Inflation & “Terminal Phase of Bubble Excess"


Late last week we were served up another contemporary reminder of the impacts of abuse of a Fiat currency when Venezuela launched its second monetary overhaul in three years by cutting six zeros from the bolivar currency in response to hyperinflation.  In 2018 they cut 5 zeros and promised single digit inflation.  In the last year Venezuela have experienced 1,743% inflation.  4 digits, not 1.

There may be many differences between what the Venezuelan government have done compared to say the US or China but the narrative of inflation being ‘transitory’ is being sorely tested.  Doug Noland is a bubble expert and he is screaming from the hilltop that we are in what he calls the ‘Terminal Phase of Bubble Excess’.  For readers wanting a quick read we can jump to his following conclusion:

“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 manifest in surging securities and asset prices, are drawing to a close.”

For those with the time to read on, the following is an excellent summation of where we are at (albeit still excerpts from a longer report):

“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 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 (CPI) at 5.3%, near the high since 1990.”

In reference to Fed Chair Powell’s comments a couple of weeks ago that everything was fine before the pandemic:

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

In reference to China’s PBOC chair Yi Gang’s comments last week that China will resist more QE as it is damaging:

“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.”

Ironically, that same day, we learned they injected $100b in response to the Evergrande debacle:

“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.”

“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 worldwide 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.”

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

“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.”

“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.”