With the Fed's balance sheet expanding at an unprecedented rate, inflation concerns have made a comeback among some market watchers on both Wall Street and Main Street.
While the monetary supply has increased drastically since the onset of the COVID-19 induced economic crisis, the velocity of money has actually fallen during this period.
So what will prevail once the pandemic dust settles - a deflationary or inflationary environment? And how should ETF investors be positioning in the meantime?
Macro specialist Eric Basmajian rejoins Let's Talk ETFs and delivers a master class in current monetary policy dynamics - and how investors can stay one step ahead of the curve.
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We keep trying to solve a problem of having too much debt by issuing even more debt. In the end we end up with lower cyclical growth the further indebted we become as a society.
Thus Eric Basmajian frames the current debate around whether current Fed actions will ultimately be inflationary or deflationary. Eric distinguishes between "productive debt", i.e. debt that leads to growth in productivity, and "unproductive debt", which is debt that only leads to future debt servicing payments but not growth.
To understand this distinction in practical terms, think about a business borrowing money to build a new factory or open a new office location. The reasonable assumption is that the additional revenue generated by the expansion of the business will lead to growth that outpaces the costs of paying back the debt. This type of borrowing is "productive" in that it leads to future growth and under normal circumstances, a healthy level of inflation.
Now consider the same business borrowing money not to build a new factory or open a new office but to keep its current level of operations and staffing afloat. Rather than an increase in productivity, this borrowing is "unproductive" in that the business will now need to divert more of its current earnings to pay down debt in the future as opposed to expanding operations.
As per Basmajian, this latter form of unproductive debt accounts for nearly all of the Fed's recent balance sheet expansion - which has been unprecedented. "You see all of these charts on Twitter showing the recent expansion in the Fed's balance sheet, which underlies the broad monetary supply base." Many people assume that this sort of balance sheet expansion is inflationary by definition.
This assumption among many watchers that an increase in the monetary supply must lead to inflation is flawed according to Basmajian. "GDP is equal to Money Supply times Velocity of Money," he explains. And the velocity of money has been falling despite the massive rise in the underlying monetary supply. "Businesses need to pay back all of this debt at some point in the future - which makes them less likely to take on more debt to grow their businesses by hiring more or opening new locations."
As Head of Macro Research at Pervalle Global, a discretionary hedge fund specializing in global macro-driven trades across all major asset classes, Basmajian spends much of his day poring over macro-economic data from across the globe. The NY-based hedge fund then makes bets based largely on Eric's reading of the macro tea leaves.
In addition to his role at Pervalle, Eric runs his own Seeking Alpha Marketplace service, EPB Macro Research. Subscribers to EPB Macro Research gain access to EPB’s Model Tactical Asset Allocation and Long-Only Asset Allocation portfolios - 2 low cost, all-ETF portfolios overseen directly by Eric. By combining an asset class mix that includes stocks, bonds, gold and commodities - tilting based on underlying macroeconomic conditions - Eric has created an all-weather portfolio which tamps down risk and volatility while attaining impressive longer-term appreciation of capital.
Whether you're an inflation bull or bear, you will not want to miss Eric's perspectives and practical portfolio advice in the latest joint episode of Let's Talk ETFs and The Marketplace Roundtable.
- 4:30 - Eric's personal COVID-19 story
- 8:00 - Stock vs. Bonds (SHY): A tale of two markets - Which is right?
- 13:30 - The current environment is a deflationary one - here's why
- 21:30 - Is the US just a generation behind Japan and Europe when it comes to monetary policy and its likely affect on underlying growth?
- 29:30 - Productive vs. Unproductive debt: Prospects for future growth (KRE) (XLF)
- 39:30 - What is the theoretical case for inflation once the dust from COVID-19 settles in a few years?
- 45:15 - What would be the likely outcome if an emerging economy's central bank followed the same playbook as the Fed?
- 48:00 - Positioning portfolios in the current environment (SPY), (PDBC), (TLT), (IEI), (SHV), (VXUS)
- 1:00:00 - Would you consider a short position in something like (XLE) or (XOP) given the potential economic downside that still exists in the energy sector?
- 1:08:30 - Are you currently over- or under-weight gold? (GLD)
- 1:14:45 - How about gold miners? (GDX)
- 1:17:00 - How do you make sense of the extreme bullish stock market action of the last month or so? (QQQ) (DIA) (IVV) (VOO)
Disclosure: I am/we are long SPY, GLD, PDBC, TLT, IEI, SHV, QQQ, VOO, BAR, SHY, GBILVXUS, KRE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Eric Basmajian is long SPY, GLD, PDBC, TLT, IEI, SHV, VXUS and is short KRE.
Jonathan Liss is long QQQ, VOO, BAR, SHY and GBIL.