations were down slightly from July’s high to 4.6%, near a 13-year high - and only 0.5% below 40-year highs. 

Forecasts have September y-o-y consumer price inflation at 5.3%, near the high since 1990.

We’ll begin with a Chair Powell comment from his September 22nd press conference: 

“If you look at the last two or three years before the pandemic hit, you saw, after a lot of long progress, you saw a really strong labor market. 

And you saw wages at the low end moving up faster than everywhere else. 

Something that’s great to see. 

We also saw the lowest unemployment rates for minorities… 

We saw a really, really healthy set of dynamics. 

And, by the way, we also -- there was no reason why it couldn’t continue. 

There were no imbalances in the economy, and then along came the pandemic. 

We were not, there was nothing in the economy that looked like a buildup of imbalances that could cause a recession. 

So, I was very much thinking that the country would really benefit from a few more years of this. 

It would have been -- so we’re all quite eager to get back to that.” 

This is somewhat confounding. 

If there were “no imbalances in the economy,” why then did the Fed resume QE in September 2019 – months ahead of the pandemic (with markets near all-time highs and unemployment at 50-year lows)? 

Federal Reserve Assets have ballooned $4.678 TN over the past two years (107 weeks), of which about $200 billion occurred prior to the Fed’s March 2020 crisis ramp up. 

There were clearly worsening fragilities in market structure. 

It’s a key analytical point that the return of QE was in response to market “imbalances” - most notably instability in the “repo” market, which had clear potential to erupt as a catalyst to prick to U.S. and global Bubbles. 

Recall also that U.S. “repo” market disorder followed on the heels of Chinese money market instability. 

Instead, reenergized U.S., Chinese and global Bubbles could not have been more vulnerable heading into the pandemic. 

Their near implosions unleashed global monetary stimulus without precedent.

September 28 – Bloomberg: 

“China’s central bank governor said quantitative easing implemented by global peers can be damaging over the long term and vowed to keep policy normal for as long as possible. 

Central banks should try their best to avoid asset purchases because in the long run they will ‘damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard,’ People’s Bank of China’s Governor Yi Gang said… 

When central banks have to purchase assets, the programs should be in proportion to the size of the market’s trouble, Yi said. 

The interest rate in some economies have approached or even dipped below zero, he said. 

‘China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,’ the governor said.”

I agree with Governor Yi’s astute assessment that QE will “damage market functions, monetize fiscal deficits, harm central banks’ reputation, blur the boundary of monetary policy and create moral hazard.” 

As for “China will extend the time for implementing normal monetary policy as much as possible and there is no need for asset purchases,” it has me pondering whether the PBOC fully comprehends the scope of the crisis they face.

September 28 – Bloomberg: 

“China’s central bank injected liquidity into the financial system for a ninth day in the longest run since December as it sought to meet a surge in seasonal demand for cash. 

The People’s Bank of China pumped in 100 billion yuan ($15.5bn) of cash with 14-day reverse repurchase agreements, resulting in a net injection of 40 billion yuan. 

The move may also have been aimed at calming jitters fueled by China Evergrande Group’s debt crisis… 

The central bank has added a total net 750 billion yuan via open market operations since Sept. 17.”

The PBOC injected over $100 billion into China’s financial system in nine days. 

This no doubt helped stabilize Chinese securities markets, including the increasingly unstable corporate debt market. 

It also hints at the scope of Chinese “QE” that will be forthcoming as de-risking/deleveraging gains momentum and China’s Bubble collapse accelerates.

Global bond markets have every reason to take notice. 

After all, the risk of a deflationary Chinese Bubble collapse has helped underpin bond prices in the face of unending massive supply and mounting inflationary pressures. 

But suddenly an even greater risk has begun to surface: An increasingly disorderly Bubble collapse could force Beijing into aggressive monetary inflation, even as China and the world are in the throes of an inflationary shock. 

September 28 – Bloomberg: 

“The world’s second-biggest economy is caught in the grips of a widening power crisis that’s threatening to stymie growth and further tangle already snarled global supply chains. 

At least 20 Chinese provinces and regions making up more than 66% of the country’s gross domestic product have announced some form of power cuts, mostly targeted at heavy industrial users. 

The reasons are two-fold -- record high coal prices are causing power generators to trim output despite soaring demand, while some areas have pro-actively halted electricity flows to meet emissions and energy intensity goals.”

September 30 – Bloomberg (Alfred Cang): 

“China’s central government officials ordered the country’s top state-owned energy companies -- from coal to electricity and oil -- to secure supplies for this winter at all costs, according to people familiar… 

The order came directly from Vice Premier Han Zheng… and was delivered during an emergency meeting earlier this week with officials from Beijing’s state-owned assets regulator and economic planning agency, the people said… 

Blackouts won’t be tolerated, the people said.”

China’s Producer Price Index was up 9.5% y-o-y in August, the high all the way back to 1995 when the Chinese economy and Credit system had minimal global impact. 

The nation’s energy crisis now has the potential to prolong what was expected to be a temporary inflationary spike. 

China will aggressively compete with Europe and others for stretched global energy supplies heading into the winter heating season. 

Already pressured by acute global supply chain issues, global inflationary pressures will be bolstered by surging energy and related commodities prices, as well as from rising prices for Chinese goods. 

September 24 – Associated Press (Christopher Rugaber): 

“Restaurant and hotel owners struggling to fill jobs. 

Supply-chain delays forcing up prices for small businesses. 

Unemployed Americans unable to find work even with job openings at a record high. 

Those and other disruptions to the U.S. economy… appear likely to endure, a group of business owners and nonprofit executives told Federal Reserve Chair Jerome Powell… 

The business challenges, described during a ‘Fed Listens’ virtual roundtable, underscore the ways that the COVID-19 outbreak and its delta variant are continuing to transform the U.S. economy… 

‘We are really living in unique times,’ Powell said at the end of the discussion. 

‘I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people. ... 

So, it’s a very fast changing economy. 

It’s going to be quite different from the one (before).’”

It's beginning to sink in that rising inflation is much more than a transitory phenomenon. 

Supply shocks and inflationary pressures are altering perceptions, attitudes and behaviors. 

Would panicked drivers have drained UK gas stations dry before the pandemic? 

Will businesses large and small manage resources (i.e. materials, inventory and labor) differently after confronting prolonged supply-chain and labor shortage nightmares? 

Will spiking prices for so many things force governments, businesses and consumers to change purchasing habits? 

And in the latest indication of changed psychology, plastered across the news was the latest clue on hording behavior: “Costco brings back purchase limits on toilet paper, cleaning supplies and more.”

Powell: “I’ve never seen these kinds of supply-chain issues, never seen an economy that combines drastic labor shortages with lots of unemployed people.” 

Well, never have we seen the Fed print $4.7 TN in two years. 

Never have we seen such concerted global monetary inflation – from the U.S., China, Europe and the “developing” economies. 

From The Institute of International Finance’s Q2 Debt Monitor: 

“Global debt soared to a new record in Q2 2021. 

Following a slight decline in Q1 2021, the global debt pile increased by some $4.8 trillion in Q2 2021. 

At a fresh all-time high of $296 trillion, global debt is now more than $36 trillion above the pre-pandemic level… 

Mature market debt heading higher again – albeit more slowly… 

The debt buildup was most substantial in the Euro Area. 

Largely driven by Germany and France, the USD value of total debt in the Euro Area increased by $1.3 trillion to over $56 trillion in Q2… 

Total debt across emerging markets rose by some $3.5 trillion in Q2 2021, and now stands at nearly $92 trillion – over $15 trillion higher than pre-pandemic level.”

“China’s debt levels rising rapidly: With total sectoral debt up by an estimated $2.3 trillion in Q2 to reach an all-time high of over $44 trillion, the pace of China’s debt buildup has been much steeper than in other countries.”

