SEMI-MONTHLY FISCAL MONETARY UPDATE – DO YOU BELIEVE IN PRICE FIXING??
Most capitalists believe that the natural laws of supply and demand encourage the most efficient production of goods and services that will benefit the largest number of consumers. Certain societal needs, such as medical care for those that cannot help themselves, educational needs for the underprivileged, safety precautions for individuals and local communities and the nation as a whole, infrastructure maintenance, etc. require governmental involvement. However, the natural tendency of politicians to overreach in an effort to satisfy their constituencies is a constant danger.
Which leads us to price fixing, our particular concern being price suppression, the control of price to a lower level than the marketplace calls for. This has been done now for almost a decade, as Central Banks, worldwide, attempt to support their business community with abnormally low interest rates. An inevitable economic distortion takes place when politicians decide that the natural laws of supply and demand have to be overridden and prices are not allowed to rise. It has been proven time and again that this approach will ultimately fail and the unintended consequences make for the cure being worse than the disease. A black market gets established in the goods and services whose prices are being controlled. The controlled price discourages production and competition among suppliers, driving prices within the controlled marketplace higher. The end result is that prices move in precisely the direction that the politicians were trying to avoid.
The best example that some of us can recall was in the 1970s. Richard Nixon, along with “closing the gold window” in August, 1971, for the first time since WWII imposed a 90 day freeze on wages and prices as well as establishing a 10% surcharge on foreign imports. Nixon suggested that these adjustments would stabilize the value of the US Dollar, protect American manufacturers from foreign opportunists and control the inflationary trend which at that point was running just under 6%. The Dow Jones Average rose 33 points the next day, its biggest gain ever at that point, and a New York Times editorial applauded Nixon’s “boldness”. The early 1970s version of today’s SPACs, Bitcoin and Gamestop was the “one decision nifty fifty”, which crashed in 1974.
While the Nixon approach may have been a short term political success, it brought on the stagflation of 1970s, led to the instability of floating currencies with the US Dollar plunging by a third, and inflation peaked in the late 1970s at 12%, accompanied by a Fed Funds Rate of 18%.
TODAY’S INTEREST RATES ARE AN UNPRECEDENTED EXAMPLE OF PRICE FIXING/SUPPRESSION
Interest rates are the economic equivalent of our body’s pituitary gland. As described in Wikipedia, the pituitary gland secretes hormones that help to control growth, blood pressure, metabolic processes, temperature regulation, pain relief, and many other functions.
In a similar fashion, interest rates control deployment of capital. In a normal marketplace, capital investment, consumer savings, stock market and bond market capital allocation, and all manner of investment are applied to opportunity based on reward and risk. The higher the perceived risk, the greater will be the required rate of return in a natural marketplace. Short circuiting the monetary metabolism allows for misallocation of capital. If money can be raised at minimal cost, why not “take a shot”.
In recorded history, there has never been anything remotely approaching the $17 trillion of sovereign debt that is trading with negative interest rates. Central banks, worldwide, in an effort to support their local economies and keep interest rates at affordable levels relative to their respective debt loads, are holding down interest rates. Governments around the world, along with their Central Bankers, are kicking the can down the road, as savers get screwed with the non-existent returns on safe deployment of their capital.
SIGNS OF THE TIMES
In short, we are experiencing “misallocation of capital” to a degree never seen before. Savers are forced to “reach for yield”, desperately try to get some sort of return in stocks, in bonds, in alternative investments, in Bitcoin, anything to replace the much safer 4%, 5% or 6% they used to get in their five to ten year US Treasury securities. Unfortunately, investors, including institutional portfolio managers that should know better, are pursuing strategies based on FOMO (Fear Of Missing Out of a market that only goes up), TINA (There is No Alternative to the apparently fully valued stock market) and MMT (Modern Monetary Theory, which says the amount of debt doesn’t matter because interest rates are minimal).
Yesterday’s front page Wall Street Journal article is headlined: “Riskiest Firms Binge on Low Cost Borrowing, Struggling Companies obtain funding at rates once reserved for the safest businesses”. The High Yield Index, including embattled retailers and fracking companies, shows a current yield of just 3.97%. Compared to the 1.2% in 10 year US Treasury Bonds, this spread of just 2.77% is at a historic low.
Corporations with questionable prospects are therefore allowed to hang on far longer than they should. Some of the biggest short term gains in the stock and bond markets are among the companies that get one last “misallocated” bite of investment capital. The end will come at some point because, while the interest rate can be managed, the debt has to be finally repaid, and the company was never well positioned. Of course, some companies, such as the $100 BILLION worth of SPACs that have been financed in the last year, can sputter along for years because they have raised so much “free” capital.
THE FINAL RESULT
This interest rate price control scheme will predictably end badly at some point, the operative phrase obviously being at some point. The natural laws of supply and demand will take over, interest rates will start going up because capital providers will finally say “basta”. The risks will be just too obvious for capital to be provided with the same minimal rate of return. Inflation will follow bond yields higher. The Central Bankers have indicated that 2% plus, as an inflation rate, is acceptable, so 2.5-3.0% won’t be too bothersome. Inflation, however, will keep moving up and the Central Bankers will have no remaining tools to maintain the interest rate suppression scheme.
At some point, someone like Paul Volker will come along to implement corrective policy, but the resultant pain will be substantial. There was a recession from 1979 (when Volker arrived) until 1982 when Volker’s adjustments took effect. Though today’s US GDP is six times that of 1980, the debt now is $28 trillion instead of $1 trillion, and the annual deficit is $3-4 trillion versus $100 billion. The resultant detoxification of the financially addicted worldwide society will be painful. The good news is that, after the ”revolution”, the sun will continue to rise in the east and set in the west. The financial assets will, however, be largely reallocated.