Larry And The Inflation Ideology

Jan. 18, 2022 7:37 PM ETDIA, IWM, QQQ, SPY51 Comments

Summary

  • Larry Summers calls for austerity to slow the economy.
  • Inflation is a supply issue, not a monetary one.
  • Raising rates will make inflation harder to control.
  • This idea was discussed in more depth with members of my private investing community, Away From The Herd. Learn More »
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The "herd" has been buzzing about inflation and even hyperinflation. In this piece, we argue against the herd's inflation ideology.

“We need to recognize that we’ve got an overheated economy that we are going to need to cool off,”... Larry Summers

There he goes again, the prima-donna inflationista spouting off. "Overheated" economy? Why does he think that? Because prices are rising and the hospitality industry is short of workers willing to work for scraps? He seems to have completely forgotten about the pandemic.

Inflation is a supply issue, not a monetary issue. If monetary expansion caused inflation, then why didn't we see inflation in the aftermath of the GFC (chart below)? Prices of goods and services were stable until the Global shutdown caused a supply disruption. Notice that spending on goods (which need to be transported from afar) went way up, but spending on services went down following the shutdown.

spending

Spending

FRED

Core inflation has fallen over the last two months (chart below). Even if we don't go back to the sub-2% inflation of the last decade, it will not be the relentless inflation that Larry and others are so confident is happening. A more historically-normal 3-4% inflation is perfectly healthy, especially if labour plays catch-up in its share of productivity gains; any gains that labour makes enters the economy and fosters growth... and corporate profits.

Core inflation

Core inflation

tradingeconomics.com

For inflation to be problematic (not transitory), the economy has to be close to full capacity utilization. At the current 76% of capacity, the economy does not need to "cool off" like Larry keeps telling us. It requires utilization of the spare capacity so that supply can meet demand. Prices will moderate as the pandemic-induced supply deficits are filled in, and monopoly pricing power is weakened (chart below).

Capacity Utilization

Capacity Utilization

FRED

Total employment is still 5% below pre-pandemic levels. Again, not a characteristic of an overheated economy; an economy with this much slack in its labour resource can't possibly be overheated (chart below).

Total Employment

Total Employment

FRED

Truck transport employment has only just reached pre-pandemic levels, almost two years after it collapsed. Now that ground transportation is back, supply issues will moderate going forward (chart below).

Truck employment

Truck Transport Employment

FRED

Then there is the issue of the "remedy" for inflation that Wall Street has been aggressively pushing; raising interest rates. Since inflation is a not a monetary issue, and since the cost of money gets reflected in the price structure of almost all goods and services, it shouldn't come as a surprise that raising rates actually increases inflation. Look at how well raising rates has turned out for Brazil and Russia (charts below).

Russia interest rate:

Russia Interest Rate

Russia Interest Rate

Trading Economics

Russia inflation:

Russia Inflation Rate

Russia Inflation

Trading Economics

Brazil interest rate:

Brazil Interest Rate

Brazil Interest Rate

Trading Economics

Brazil inflation:

Brazil Inflation Rate

Brazil Inflation Rate

Trading Economics

Increasing the interest rate, increases inflation... until the economy slows down and falls into a recession. It is like pouring gas on a kitchen fire, and when the house burns down, taking credit for having put out the fire, which is exactly what Volcker did in the late 70s. The chart below shows the positive correlation between rates, inflation, and recessions for the US.

Inflation and CPI

Inflation and CPI

FRED, angtraders.com

It is a near-certainty that the Fed will, in line with Wall Street's wishes, raise rates at the end of the current quarter even if inflation has moderated by the time they stop doing QE. Do they really think that raising rates and lowering the liquidity in the banking system are going to magically produce more computer chips and increase the supply of cars?

Luckily for stock market investors, rising rates do not hurt the stock market...until rates get too high and debt levels can no longer be maintained.

Rates and the SPX

Rates and the SPX

angtraders.com, stockcharts.com

Since rates are at zero, it will take more than two or three rate hikes this year to negatively impact the market. Debtors are in the best shape they have been in decades, and have the ability to carry much higher levels of debt even if rates are non-zero (chart below).

Debt Burden and Delinquency

Debt Burden and Delinquency

FRED

Corporations are also able to absorb more debt as illustrated by the profits-to-debt ratio; profits are high relative to debt (chart below).

Profit-to-debt ratio

Profit-to-debt ratio

FRED

Despite all the warnings about stock bubbles and an unsustainable level of margin debt, the reality is that the ratio of margin debt to equity value is at a near-historic low. Margin debt will not become problematic as a result of two or three rate hikes (FFR at 1%).

Margin debt to equity value ratio

Margin debt to equity value ratio

FRED

Rising rates will not end the bull market in stocks, but it will also not reduce inflation.

The herd has it exactly backwards.

Investors can bet against the inflation ideology by holding broad spectrum ETFs such as SPY, DIA, IWM, and QQQ.

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This article was written by

ANG Traders profile picture
3.82K Followers
An MMT-based analysis of the equity markets
I have a degree in Math and Science from the University of Toronto, as well as a degree in education, also from U of T.

During my 44-years of investing, I have come to understand that the only constants in the stock market are fear and funds (money), and that Modern Monetary Theory (MMT) provides the best description of how money moves through the economy.

In partnership with David Huston, we search for and analyze repetitive sentiment and fund-flow-based patterns in the stock market's price history, and offer a Marketplace service, Away From the Herd, that reports our findings and allows subscribers to replicate the trades we are involved in for our own accounts. My four decades of experience in the market have taught me to not trade "for the sake of trading". Identifying, and staying with the primary trend is key to wealth accumulation. We use a variety of investment instruments such as stocks, ETFs, and options to take advantage of opportunities as they arise.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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