Expanding at a blistering (“Terminal Phase of Bubble Excess”) 23% annualized rate, China ended Q2 with a debt-to-GDP ratio of 329% (led by the Non-Financial Corporate sector’s 158%). 

The U.S. ended Q2 with a debt-to-GDP ratio of 367%, with global debt at 353%. 

All-Embracing.

Rather than moderating back toward the Fed’s 2% target, inflationary pressures are broadening and accelerating – energy, commodities, housing and food, most conspicuously. 

Between last week’s press conference and this week’s congressional testimonies, Chair Powell has been peppered with inflation questions. 

It has become increasingly difficult to both dismiss inflation risk and assert the Fed has the situation under control. 

Below are some of his responses:

“The current inflation spike is really a consequence of supply constraints meeting very strong demand, and that is all associated with the reopening of the economy -- which is a process that will have a beginning, a middle and an end.”

“It’s also frustrating to see the bottlenecks and supply chain problems not getting better — in fact at the margins apparently getting a little bit worse. 

We see that continuing into next year probably and holding up inflation longer than we had thought.”

“We have an expectation that high inflation will abate, because we think the factors that are causing it are temporary and tied to the pandemic and the reopening of the economy. 

These aren’t things that we can control.”

“We expect that [prices being affected by supply side constrictions] will abate, that they’ll lessen and over time will come back down. 

Exactly when that will happen is not possible to say, but I would say we should be seeing some relief in coming months and over the course of the first half of next year.”

And from the Associated Press (Christopher Rugaber): 

“Powell has also said that if there were indications that inflation could rise to unsustainable levels, the Fed would hike rates to bring it under control. 

‘We just have to balance the two… 

But I would say our expectation is that inflation will come down and we won’t ultimately face that difficult trade-off of having the two goals in tension.’”

The “two goals in tension” would be stable prices and full employment. 

Despite an unprecedented 10 million job openings and a 5.2% unemployment rate, Fed officials still assert that the U.S. economy is “far away” from full employment. 

September 27 – Reuters (Ann Saphir): 

“The Federal Reserve’s ‘highest priority’ is to make sure millions of Americans now out of a job can get back to work, Minneapolis Federal Reserve Bank President Neel Kashkari said… 

‘Putting Americans back to work…to me that’s our highest priority,’ Kashkari said at the Community Foundations Leading Change Fall Forum, adding that ‘of course’ the Fed will pay close attention to inflation and keep that in check. 

Recent high readings of inflation do not signal permanently higher inflation, he said: ‘We don’t want to overreact to short-term price movements.’”

I sympathize with the unemployed and underemployed. 

But at this precarious phase of the cycle, monetary and price stability must be the Fed’s highest priority. 

Priority must be given to returning stability to a system responsible for the wellbeing of its 330 million citizens. 

“Money printing” is definitely not in our nation’s best interest, and this runaway experiment in monetary inflation needs to come to an end. 

Late in the “Terminal Phase” of Bubble wealth redistribution and destruction, our great nation faces greater peril by the day.

Powell: 

“Of course, if we were to see sustained higher inflation and that were to become a serious concern, I would tell you the FOMC would certainly respond and we would use our tools to ensure that inflation runs at levels that are consistent with our goal.”

Higher inflation is in the process of being sustained – and it should today be a serious concern – yet few believe the Fed will actually use their “tools” to suppress it. 

To begin with, inflation dynamics are not under the Fed’s control. 

More today than ever before, inflation is a global phenomenon. 

What's more, a strong case can be made that China has supplanted the U.S.'s traditional commanding role in global inflationary dynamics.

The eminent market and economic analyst Mohammed El-Erian has been at the top of his game. 

His Friday Bloomberg piece is spot on: 

“Demand Is Not the Economy’s Problem. 

Supply Is - Policy Makers and Central Bankers are Stuck in a Mindset From the Last Crisis and Need to Alter Their Thinking.” 

And appearing Friday morning on Bloomberg TV, Mr. El-Erian made an astute observation: 

“When it comes to an orderly taper, the window is closing… 

We’re still buying $120 billion of assets every single month – what we have been buying since the worst of the Covid crisis. 

Does it make sense in this environment when demand isn’t a problem, when bond markets are wide open?”

It makes no sense. 

From my analytical perspective, the window has closed. 

Bubble fragilities preclude an orderly taper. 

What’s more, our focus on the Fed is too narrow. 

The window to a “tapering” of global monetary inflation is at this point likely shut as well. 

Whether they realize it yet or not, the PBOC has likely commenced what will prove to be massive ongoing liquidity injections. 

I’m also skeptical that the Fed, ECB, Bank of Japan and the Bank of England will have the gumption to wind down their QE programs. 

China is providing an early glimpse of the serious predicament about to envelop the world: liquidity injections necessary to keep Bubbles from imploding will come concurrently with problematic supply shocks, acute economic imbalances, and destabilizing price pressures. 

At the end of the day, I don’t see the “two goals in tension” being price stability vs. full employment. 

The unfolding conflict is poised to match general price stability against market stability. 

If the Fed and others are, here in the ninth inning, determined to sustain securities and asset price Bubbles, the world faces the prospect of momentous Monetary Disorder and inflationary mayhem. 

Key Issue: With inflation raging and the Republicans breathing down their necks, will the Fed flinch when faltering markets, in a raving tantrum, demand another quick Trillion or two? 

So many facets of the current environment point to monumental changes in policy, financial and market backdrops. 

The halcyon days, where the consequences of egregious monetary inflation primarily manifested in surging securities and asset prices, are drawing to a close.

Could the environment possibly encompass a greater litany of uncertainties? 

And I would expect markets to become only more volatile and unstable – equities, corporate Credit, commodities, currencies and derivatives more generally. 

Over the past two weeks, local currency bond yields have surged 121 bps in Turkey, 54 bps in Romania, 42 bps in Chile, 36 bps in Mexico, 27 bps in South Africa and 26 bps in Russia. 

In the currencies, the Chilean peso is down 2.5%, the Turkey lira 2.5%, the Hungarian forint 2.3%, and the Mexican peso 2.1%. 

Pain in “carry trade” leveraged speculation is intensifying, with the U.S. dollar index jumping to one-year highs - likely signaling de-risking/deleveraging dynamics have gained important momentum. 

EM – including China – sovereign CDS have moved sharply higher. 

In short, “risk off” contagion has jumped from China’s “periphery” to the global “periphery,” with “core” Chinese and U.S. markets increasingly vulnerable.

Senator Pat Toomey: 

“We’re now seeing rates of inflation considerably higher than the Fed projected and it’s hurting businesses, consumers, and workers. 

And you don’t have to just take my word for it. 

Here’s what the CFO of one of the biggest retailers in America, Costco, said last week, and I quote, ‘Inflationary factors abound. 

High labor costs, higher freight costs, higher transportation demand, along with container shortages and port delays, increased demand in certain product categories, various shortages of everything from computer chips to oils and chemicals.’ 

To address this threat, I urge the Fed to accelerate the process of normalizing monetary policy so that it does not fall further behind the curve in responding to the inflation that is already with us."

Ashes from ashes

How America wasted its unipolar moment

The war on terror improved neither the nation’s standing nor the nation itself


When, in 1998, President Bill Clinton fired cruise missiles at terrorist bases in Afghanistan and Sudan, a reporter asked the secretary of defence if there wasn’t a “striking resemblance” to the plot of “Wag the Dog”, a film in which a White House consultant confects a faraway war to distract from a presidential sex scandal. 

Popular culture and sex scandals loomed large in American society during the 1990s; foreign affairs did not. 

Abroad was where the impediments to Ross and Rachel’s predestined coupledom came from in “Friends”.

Those who still paid attention to America’s role in the world lacked a definition for it. 

Having become the world’s only superpower, America had very little idea how to use that power—if, indeed, it should use it that much at all.

