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Global equities research: Goldilocks seeking the inflationary porridge which is ‘just right'


‘In the end, policy makers always print’. Such is the view of Ray Dalio, the Co-Chief Investment Officer and founder of Bridgewater, one of the world’s largest hedge funds. Two years ago, he published a very helpful book in which he spelt out the four unpalatable choices facing a government with too much debt. You can cut spending. You can raise taxes. You can refuse to pay the debt you owe. Or, you can print more money. What will governments choose when covid-19 has finally been slain but the debt produced in order to kill it off is larger than ever?

In the aftermath of the global financial crisis (GFC), all four have been tried even if outright defaults have been rare. Of these, money printing has been the most effective. Twelve years ago, ‘quantitative easing’ was a new term for an old idea which was soon turned into the short acronym ‘QE’. Over a decade on, there is another new term for the same old idea with a similar propensity to be turned into a catchy acronym. The term is ‘Modern Monetary Theory’ and its catchy acronym is ‘MMT’. However, the end product is still the same: printing money.

‘Printing money’ does not have a good name. For those with a feel for history, it conjures up images of German householders in the Weimar republic with wheel-barrows of cash at the local corner shop seeking to exchange all this paper for a few potatoes. When you are no longer sure what that paper is worth, as a shop-keeper you might be tempted to keep the potatoes and send the wheel-barrow driver away. At least you can eat potatoes.

That is the problem with money. It is only worth as much as people’s trust in its value. That is why central banks the world over are housed in sturdy looking buildings. They are hard stone analogies of the solidity and trustworthiness of the central bankers within who manage the value of our national currency. Central bankers, then, have to tread carefully not to disturb that trust. QE was born over a decade ago to much worried fretting that this central bankers’ brain-child would grow up to be an inflationary arsonist. They were wrong. But what of MMT, its younger sibling, still gestating in the minds of central bankers? Will it seed future inflationary fires? The difference between the two is that between past debt and present need. Under QE, central banks buy existing stocks of debt from banks, thus keeping interest rates low and debt markets liquid. MMT deals with the direct financing of government spending.

When the economy has been put in a form of induced cardiac arrest, the most obvious symptom is an oil price pulse which can no longer even be felt. Revenues and profits stop pumping round the nation, and a drastic fall off in tax income is the result. You can see how tempting (and necessary?) creating replacement tax revenues at the stroke of a central bank key-board will become. The pressure for such central bank help comes not only from the appetites of hard-pressed politicians. It also comes from the decade long memory of an electorate which thought it had finally left ‘austerity’ behind. It won’t take kindly to more in the aftermath of covid-19.

In the tussle between capital and labour, it was capital which won in the years after the GFC. For QE might have saved the financial system, but through pushing interest rates to record lows, it also proved to be the bedrock for the longest bull market in US history. If you were fortunate enough to own assets, you got considerably richer. If you relied on your income just to get by, you got comparatively poorer with every passing year. Populism thrived. So, loud calls come for a ‘People’s QE’ to bail out ‘Main Street rather than Wall Street’. There are votes in heeding such calls.

In the short term, when the global economy hides at home from an unseen enemy, the shocking collapse in demand can only be deflationary. But as we pick our way through this crisis to better days, the vast costs which governments across the world will have borne will still be very present. The temptation to inflate a part of that debt away will come both from politicians and their electorate.

Greater inflation should mean higher interest rates and lower asset values. It should also mean higher wage growth. When you combine this with governments keen to get their pound of flesh for supporting the corporate world through this crisis, then the ‘winner’ of this crisis in the decade to come is more likely to be labour than capital.

But messing with the value of money has always been a dangerous game. When it comes to inflation, like Goldilocks looking out for the perfect porridge you want it ‘not too hot’ and ‘not too cold’. That is not easy to pull off. Aristotle over 2,300 years ago was already warning those who try to change the value of money to their own ends.

‘It is named money (nomisma) because it exists not by nature but by law (nomos) and it is in our power to change it and make it useless.’

Finding the inflationary porridge which is ‘just right’ is never easy.


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CLI01611 Expiry 30/04/2021