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Inflation Challenges

The broad US stock indexes made new all time highs this week along with Bitcoin.

I keep kicking myself how stupid I was for falling in love with my deflationary thesis, being intellectually lazy at the same time becoming emotionally stubborn. I fooled myself that I was being resilient and I was cleverer and more robust than the crowd. I can thankfully say that while I got the the US stock market call wrong, I at least got my Bitcoin and crypto call right leaving me ahead of the game. Let me explain my self flagellation.

In the chart I started this letter with you get to see the massive amounts of cash being piled into the banking system in 2020 by the Treasury spending less than the huge amounts of bonds being issued. It was a pretty safe bet to realise that it wouldn't take long before Treasury would spend more than they issued as you can see in the collapse of cash on hand in the banking system throughout 2021.

This is actually quite complex stuff if you are not a monetary economist or bond trader dealing with it daily. I am not sure I fully understand it myself. What is clear to me though is that all that money that came gushing out of the banking system into the hands of every day people was always going to go into assets like real estate, stocks, bonds, and consumer goods. I should have been more bullish on stocks - my bad.

If one puts aside the various supply side "cost-push" shocks which can be transitory and focuses on the "demand pull" effects then you get to understand the subject of today's letter inflation. I will share a couple of charts highlighting the inflationary pressures we are seeing today and then discuss one of the challenges that makes inflation such a bad thing for an economy.

I always like to see the big picture first before going deeper into specifics.

Below you can see a long dated chart of CPI (consumer price inflation) in the USA running well above 5% year on year. It appears that inflation is on the rise and if we go through that 100yr trend line I drew then we are in big trouble. On Friday Federal Reserve Chairman Jerome Powell acknowledged that inflation pressures "are likely to last longer than previously expected" noting they could run "well into next year". He also added he expects the Fed to soon begin pulling back on its extraordinary measures. Amazing how accountability is something these kinds of people never seem to bring to account. 


The ECB has kept base rates negative since 2014. German Producer Price Inflation is in double figures above levels last seen in 1977. The fact that the effective rate was below zero a year ago is now something of the past. Houston, I mean Brussels we have a problem.



Inflation Challenge


There are a number of challenges to an economy that is suffering from high inflation; primarily the social unrest that comes from increased inequality with the widening gap between the haves and the have-nots.

I was speaking to a wise man of 75 yesterday and he shared with me a story that affected his business profoundly in the late 1970's. He told me that he was living in Israel running a clothing business when inflation was running at more than 400%. He said that one day the goods he bought went up 25% in price in one day.

You see when we are in a hyper inflation environment (by the way Jack Dorsey said yesterday we are heading towards hyper inflation) it becomes impossible for businesses to manage the ever increasing price of the goods they wish to sell.  Let us take a simple example of an ecommerce business. You sell goods on your site today for $1000. The sale comes through at 10pm. The following morning you get to the office and purchase the goods you just sold. The problem is the price now is not $800 which you used to price the item on your site, in fact it is now $1000. 

The inability for a businessman to price his goods effectively is a recipe for business failure. This small example is what effects the economy in a major way when experiencing inflation.

We will look at ways to play the inflation game in coming letters. I will just draw Gold to your attention. Bitcoin has played out the inflationary story perfectly, however, Gold has lagged big time. I think we should be looking to see Gold break out to new highs in coming months.