September 11th 2001 brought this era of distraction and aimlessness to an end. 

The horror of that day unified the country, all but erasing memories of President George W. Bush’s divisive victory over Al Gore the year before. 

It also created, for Americans, the prospect of global solidarity. 

“The world has changed in a way that we are all vulnerable,” said Joe Biden, the chairman of the Senate foreign-relations committee, the following day.

America’s mission, he went on, was obvious: to take the lead in “a struggle between civilisation and barbarity”. 

A few weeks later, at the Council on Foreign Relations in New York, Mr Biden imagined how that new purpose—and specifically a new common cause with Russia which the struggle would make not just possible but necessary—“could shape this half-century as the cold war shaped the last”.

A big claim. 

The strategy of containing the Soviet Union, first articulated by George Kennan, a diplomat, in 1947, governed America’s conduct in the world from then until the Soviet Union’s dissolution. 

It provided nine successive presidential administrations with a compass and a rallying point, producing not just a series of capital-d doctrines (preceded by names like Truman, Eisenhower, Kennedy, Carter), but also a national highway system, a science boom and a common cause—as well as witch-hunts for communists and the folly of Vietnam. 

It led to a green revolution in developing-country agriculture and put a man on the Moon.

It also justified hard trade-offs in foreign policy. 

It gave presidents a rationale, however thin, for alliances with despots. 

It argued for patience in building democratic institutions in South Korea and Taiwan like those established in West Germany and Japan. 

In 1972 it prompted the boldest stroke in late-20th-century American diplomacy: the opening to China.

When the Berlin Wall fell, America’s accumulated economic, technological, cultural and military power lost its counterweight. 

After Iraqi troops swept into Kuwait the following year the world soon got a glimpse of what this “unipolar” era might look like. 

The spectacularly one-sided Gulf war of 1991 provided the first large-scale demonstration of America’s might in decades. 

Stealth, precision-guided munitions and long-range cruise missiles developed during the cold war found new application beyond it.

The institutions, mindset and, in the form of the first George Bush, leadership demonstrated in that war were also products of the world gone by—and less adaptable to new forms of conflict. 

Cold-war concerns about coalition-building and the sanctity of state borders worked reasonably well when it came to liberating Kuwait. 

The lessons of the previous 40 years were far less helpful when it came to shoring up weak states, such as Somalia, or quelling intra-state conflict, as in Rwanda or Bosnia, or fighting transnational threats such as terrorism. 

And by leaving Saddam Hussein in power the war also implied, unsatisfyingly to some, that while borders mattered to America, tyranny did not.

The lack of a settled idea about what, if anything, the lone hyperpower should do about such problems made foreign policy in the 1990s “like being set loose on the ocean and there wasn’t really any charted course”, as Madeleine Albright, Mr Clinton’s secretary of state, later put it. 

The task of coming up with a guiding principle for America’s role as overarching as containment became known in the White House as the “Kennan sweepstakes”; aides consulted Mr Kennan himself. 

But to no real avail. 

As Joe Biden said in 1998—the same year the Clinton administration had launched its first, derided missile strikes against al-Qaeda—there was “no consensus on the us role in the world”.


When Mr Biden delivered his talk at the Council on Foreign Relations in October 2001 American forces had just invaded Afghanistan in order to accomplish what those missile strikes had not. 

A new consensus had crystallised, and Mr Biden imagined it being backed by the rest of the world. 

Vladimir Putin, he said, was a strategic thinker who was taking on reactionaries because he saw “he must cast his lot with the West”. 

America and China now shared interests in fighting terrorism and maintaining peace in Central Asia. 

Even Iran might warm to the Americans. 

It was, after all, helping in Afghanistan.


Twenty years on, the world is not the one Mr Biden hoped for. 

The framework George W. Bush’s administration adopted for its post-9/11 mission in the world, the global war on terror, certainly put an end to the foreign-policy establishment’s worries about the role of their hyperpower and how fully to use its force. 

Containing the Soviet Union had kept a lid on America, too, forcing it to acknowledge complex geopolitical interests, accept lesser evils to fend off greater ones and cautiously avoid pushing its nuclear adversary too far. 

Now America could be uncontained.

But for all the deaths that followed, Afghanistan sits today in the hands from which it was being taken when Mr Biden was giving his speech. 

The calamitous invasion of Iraq has left behind a country divided and under the sway of an Iran that has not warmed to America one little bit. 

And the effort expended in the war on terror has undermined America’s ability to face the challenge from China on which Mr Biden needs, and would prefer, to focus. 

It is a challenge which comes, as the cold war’s did, from a rival great power offering a fundamentally different political settlement and seeking global influence.

With the time long past for imagining China and Russia standing shoulder-to-shoulder with America, Mr Biden now wants to constrain them by reaffirming what his administration, in an incantatory manner, calls the rules-based international order. 

But having bent and broken those rules for 20 years, America has strained their credibility, as well as its own.

Fighting a furtive, transnational enemy made respect for sovereignty a luxury America no longer chose to afford. 

To deny terrorists any haven, it could not permit weak states to suppurate. 

Norms were abnegated, allegiance all: either you were with America, Mr Bush said, or you were with the terrorists. 

Helpful tyrants were tolerated. America’s neglect of (under Mr Bush and his successor, Barack Obama) and contempt for (under Donald Trump) international institutions like the un has left them ill equipped to help.

Fools rush in

As the Bush administration began rallying support for war in Iraq, Mr Kennan, then aged 98, warned against the new strategy. 

Even a sole superpower could not “confront all the painful and dangerous situations that exist in this world”. 

It was, he said, “beyond our capabilities”. 

He accused Democrats of going along with Mr Bush out of timidity.

Mr Biden could have been one of those he had in mind. 

In a speech given in 2002, during the Senate’s debate over the Iraq-war authorisation, he emphasised the importance of un support for an invasion; he spoke of the danger of any country arrogating to itself the right to wage war to prevent a possible, eventual threat; and he warned of the “sin of Vietnam”, of “the failure of two presidents to level with the American people of what the costs would be”. 

And then he voted for the war.

So did all other leading Democrats with aspirations to be president. 

Voicing doubt was left to those whose aspirations were yet to come—such as Mr Obama—and to those whose aspirations had already passed by. 

Mr Gore, the only nationally elected politician to have served in Vietnam, had supported the first Gulf war in 1991, unlike Mr Biden and most other Democratic senators. 

In 2002 he strongly criticised the rush to return.

In 2005 Mr Bush’s second inaugural address gave perhaps the loftiest description of what had become known as the Bush Doctrine, calling for the kind of unilateral, preventive action Mr Biden said he opposed but had, in practice, voted for. 

“We are led, by events and common sense, to one conclusion: the survival of liberty in our land increasingly depends on the success of liberty in other lands,” Mr Bush declared. 

“The best hope for peace in our world is the expansion of freedom in all the world…America’s vital interests and our deepest beliefs are now one.”

This was not true, and the way the war was prosecuted made that painfully clear. 

Various strategically placed and well-disposed tyrants were untroubled by the war against terror. 

Mr Bush, unlike his father, felt no need to secure the blessing of the global assembly which the United States had helped found in order to maintain peace and security. 

America had been imprisoning people at Guantánamo Bay, beyond the jurisdiction of federal courts, since January 2002. 

There and elsewhere, America and its fellow travellers tortured people it had captured. 

In Washington they sought to justify that practice.

The next two presidents tried and failed to escape the dynamic of the war on terror. 

Mr Obama spoke a language of liberal internationalism as grand as Mr Bush’s. 

“The people of the world want change,” he said in his first speech to the un General Assembly, in 2009. 

“They will not long tolerate those who are on the wrong side of history.” 

But he did not share Mr Bush’s appetite for unilateral intervention. 

