fungible thoughts

You’re probably asking yourself, “Whoa there, cowboy. Inflation is good? How are rising costs be good? How is less disposable income good? It costs twice as much to fill up the fridge as it did six months ago? How is that good?!”

I borrowed a majority of these ideas from a recent interview by Russell Napier. Please go read that article first as his narrative is much more coherent than mine.

Let’s start with the building blocks and a few structural issues facing our current economic environment:

• The current global fiscal regime is experiencing higher government debt to nominal GDP ratios than the years following WWII. With such high debt levels how will they continue to borrow?
• The narrative of hard-work equals success has stagnated, with opportunities to grow human capital being reserved for the elite. Scalable professions, i.e. jobs which decouple hourly productivity from wages, are reserved for individuals and families with the ability to pay increased higher education costs. Where’s the social mobility?
• Sustainable development has entered the Overton Window on both sides of the political spectrum. A government’s job is to protect and aid citizens, especially as environmental disasters become more frequent and costly. This says nothing about whether or not you “believe” in climate change; it’s about providing goods and services to your voter base. But with such low unemployment, where do we get the labor and capital to complete these projects?
• Corporate debt service ratios are high and rising amid rising interest rates. Household costs are rising, labor is a scarce commodity, and unionization rates are on the rise. Labor dynamics lead to a stickier workforce equipped to make demands about wage growth, but companies are less willing to pay them without certain concessions and guarantees around future debt payments from creditors. Why won’t unemployment rise significantly?

And now the narrative. Recall that the following is not prophecy, but a way of thinking that can, of course, be perfectly wrong. Now that I’ve covered my ass, let’s get to the above listed concerns.

Throughout the Covid-19 pandemic, the US government enacted initiatives designed to calm credit markets, sustain corporations, and aid consumers. Governmental power to influence where, when, and how debt is created is not new, but it’s not Laissez–faire free-market economics. The government didn’t trust banks to keep the credit flowing as the pandemic ravaged the economy; thus, government incentivization.

In recent months, we’ve seen direct relief from governments to consumers through subsidization of energy costs and student debt relief. This action was taken in the face of rising interest rates and shrinking balance sheets at central banks all over the globe. Central banks are fighting inflation while governments are stoking it. Governments have effectively taken control over the money creating mechanisms formerly governed by central banks.

Inflation has taken power out of the hands of the free market and dropped it in the lap of government agencies, creating incentives for governments to protect and aid their voters. All this points to greater government control over capital investment.

Dependent on their voter bases, governments will push capital expenditure into areas deemed most important by their constituents.

What about unemployment? Doesn’t high inflation mean higher costs for employers, thus less resources to spend on employees?

A sticker work force with stronger labor laws and higher unionization rates will push companies to raise wages as they compete for the retention of human capital. This isn’t to say certain sectors and demographics won’t see large increases in unemployment. Pilots, for example, were grounded as global travel stalled during the Covid pandemic.

In these industries where unemployment increases significantly, the above mentioned shift in power means governments have more control over the mechanisms by which aid is provided. Instead of a blanket policy of “easy money” enacted by central banks, largely benefitting the wealthy, we’ll get more tailored aid in the form of government sponsored debt programs.

This means the big, structural issues might finally be forced into the spotlight. In the US, aging infrastructure has been a popular issue on voters minds when filling out their ballots. Outdated public services could see more capital, both human and financial, leading to better outcomes and a more sustainable future. Not only that, they can continue providing energy cost and student debt relief, giving aid to where it’s most needed.

The free market outcome of rising inflation and rising rates is an economic slowdown with banks tightening lending, making it more expensive for borrowers. There exists some level where governments determine the debt rates are too high and will issue an implicit guarantee for corporate debt, shifting the cost from companies to the government, creating incentives for borrowing.

While this level may be determined to be below the rate of inflation (i.e. negative real yield), there exists a “captive audience” of buyers of debt: pensions and other funds with a legal obligation to own a certain portion of government debt for safety purposes. The answer to why would anyone would ever buy a negative yielding bond is that they have to.

There exist captive buyers of negative real yields, so while nominal GDP growth prints are positive the government can keep borrowing costs low. This helps borrowers and hurts lenders (which are legally obligated to continue to lend!).

When inflation is high, prices of goods and services rise, leading to higher corporate revenues. As companies borrow at negative real rates, their debt levels fall relative to revenues. Higher inflation with artificially capped debt yields leads to healthier corporate balance sheets, able to shoulder the higher costs associated with employment.

The same is true for government debt levels. As inflation outpaces interest rates, debt to GDP ratios fall allowing governments to borrow more leading to more fiscal stimulus.

In this narrative, governments have more mandate to do more for their citizens. Given where we are in the economic cycle, free market dynamics can’t solve the structural issues inherent to our system. We need intervention to stop the destruction of the societal and environmental fabric that makes our world work.

All this goes without saying that the political spectrum has shifted towards protecting what’s “mine”. Voters gave these nationalistic policy makers the green light before they even knew it was the perfect storm of incentivizing variables! All in all, this is an incredible opportunity to for policy makers to capitalize on new found power to create a better system for their voters.

Yes, there will be short term pain and global trade may never be the same, but in the long run I am optimistic.

Thanks for reading,

/tommander

Read this too. IMF: Global Debt Reaches a Record $226 Trillion