In today’s Capital & Conflict… a trillion dollar loss in the bond market… inflation rising… the new monetary playbook… what is MFFP?… introducing a map for your money… and more
Ouch. Hidden behind the madness of last week’s momentous events, the world’s combined bond markets lost $1 trillion in value.
It’s not often we talk about losses running into the trillions. And in the week that it became clear the tectonic plates beneath the political and economic world are shifting, it’s a move that’s doubly significant.
For a market that big to move that quickly – a $1 trillion move is, roughly speaking, a 2% loss in the bond market (which is many, many times bigger than the stock market) – can’t be ignored.
So what does it mean? We’re always telling you that prices are signals – so what’s a move like this telling us?
The short answer is: inflation and rising rates dead ahead, off the back of highly inflationary fiscal and monetary policy. Today I want to show you why, what it means for you and how you can turn these forces to your advantage.
When political change signifies monetary change
To understand why bonds would sell-off, you first need to remember that bonds don’t like inflation. That’s important because the outlier political events seen in 2016 signal a change to monetary and fiscal policy that could be hugely inflationary.
It would be tempting to suggest that there’s a direct relationship between political events and monetary policy. The idea that Trump’s election, or Brexit sweeping a new Tory government into power, means new governments who will directly challenge and influence central banks’ monetary policy seems neat and uncomplicated: new leaders, new policy across the board.
I don’t think that’s what’s happening though. I think it’s more subtle than that. I think what we’re seeing is, in part, the electorate rejecting the monetary policies we’ve seen since the financial crisis.
Not in a literal sense. I doubt many people stood in line at the polling stations thinking, “I can’t wait to stick in to those damned central bankers.” But on another level there’s definitely a case to be made that political change and a change to monetary policy come hand in hand.
If we take central bank policy at its word, the goal is to keep prices stable (generally with inflation around 2%) and to achieve full employment. (That’s the case in the US officially; here in Britain we don’t have the employment targets.)
And to be fair, if the goal is get more people into work by managing the “levers” of the monetary system, you’d have to say it’s worked. Unemployment in the US is just 4.9% – less than half what it was at its peak under the Obama administration. That’s pretty low. Based on those figures it’d be hard to make the case that people voted so decisively for political change because they were out of work. And generally you’d think high employment correlates with people feeling happier and more content at their lot in life.
But maybe that fits the deeper story
There is clearly a disconnect between the political and financial elite and the vast numbers of people who’ve voted against the status quo.
To me that suggests the world the authorities see when they look at the figures and the reality of people’s lives no longer matches. You can point at the unemployment rate all you like, but if people’s experience is that the trillions of dollars in stimulus help the banks, financial asset owners and the people in charge of the system itself… they’ll turn against it eventually.
Or to put it another way: there’s the “reality” the establishment sees in the data (and bases its decisions on)… and the “reality” of people’s lives, which they vote on.
Perhaps once those two realities were one and the same. But no longer. (Do you agree? I’m on [email protected] if you have another theory.)
It’s not the whole story. But I think you’d be daft not to acknowledge it. So what does it mean?
The new monetary playbook
To me it’s hard to see how the monetary policies we’ve seen over the last eight years can continue as if nothing has happened.
We got a taste of that here in Britain after Brexit. Following the vote, what did the Bank of England do? It didn’t wait long – certainly not long enough to see any real economic data on what the vote actually meant for the economy – before hitting the big red PRINT button.
That’s to be expected. It’s part of the playbook every central bank has used since the financial crisis. Print money, pump it into the financial system, hope it lowers rates and gets banks lending to support the economy.
But after Brexit, something different happened.
There was a genuine political and popular backlash against the move. Theresa May seemed to openly criticise the bank. Our very own Tim Price started his petition against quantitative easing (QE) itself, which gained thousands of signatures in a very short period of time. And of course, the financial markets responded by panning the pound down to $1.20 (and below, briefly).
And the pressure told. Last month the bank announced that it wouldn’t be extending its QE programme and had scrapped the idea of more rate cuts. That’s about as close as you’ll get to an admission of error.
Arguably, that marked the high point of part one of the central bank policy experiment. It was a sign that vehement anti-establishment feeling could start to influence central bank policy. Donald Trump’s election is just another data point in that trend.
Trumpflation dead ahead
That will all have knock-on effects on the rest of the world. If the authorities can’t keep printing money and putting it in the hands of the banks in the way we’ve seen since 2009… they’ll try something else to keep the show on the road.
They need a new playbook. Expect governments to step into the breach. Fiscal policy (government spending) will make a comeback in the place of pure monetary policy.
That means putting money in the hands of the people. It may mean tax cuts. Or it may mean infrastructure spending. Both of those things are inflationary.
Given no Western state really has the money to be doing this, governments will likely need to borrow to do so.
Or perhaps not. This is where monetary policy will dovetail with fiscal policy. Expect to see direct monetisation to pay for government spending – central banks printing money and giving it directly to the government to spend. You may know that idea by another name:
Helicopter money!
By the way, this is an idea that had already started to gain legitimacy among the academic and economic elite well before Trump or Brexit. Former Federal Reserve chief Ben Bernanke called this a Money-Financed Fiscal Program.
As Bernanke put it in a blog post earlier this year, with added emphasis from me:
In theory at least, helicopter money could prove a valuable tool. In particular, it has the attractive feature that it should work even when more conventional monetary policies are ineffective and the initial level of government debt is high… The fact that no responsible government would ever literally drop money from the sky should not prevent us from exploring the logic of Friedman’s thought experiment, which was designed to show — in admittedly extreme terms — why governments should never have to give in to deflation…
In more prosaic and realistic terms, a “helicopter drop” of money is an expansionary fiscal policy — an increase in public spending or a tax cut — financed by a permanent increase in the money stock.
To get away from the fanciful imagery, for the rest of this post I will call such a policy a Money-Financed Fiscal Program, or MFFP.
In a world of extreme policies, extreme events and extreme rhetoric, you have to be prepared for increasingly extreme outcomes. To be prepared you have to first understand what’s happening. Then you have to formulate a plan for what you’ll do with your money.
Right now what all this means is inflation expectations are picking up
That’s the “Trump Trade” so far – plan for inflation, buy commodities and other businesses that perform well in an inflationary environment (look at supermarkets, according to Charlie Morris).
If you want to participate in that trade, it’s worth keeping in mind that the market is already moving – copper and copper stocks spiked sharply last week as the markets started preparing for increased inflation.
Inflation would be bad news for the bond market, which is still trading at historic highs. In an inflationary environment you don’t want to be overweight bonds. That’s what led to the sell-off in the bond market last week and the $1 trillion in losses. We’ll keep an eye on that situation as it develops – if inflation expectations really take off, we could see a rout in the bond market.
That would really make the next year interesting. And painful, if you get it wrong. Keep your eyes peeled. And in the meantime, let me know whether all this worries you – and how you’re trading it, if that’s the case – at [email protected].
And I’ll be in touch tomorrow with the second key trend you need to understand right now: rising rates. I’ll even share a “money map” Charlie Morris has developed to help you understand where your money needs to be to take advantage.
Until tomorrow,
Nick O’Connor
Associate Publisher, Capital & Conflict
Category: Central Banks