He tried to summon other countries to achieve priorities he insisted were not just America’s, arguing—as his vice-president, Mr Biden, had in 2001—that more than at any time in history, national interests aligned. 

But most other countries persisted in not viewing their interests as identical with America’s. Mr Obama’s commitment to multilateralism and international rules remained at best ambivalent. 

The 540 drone strikes with which he prosecuted the war on terror over his eight years in office killed thousands, hundreds of whom were in no way targets.

Mr Trump also failed to end the wars that began after 9/11. But he stripped off the idealistic wrapper and tossed it aside. 

With his zest for puncturing pieties, Mr Trump confirmed many people’s suspicions that America’s professed ideals were camouflage for the exercise of power in the pursuit of self-interest, painting a dark picture of America’s history. 

“There are a lot of killers. You think our country’s so innocent?” he asked in 2017 while defending Mr Putin in an interview on Fox News.

Angels fear to tread

Now Mr Biden has presided over a lurch for the exit in Afghanistan and is ending combat operations in Iraq. 

American defeat, dissension and bumbling have played into Chinese claims that it is time for someone else to shape the international system. 

For China, the withdrawal “is just one more bit of evidence for the proposition that the United States is a power in decline,” says Aaron Friedberg of Princeton University.

America—and Mr Biden—have been here before. 

On April 23rd 1975, when the fall of Saigon was just a week away, Mr Biden rose in the Senate chamber to address America’s history in Asia and its standing in the world. 

Just 32, brimming with ambition and self-assurance, Mr Biden instructed his colleagues about a pattern in American foreign policy that he saw reaching back to Commodore Matthew Perry’s arrival in Tokyo Bay in the mid-19th century. 

“It seems that, in respect to Asia, our foreign policy has been one of magnificent obsessions and lost causes,” he declared.

And yet, though Mr Biden had long opposed “the shambles that is Vietnam” (and felt, in a phrase that today has a shameful added resonance, that “the United States has no obligation to evacuate one, or 100,001, South Vietnamese”), he also rejected any suggestion that defeat heralded twilight for America. 

“In my judgment, there is occurring no ‘fading of America’, as some commentators are trying to call it—no time for pretentious talk of ‘watersheds’ and ‘tides of history’ running against us as a nation,” he said. 

“As I read the news dispatches, the need is not to reassure other nations that we are not withdrawing into a shell. 

The need is that we should have more confidence in ourselves.”


Mr. Biden’s confidence in his own judgment, and in America, turned out to be well placed. 

In the coming years other foreign-policy disasters awaited—in Iran (repeatedly), in Central America, in Lebanon. 

But so did victory in the cold war.

Whether such confidence would be so well placed today is less clear; certainly today’s Mr Biden has yet to voice that confidence so full-throatedly. 

Then America could count on allies in nato and beyond that were committed to the pursuit of shared objectives. 

Despite the disillusionment of the 1970s, relative to today America’s major public and private institutions generally retained the broad, bipartisan trust of the public, notes Henry Brady, a political scientist at the University of California, Berkeley. 

That allowed thoroughgoing reforms in the executive branch, the intelligence agencies, the campaign-finance system and the armed forces, reforms that sustained the struggle through the cold war and strengthened democracy at home.

“It was a yeasty time, intellectually,” says Gary Hart, who joined the Senate as a leader of the reform-minded post-Watergate class of 1974. 

“There were a lot of corridor conversations, particularly among Democrats. 

Everything was up for debate and resolution.” 

Now, he adds, “I just don’t sense any systemic reform efforts going on anywhere.”

The sloppy punctuation with which Mr Biden has ended the wars of 9/11 may not signal the “fading of America” in which he disbelieved almost half a century ago. 

But it does mark the end, for now, of a faded idea, about the imperative of spreading America’s ideals throughout the world. 

America’s confidence in its own model is shaken. 

From the vantage of an America where citizens have assaulted their capitol, it can be hard to recall the upwelling of unity on September 11th 2001—a day when legislators of both parties gathered on the steps of the same building and, impromptu, sang “God Bless America”. 

Conflicted over whether its national story is a source of pride or shame, America is struggling to articulate its ideals, with conviction, to itself, let alone to others. 

A hardened president leads a tired nation.

It may be that a less righteous yet still influential America will prove a force for patient and durable, rather than destabilising, change. 

After what Mr Biden’s aides call a decades-long national “detour”, the contest with China may allow the assertion of strength and purpose abroad to redound to the nation’s advantage at home.

Competitors, after all, can help. 

Mr Kennan thought Americans were lucky to have the Soviet Union around. 

Their very survival, he wrote in 1947, depended on “pulling themselves together and accepting the responsibilities of moral and political leadership that history plainly intended them to bear”. 

Whatever history may have intended, it proved him more right than wrong about the effects of the cold war. 

It did give America national purpose. 

As Mr Gore put it when accepting the Supreme Court decision which delivered the presidency to Mr Bush in 2000, “This is America and we put country before party.”

The war on terror has had no such ennobling or unifying results. 

Not only has America failed to strengthen an international order that conforms to its values. 

America’s own public institutions and many of its private ones—whether from confusion, exhaustion, fear or partisan political assault—are also emerging weaker from this 20-year experiment in power projection. 

One measure is the fact that an act of political grace, of deference to an American ideal, like that of Mr Gore now seems all but unthinkable. 

The message he saw his concession sending to “our fellow members of the world community”—that the strength of American democracy is shown most clearly through the difficulties it can overcome—may still be true. 

But the 21 years since have not provided much support for it. 


Will Shortages Ruin the Holidays? What You Need to Know.

By Jack Hough

Cargo ships docked at the Port of Los Angeles in September. Photograph by Spencer Lowell


Keewa Nurullah recently discovered a hot seller for Christmas. 

“I posted these cute little scooters on Instagram,” says the owner of Kido, an online seller of clothing, toys, and books, with a store in Chicago’s South Loop. 

“The likes were piling up, and people were headed to the site.”

The metal push scooters for 2-to-5-year-olds, called Primo, resemble the Italian motorbike Vespa. 

Nurullah suspects that demand got a boost from the June release on Disney+ of Luca, which stars a teenage sea monster who takes to land in human form with dreams of owning a Vespa. 

But when Nurullah sent an email to check on inventory, she was told the factory was closed.

That factory, in Ho Chi Minh City, Vietnam, belongs to Ambosstoys, founded by brothers-in-law Elisha Ruesch and Nguyen Nguyen, who launched the Primo at the 2019 New York Toy Fair. “From the beginning, it was a success,” Ruesch says.

Then Vietnam, which had fared well with its Covid-19 response, was hit hard by the Delta variant and went into lockdown in July. 

Ambosstoys closed production. Ruesch now hopes to reopen his factory next week, but it will take a month to ramp up output, and ports are clogged.

“I had to make the decision last week,” he says of supplying U.S. sellers with more scooters for Christmas. 

“It’s too late.”

December outages of hit toys are nothing new. 

This year could see more shortfalls than most, judging by the 88 vessels backed up near an important California port complex. 

But predictions of holiday sales strangled by supply-chain havoc—think Charlie Brown Christmas trees surrounded by few boxes and bows—look decidedly overblown.

In late spring, Barron’s reported on a seeming “everything shortage” set off by abrupt pandemic shifts in consumer spending, combined with company miscalculations and freak events (“The Everything Shortage Is Here”). 

Now, our conversations with retailers, manufacturers, shippers, and Wall Street forecasters indicate that businesses are learning to cope with bottlenecks, which will largely ease next year, albeit slowly.

Virus trends have taken a promising turn in recent weeks. 

Critical overseas manufacturing centers are reopening. 

Consumers are only slowly returning to spending on experiences after a huge shift in preference toward household goods, but that reversal will continue and even pick up speed as new Covid cases fall and vaccines become available for children. 

Even those backed-up ships could be hiding good news.

“You’ve heard it here first: Christmas will happen on Dec. 25,” says Gene Seroka, executive director of the Port of Los Angeles. 

“Many of our savvy retailers and importers advanced their orders. 

We started seeing Christmas goods arrive on our shores back in June of this year. 

Normally, that arrival would take place at the end of August, beginning of September.”

Keewa Nurullah, owner of Kido in Chicago, with a Primo Classic scooter. Photograph by Evan Jenkins


Large retailers with sophisticated supply chains—like Walmart (ticker: WMT), Target (TGT), and Costco Wholesale (COST)—will continue to thrive, as will transportation brokers like XPO Logistics (XPO), which can help level the field for smaller companies. 

Toy giants Mattel (MAT) and Hasbro (HAS) will have a holiday edge over smaller rivals.

For shoppers, Xbox One gaming consoles will be easier to come by than PlayStation 5s. 

Videogame publishers will do well, along with GameStop (GME)—although what that means for its stock is up to the meme chasers at Reddit.

Inflation, which has lately sparked a rise in bond yields from barely perceptible levels to almost mentionable ones, could remain elevated and uneven through the holidays: Turkey, up 6% from a year ago, might be easier to swallow than pot roast, up 13%. 

Labor markets remain tight. 

Higher pay and prices for manufactured goods will stick, but overall inflation is likely to slow to unalarming levels next year. 

All told, fourth-quarter mirth estimates appear beatable, and a happy new year for shareholders isn’t out of the question.

The causes for shortages since the start of the pandemic have been many and varied, but they fall into a few groups. 

A handful were true one-offs, like the March grounding of a ship that blocked the Suez Canal, which carries 12% of worldwide trade, or a Louisiana factory fire in August 2020 that knocked out production of swimming-pool chlorine.



Some were actions with unforeseen consequences. 

Executives following playbooks written during the global financial crisis slashed orders at the pandemic’s start and were caught short-handed. 

Brexit drove off too many United Kingdom truck drivers, resulting in fuel lines. 

Decades of trimming fat from supply chains may have left them too fragile.

But most causes have been direct results of the virus. 

That missed trip to Disney World, with the funds redeployed on a new patio set and big-screen TV, was part of a vast spending shift from services to goods, bolstered by stimulus checks. 

Exports from Asia, where many consumer goods are made, jumped 20 percentage points relative to those from Europe and the U.S., according to investment bank UBS. 

That compares with just a 1.5 percentage point increase over five years before the virus arrived.

Vaccines should have reversed that trend, but the uptake was slow in places, and variant cases raged. 

As a result, goods spending has been falling by only about a point a month since March, and remains 15 points above prepandemic levels.

That has led to runs on key components, like computer chips for appliances and vehicles. 

Spending on plants and equipment to make those items is expected to surge more than 50% this year from prepandemic levels, but shortages there are likely to stretch well into next year.

Passenger planes carry about half of airfreight, so a sluggish recovery for air travel has added to shipping burdens. 

Trans-Pacific shipments are up some 30% this year, which has worsened a shortage of 40-foot shipping containers. 

The cost to send one of them from Shanghai to Los Angeles has jumped to nearly $20,000 from $2,000 in a year and a half. (It is still relatively cheap to send one in the other direction.)

Under normal circumstances, the ideal number of ships to drop anchor outside of California’s San Pedro Bay Ports Complex, which consists of the busy ports of Los Angeles and Long Beach, is zero. 

In June there were six, down from an earlier pandemic high of 40. 

Among the 88 vessels recently waiting to dock, 64 are carrying containers, with about half of these headed for each port. 

Los Angeles port chief Seroka compares ship arrivals now to drivers being squeezed from 10 lanes to five. 

Port productivity is up, he says, but truckers and warehouses haven’t added as much capacity as shippers, so unloaded containers are sitting at the port for six days rather than two, and at warehouse doors for seven or eight days versus three or four.

A cargo ship docked at the Port of Los Angeles. / Photograph by Spencer Lowell


The ship jam will not be cleared by Christmas, Seroka says. 

And retailers tell him they plan to spend early next year replenishing inventories, which have been running unusually low relative to sales. But he predicts a holiday of plenty.

“There will be goods on the store shelves, in the fulfillment centers, for us to order,” he says. 

“My only advice is maybe for the American consumer, like I’m doing, to shop a little early.”

Trucking companies have struggled to find new drivers. 

XPO Logistics, which operates its own trucking network and provides brokerage service for others, has sped up graduations at its driving schools.

“That piece of it, certainly for us, is beginning to abate,” says its chief strategy officer, Matt Fassler. 

Industry capacity remains exceptionally tight, but retailers have had time to prepare, Fassler says, and shoppers can expect full shelves: “There will in fact be gifts under their trees.”

Signs of supply-chain stress remain unnerving to investors. 

In a recent earnings report, Nike (NKE) lowered its revenue forecast to account in part for factory closures in Vietnam. 

Shares lost 6% in a day. 

But there are also signs that relief is coming. 

New Balance recently told analysts that its Vietnam factories could return to 60% to 70% capacity by mid-October, versus 30% to 40% today. 

If there is one promising indicator on that front, it’s that Covid cases worldwide and in the U.S. have been falling since the end of August.

Toy makers sound confident, mostly. 

At a recent Goldman Sachs conference, Barbie maker Mattel confirmed that it has already factored shipping challenges into its full-year guidance for a 12% to 14% sales increase. 

It and Nerf maker Hasbro said some sales might slip from the third to the fourth quarter, but wouldn’t hurt overall holiday business. 

“Maybe we’d like a little more product in certain categories, but we’ll have the product for the holidays,” said Hasbro CEO Brian Goldner.

Yet at smaller MGA Entertainment, which makes Bratz dolls, founder Isaac Larian is easily the most bearish-sounding of the group.

“It’s a nightmare, a worldwide nightmare,” he tells Barron’s about transportation delays. 

“Forty-three years I’ve been in business. 

I have never seen anything like this before.”

An aerial view of shipping containers at the Port of Los Angeles. / Photograph by Spencer Lowell


He says he expects holiday sales for his privately held company to be flat or up by a single-digit percentage. 

But he predicts shortages and sales declines for the broader industry, followed by delayed merchandise arriving too late for Christmas, resulting in an inventory overhang next year, and a “major recession.”

Jefferies analyst Stephanie Wissink, who covers mass merchants and toy companies, says holiday goods availability could go either way, depending on whether congestion eases over the next 30 days.

Most years, retailers can replenish inventories two or three times between mid-October and mid-December, she says. 

This year, shoppers could see healthy stock levels to start, then a drawdown and a small surge, before popular items run out. 

“If there’s something on your holiday hit list and you see it, you better buy it, because it may not be there a couple of weeks later,” she says.

If that something is a PlayStation 5, good luck. 

Console makers often guess too low on demand for new machines, but shortages lasting a year are rare, says Michael Pachter, who covers videogaming for Wedbush Securities. 

This one is attributable to a scarcity of semiconductors combined with lockdowns. 

“Guilty parents were suddenly cooped up with their kids, and their kids weren’t going to school and weren’t playing Little League and had nothing better to do,” Pachter says.

“We’re looking at Etsy, and we hadn’t before, just to see if there are any small makers who are working out of a garage workshop that can maybe fill in some of the gaps.”

— Keewa Nurullah, owner of Kido in Chicago

Xbox One machines just became available online at Walmart and Target this past week, but that may change, says Pachter. 

His top tip for securing a $499 PS5 in a hurry is to pay $1,000 on eBay . 

But he notes that when eBay prices are near “par,” or $499, it’s a sign that the machines are in stock somewhere.

As for GameStop, Pachter says that it will thrive this holiday and receive plenty of consoles, and that the “Reddit raiders” are “directionally right,” but also that the stock is “overvalued by $150.” 

He is bullish on videogame publishers Activision Blizzard (ATVI), Electronic Arts (EA), and Take-Two Interactive Software (TTWO), but says Take-Two is less well positioned for the holidays because it recently delayed the release of a remastered version of its popular Grand Theft Auto 5.

Wissink at Jefferies says big retailers can afford to commission their own container fleets—a clear advantage now. 

She recommends Walmart for stock buyers, because it appears likely to emulate what has worked well for Target, the standout in the group.

Among toy makers, she prefers Hasbro stock to Mattel, because Hasbro has seen strong growth in digital games based on the role-playing franchises Dungeons & Dragons and Magic: The Gathering, and has an in-house studio to turn toys into shows for streaming services like Netflix (NFLX). 

This year, it’s particularly difficult to predict which toys will be hits, because of canceled toy fairs and few theater releases of children’s movies.

In conversations with executives, Wissink says many sound surprised at the strong demand for what are called poppets or waffle fidgets, which have rows of bubbles. 

“You poke the spaces and then you flip it over and you poke them the other way,” she says.

At a Rhode Island mall this past week, a teenager tending four trinket kiosks said that poppets have been selling well and there has already been mention of the holidays. 

“I’ve had a couple of parents say they might as well save these items for Christmas,” she says.

Jess Dankert, vice president for supply chain at the Retail Industry Leaders Association, a trade group, says that doomsday holiday forecasts are off the mark and that big retailers are managing extraordinary shipping constraints well. 

She adds, however, that online shoppers in particular should start early because of how busy parcel carriers will be. 

“Hopefully, we will be able to retire the word ‘unprecedented’ after this, because it certainly gets a workout these days,” she says.

Soaring prices for trans-Pacific shipping would seem a key reason that the U.S. inflation rate has jumped to over 5% from 1.3% a year ago. 

In fact, it has contributed only 0.05 percentage point to the increase, estimates UBS, because shipping is a small part of the cost of importing goods, and not nearly all goods are affected by those rates. 

Much of the inflation surge has come from components that slumped a year ago, like energy. Futures suggest that energy prices will moderate.

Inflation measures that trim items with outlying price gains imply that the headline measure will come down, but slowly, as bottlenecks ease, UBS says.

Back at scooter maker Ambosstoys, Ruesch is disappointed that he can’t get more Primos to the U.S. in time for Christmas, but he expects demand to remain strong next year, and is planning to introduce a follow-up toy in February. 

“It’s top secret,” he says, before hinting that it’s a scooter for older kids, ages 5 to 7.

In Chicago, Nurullah at Kido is pleased that business is growing, despite difficulty ordering some items. 

And while retail giants are flexing their supply-chain heft, she’s thinking small by turning to arts-and-crafts sellers online: “We’re looking at Etsy (ETSY) and we hadn’t before, just to see if there are any small makers who are working out of a garage workshop who can maybe fill in some of the gaps.”


Jackson Cantrell contributed to this report. 

Junk yields are junky

And who cares about payment for order flow?

Robert Armstrong 

© Financial Times



Real euro junk yields are not negative so much as pathetic

On Tuesday the FT reported the following, under the headline “Real yields on European junk bonds go negative for first time”:

The yield on ICE BofA index of European high-yield bonds was pushed down to 2.34 per cent this week, marking the first time buyers of so-called high yield European currency bonds have accepted payments below consumer price inflation in the eurozone, which hit a decade high of 3 per cent in August.

All true, but if I buy a junk-rated bond with (say) five years to maturity, I don’t care about the inflation rate now; I care about the rate of inflation over the next five years. 

And expectations for inflation in the eurozone over the next five years are lower than 2.34 per cent. 

As of Thursday, according to the five-year five-year euro inflation swap, inflation is expected to run at 1.75 per cent over that period. 

The junk yield has surged back to 2.4 per cent, leaving a princely real junk yield (the nominal yield minus expected inflation) of 65 basis points.

Tomas Hirst of CreditSights made this point on Twitter, pointing out that euro junk traded at slightly lower real yields back in 2017:


My question for him was, yes, real yields are positive, but how is anyone going to make money buying this stuff with 65bp of real yield? 

This seems bonkers. 

He said:

You are not jumping up and down saying there is great value here. 

We all understand that if defaults pick up, that is a problem, because you are not being compensated for that . . . you are not even being compensated for supply risk. 

We think there is a lot of leveraged buyout financing coming — perhaps €25bn to €30bn worth — and a lot of that is going to hit the B tier [the second-highest rung of high yield] . . . 

It doesn’t take a lot to make investors say, do we want to own this stuff, or do we want to own the stuff that is coming to market, which has to pay [a higher yield]?

We live in a world priced for very, very, very low returns.

Payment for order flow: the case for who cares

It is weird that my retail broker gets paid for giving my stock order to another company to execute. 

Why should my little order be worth paying for, unless I am being taken advantage of? 

I mean, in a poker game, if I don’t know who the sucker is, the sucker is me.

Sheila Bair, the former chair of the US Federal Deposit Insurance Corporation and a persistent regulatory gadfly, thinks I am, in fact, the sucker. 

Here she is, writing in the FT on Wednesday:

Critics say payment for order flow, or PFOF, represents an inherent conflict of interest, sensibly observing that brokers should be routing orders where they can get the best price for their customers, not the best deal for themselves.

Supporters argue that PFOF benefits retail investors, as market makers are required to provide prices that are better than quotes displayed by regulated exchanges. 

They add that broker profits from PFOF allow them to offer commission-free trading.

But it is far from clear whether PFOF actually reduces costs for retail investors, or simply makes their costs less transparent. 

By allowing market makers to attract order flow with a lawful bribe, not a best price, PFOF gives them every incentive to hide the true price at which they are willing to trade, probably leading to poorer executions for retail traders

The words that stick out from that passage are “far from clear” and “probably”. 

Am I getting screwed here or not?

Here is a bit of a Barron’s interview with Gary Gensler, chair of the SEC, who says that banning for payment flow is “on the table”:

Gensler says the practice has “an inherent conflict of interest”. 

Market makers make a small spread on each trade, but that’s not all they get, he said.

“They get the data, they get the first look, they get to match off buyers and sellers out of that order flow,” he said. 

“That may not be the most efficient markets for the 2020s.”

He didn’t say whether the agency has found instances where the conflicts of interests resulted in harm to investors.

He didn’t say? 

It sounds like Gensler isn’t quite sure if I’m getting screwed, either. 

Furthermore, what he seems to be worried about is that one group of institutional traders is getting better information about order flow than another. 

This is the sort of thing that helps one guy with a lot of computers capture a few basis points of profit at the expense of another guy with a lot of computers. 

And that seems very far indeed from the question of whether little ol’ Rob Armstrong is getting played for a sucker or not.

There are also two good reasons for thinking that I and other retail traders are not being played for suckers. 

Retail trades are now mostly free, and bid-ask spreads are very tight. 

Here are average spreads on the S&P 500 over the past 10 years, as provided by Larry Tabb, head of market structure research at Bloomberg:


You can see that the Covid-linked volatility caused spreads to blow out in March last year. 

But what did they blow out to? 

Less than two-tenths of a per cent. 

Today we remain at an above average six-hundredth of a per cent. 

These are cost levels that, as a retail investor, I really truly deeply don’t care about, especially given I am not paying a trading commission. 

If some market maker is screwing some other market maker out of their slice of six-hundredths of 1 per cent of my trade, I say, “Screw away! 

This is America!” 

It is probably worth saying a little bit about the economics of payment for retail order flow here. 

Here is how it works, as best as I can understand it (it is explained somewhat better and at greater length here):

- Some trading takes place on public exchanges, where it is visible to everyone;

- Bid-ask spreads on exchanges are relatively wide. 

This is true in part because market makers on the exchange need to be compensated for the possibility that a series of orders from a mighty whale of an institutional trader is about to move the market against them. 

Say our market maker buys 100 shares of stock X for $100 each, but that big whale keeps the sell orders coming and coming, pushing the market down to $99.99, $99.98, and so on. 

Market makers don’t want to build up inventory; they have to sell what they buy; the falling price is bad news. 

So the exchange market makers put in a bit more spread, in case the whales start splashing around;

- Wholesale traders, such as Citadel Securities or Virtu, buy bunches of small orders from retail brokers such as Robinhood and trades them on a private platform, off the exchange, where they can’t be seen by everyone;

- The wholesaler is required to execute the trades inside of the public bid-ask spread available on the exchange. 

But the wholesaler doesn’t let any whale traders into their private trading pool. 

They specialise in buying and matching minnow trades, so their private pool spreads can be tighter than the public exchanges’ and they can still make money. 

The wholesalers can also price their trades to smaller fractions of a penny than is allowed on the exchanges, which helps. 

They also don’t have to pay exchange fees;

- So the wholesalers can afford to take some of the money they make and pay it to the broker who passed on the trades.

Now you see why Gensler mentioned the “they get the first look” stuff. 

Because who is really getting mistreated? 

The institutions that trade on the exchange, who don’t get to see what is going on with the minnows in the wholesale traders’ private pools. 

That does seem unfair, because minnows have good intel, as every fisherman knows.

Now, if a huge financial institution is losing out because of unfair competition, that is something someone should care about, because anti-competitive behaviour makes the economy less efficient (it also seems like the massive amounts of money spent on high-speed trading technology would be more productively spent on something other than a zero-sum fight over fractions of pennies, but that’s another issue).

But the person who should care about this is not me, the retail investor, because if I’m getting screwed, it’s only for a tiny amount of money that does not matter to me one bit.

The Fed Wants To Eat Your Money, And Your Cash Is Trash


Summary

  • Wonder why equity prices, home prices, bond prices, and even junk investment prices are moving all in one direction - up?
  • The power of "Excess Cash in the System" explained.
  • The Fed "wants" to drive inflation higher.
  • Cash is trash today and should be put to work!
  • Why this market is set to keep soaring.
The iconic Charging Bull statue is not surrounded by the usual crowd because the city is deserted during the state of emergency triggered by the COVID-19 pandemic.
Alex Potemkin/iStock Unreleased via Getty Images

Co-produced with “Hidden Opportunities”

The markets keep exhibiting signs of great strength and resiliency as the pace of the supercharged U.S. and global recovery accelerates. 

The S&P 500 index (SPY) already broke well above the 4500 level, which is an extremely bullish signal. 

This market is supported by strong economic fundamentals, GDP growth, strong corporate earnings, cheap money, and excess liquidity. 

Furthermore, we're in the midst of the strongest earnings environment in more than a decade, as we have been seeing in the vast majority of our economically sensitive stocks reporting stellar earnings! 

However, we cannot underestimate the main driver of this bull market, which is cheap money and excess liquidity.

The Power of Excess Cash in the System

1- Wonder why house prices are soaring?

With mortgage rates at record low levels, everyone wants to fulfill their dream of owning a home. 

And why not when the cost of borrowing is this cheap. 

Consumers have been aggressively deploying their excess cash to make down payments on homes. 

Result - the median house price in the U.S. is $375,000, up 16% YoY after several years of being relatively flat.

Source: fred.stlouisfed.org

2- Why are the stock markets reaching highs after highs?

Why won't they? 

Americans are flush with more cash in their bank account than ever before. 

Since the pandemic's beginning, CD and savings rates have been near zero, so consumers are pursuing other investments. 

Any asset class you can think of has soared over the past year.

  • Virtual Currencies: Data from The Harris Poll shows that nearly one in 10 Americans used the stimulus checks to invest in cryptocurrencies, driving their prices up to record levels - Bitcoin is up 381% over the past year.
  • The stock market: Popular U.S. indices continue to make new highs. 

  • The S&P 500 is up 20% YTD and is past the 4500 level. 

  • The stock market has clearly benefited from excess cash in investors' pockets.

3- Why are "smart money" investors leveraging up their accounts?

FINRA's measure of margin debt is up about 50% since pre-COVID levels. 

This metric tells us about the amount of money that investors borrow from their brokers to leverage their accounts and accelerate their returns.


We can clearly see the relationship between the S&P 500 and the margin debt. 

Higher leverage is a sign of increased market bullishness, and margin debt is typically seen as a leading indicator for the market. 

Here, it's indicative of new market highs on the horizon.

Source: Advisor Perspectives

4- Why even Junk Bond Prices are Soaring?

High demand for junk bonds has resulted in negative "real yields" (inflation adjusted) for the first time in history. 

The ICE BofA U.S. High Yield Index that is composed of below investment grade corporate debt (commonly referred to as "junk”) currently yields below the inflation rate.

Source: fred.stlouisfed.org


So investors are ready to buy just about anything for "some kind" of return.

The reason for these higher prices across the board is "excess liquidity in the system," and its implications...

  1. In today's yield-less world, every investor is looking for some kind of return. 
  2. Cash sitting in the bank, or in CDs or money markets, are generating negative returns, when we adjust for inflation. 
  3. There are too many dollars in the system looking for returns of any kind, even meager returns. 
  4. And these dollars are flooding into limited pools of investments! 
  5. Excess liquidity chasing too few opportunities such as the equity markets is the main driver for this bull market.
  6. Excess liquidity is inflationary by itself, and reduces your purchasing power. 
  7. Smart investors are realizing that cash on the sidelines is a losing proposition, and should be put to work. 
  8. This re-enforces, even more, the value of "non-cash assets" including the stock markets, real estate, and even the bond markets.
  9. Inflationary pressures keep increasing, as reported month after month from government data, making cash even less attractive for investors who are seeing their purchasing power evaporate. 

  10. This is driving more money into the same limited pools of investments.

I keep emphasizing that the "Bubble of Cash" in the hand of investors is inflating everything. 

This is what's driving everything. 

Cash is cheap to borrow, encouraging more borrowing. 

Banks have tons of liquidity on hand, encouraging more lending. 

U.S. reserves of depository institutions are higher than ever, over $3.9 trillion.


The bottom line is that inflation expectations are soaring. 

High liquidity is driving prices up almost everywhere you look. 

Smart investors are afraid to be left behind with worthless cash, and they are perfectly right!

Inflation? What Inflation?

I think all of us, including me, you know, really weren’t really prepared for this inflation shock.

James Bullard, CEO & President of The Federal Reserve Bank of St. Louis

Source: Wall Street Journal

Aug. 27, Core PCE, the preferred inflation measure of the Federal Reserve, came in at 3.6%. 

Core PCE excludes large, and what most people would consider essential expenses, food, and energy, representing its biggest move since July 1991.

Source: bea.gov


As a reminder, back in December 2020, the Fed projected inflation, as measured by Core PCE, would be 1.8% in 2021. 

In other words that inflation would be about the same as it was in 2018, the last time the Fed hiked interest rates.


We can call that a swing and a miss. 

It's also worth noting that we did not see deflation for even a single month. 

While PCE fell in April 2020, it remained positive. 

The cost of living did not go down during COVID. What we saw was government stimulus artificially increasing income.

So this spike in inflation is not "making up" for a year of zero inflation as some have suggested. 

It's on top of last year's average of 1.4% growth in Core PCE.

The Fed Wants to "Eat Your Money" by Driving Inflation Higher

The Fed is pumping more and more liquidity into the system. 

And they have no intention of stopping. 

What they did during the Great Financial Crisis pales in comparison to what we see today.

Source: fred.stlouisfed.org


The Fed continues to pump liquidity into the system and maintain a 0% target rate even as inflation pressures continue to mount. Even ignoring their own preferred metrics.

Yet despite signs that inflation is much higher than expected, the Federal Reserve reiterated recently that it will "hold the line." Voting to maintain the target rate at 0-0.25%, while also continuing to pump more money into the financial system by continuing to buy Treasuries and agency MBS (mortgage-backed securities).

In fact, I would argue today that the Fed and the government are happy that inflation running high. 

Why? 

Because today, if you add the government debt, corporate debt, and consumer debt, the United States is more indebted than it has ever been historically. 

The total non-financial debt/GDP ratio is nearly 300%. 

This massive level of debt is a financial time bomb that could explode anytime. 

When it does, it would collapse the economy into a major recession with widespread defaults, causing the financial and the housing markets to crash, and setting up for major bank failures.

In the face of this major threat, policymakers are not leaving anything to chance. 

It's becoming increasingly clear that the government is fighting this danger with two different tools:

  1. Keep pumping liquidity in the system so that debt can be refinanced, and avoid the risk of a financial collapse.
  2. Printing money and pumping more liquidity to drive inflation even higher. 

  3. As inflation runs high and the currency devaluates, the level of global debt is reduced.

Therefore, a high level of inflation seems to have become a policy goal to alleviate indebtedness. It's quite simple. 

If you own a mortgage of $100,000 on a $200,000 home, and inflation drives the value of your home to $400,000, then your debt level is reduced immediately from 50% to 25%, which makes it more manageable. 

At the same time, GDP goes up, because the value of new construction has gone up. 

So you have an immediate reduction in the debt/GDP ratio.

Source: Getty


As investors, there are a few items we must take into consideration when positioning our portfolios:

  1. Inflation is happening - as consumers, we're seeing it in our daily lives and feeling its pain.
  2. The flavor of inflation is changing from commodity shortages to labor shortages – this means that inflation will be much more permanent than the Fed expects. The Federal Reserve and many economists are grossly underestimating the long-term ramifications of the labor shortage.
  3. The "Bubble of Cash" is going to continue to drive the markets. The Fed has the pedal to the metal and cannot slow down. Note that during the mortgage crisis, the Fed was unable to meaningfully reduce its balance sheet for over a decade. The current Fed has shown even more hesitance to do anything that negatively impacts the markets.
  4. The Federal Reserve is not only unwilling to do anything about inflation, but it's actually very happy with it. It reduces the risks of a hard economic landing by making debt levels less meaningful, even at the cost of depleting your savings.

  1. The Labor Shortage

Last year, a lot of people were laid off when the businesses they worked for closed down. 

This year, they are not eager to return to work. The workforce participation rate is the lowest it has been since 1976.

Source: fred.stlouisfed.org


This has occurred, even as the number of job openings is higher than ever. 

Businesses around the world are being plagued by staffing shortages, many cutting their hours

The impact is especially hard on lower-wage jobs like the food and hospitality industries. 

Many factories have struggled, especially with positions that require experience.

How are businesses going to encourage employees to come back to work? 

Money. 

Economics 101, when demand is higher than supply, prices rise. 

Right now, the demand for workers is much higher than the supply.

We're not going to get into politics. 

Some see wages rising as a good thing. 

We will stop by simply observing that it's happening and that wages are likely to go much higher as potential workers sit on the sidelines even as demand for more labor increases.

Ultimately, what happens when wages go up? 

Prices go up. 

And that's called inflation. 

Unlike commodities, where we often see a lot of volatility in prices, wages are much more "sticky." 

Employers will be forced to offer increasing wages as they compete with others over a smaller workforce.

Source: redbubble

Cash is Trash today and Should be put to Work.

It's becoming increasingly clear that the Fed is more concerned about the risks of the massive U.S. debt rather than the risk of a red-hot economy with soaring prices. 

They continue to stress that they're not going to change anything. 

This explains why the current Fed is far more "dovish" than we have seen in many decades. 

Put simply, the Fed has two choices to face, a deep recession due to excessive debt, or a high inflation that would reduce the level of debt, but make people poorer by eating away their savings. 

They chose to avoid recession at any cost, and you cannot blame them. It is their mandate.

For investors like us, today we're faced with a clear path to a red-hot economy financed by the government, and resulting in soaring inflation and asset prices. 

It has become our urgent priority to keep ahead of inflation to protect both the value of our asset base and the purchasing power of our income stream. 

This means that we want to be invested in companies that are economically sensitive and will benefit from an economy that is running hot, and will benefit from 0% short-term rates.

Stocks we want to focus on are:

  • BDCs (business development companies) (BIZD): These companies invest in small to medium-sized businesses that will expand rapidly in a super-heated economy. Additionally, the access to cheap debt provides fertile ground for expansion.
  • Property REITs (VNQ): Real estate directly benefits from cheap debt as buying real estate with 30%-40% debt is common. Interest is usually the largest single expense for most REITs and they're benefiting from refinancing at cheap rates. 
  • Additionally, physical real estate appreciates in value during periods of inflation. 
  • REITs that are expanding rapidly and those that have leases tied to inflation will outperform.
  • Mortgage REITs (REM): Not all mortgage REITs are alike, and we want to be exposed to those solid ones that benefit from low financing costs and can maintain a high interest rate spread in the current environment. These also operate in an economically sensitive sector.
  • Commodities (XLB) (PICK): We saw commodities pull back in July, and this was a "reversion to the mean" caused by an overcrowded trade. Prices never move in a straight line and traders will move in and out of a trade trying to catch short-term price movements. 
  • With confirmation that inflation is persistent and is heading higher, inflation-resistant stocks will see new highs again, especially in the commodity sector.
  • Collateralized Loan Obligations (or CLO funds): CLOs provide another great opportunity to get exposure to a heating economy with enormous yields. CLOs in booming economies experience low default risk, and great re-investment opportunities, making them prime winners for income seekers.

  • Preferred stocks (PFFA): High-yield preferred stocks have historically exhibited minimal correlation to medium-term Treasuries. In this market where equity and bond instruments are soaring together, it is important to have such a diversification for a protected income stream. Moreover, above-average yields of preferred securities are excellent for inflation-beating income.

  • Value over Growth: "Value" stocks have historically outperformed "growth" stocks when inflation is running high. Why? It's simple. Growth stocks bank on future cash flow, which becomes less valuable when discounted at "high inflation rates." Therefore, their growth potential becomes less attractive. Value stocks on the other hand are generally those companies that are valued based on their current cash-flows, rather than their potential ones. These same value stocks tend to be smaller and medium-sized companies that are the most flexible to bank on economic growth, and provide the best hedges against inflation.

  • High Yield: By definition, when there's inflation, receiving cash today is better than receiving cash in the future. The main focus of our Income Method is to achieve a high level of immediate income. One great thing about investing in super high dividend stocks is that if you're collecting a 7% yield on your income, you're already beating inflation, without even re-investing a penny. If you re-invest some of your earnings, you are empowering more future income.

We like exposure to sectors that are not reliant on large amounts of labor. 

Our REITs and BDCs often count their employees in the dozens. 

Sectors like hospitality, food and beverage, and manufacturing are enjoying price appreciation from the reopening rebound, but when the costs of labor rise, they will see margins compressed. 

Therefore it's key to know where you are investing your money.

Source: Getty

Bottom Line

Do you feel everything is getting more expensive while the purchasing power of the dollars in your bank is shrinking? 

Many do, and this is why "asset values" are soaring because smart investors are getting rid of their cash.

Yes, inflation is soaring, and the Fed wants to eat your money to reduce debt levels. 

Your cash is trash. 

You need urgently to get your money working for you and fight this trend.

The good news is that the future looks bright if you're invested in the right stocks and sectors. 

I remain confident that we're set for a multi-year global economic and market expansion financed by the U.S. Government and others across the globe. 

It's not too late to act now. 

When inflation is flaring, you don't want to be the last person holding cash.