The election of Christine Lagarde to head the European Central Bank is the latest confirmation. This is not personal; I have no intention of questioning her abilities. But the election of a politician to head the world’s second most important central bank has significance. It shows the process by which central banks are gradually losing their independence. This will result in inflation sooner or later, which will unexpectedly affect investors.
Lagarde’s nomination logically fits in perfectly with international processes, and we can also say that she is a reasonable choice. Monetary policy has run out of tools worldwide. Interest rates are close to zero, forcing the purchase of assets at a forced rate. What else can they do if the global economy continues to deteriorate? Not much.
It seems clear that the leading role in crisis management will be shifted to fiscal policy. Which, due to high public debt worldwide, is not well prepared to tackle the crisis management in itself, but the parallel use of the already practiced QE (central bank government securities purchase) and fiscal stimulus can be a solution to this problem. This is the main message of modern monetary theory (MMT), which has been increasingly mentioned recently.
Fiscal and monetary policy in cooperation. It is clear why it is a logical step to elect a politician to head the ECB. The only question is that in the world of MMT, what guarantees that politicians will not use this tool “too much”. After all, who does not want to buy voters from money printed by the central banks? Of course, linking the central bank and fiscal policy is not a new thing at all, in fact. The need for the central banks’ independence arose precisely since without it, there was always trouble (hyperinflation) sooner or later.
MMT (in cover) is already taking place in the world today, for example in Japan or in China. In the US, on the one hand, Trump is constantly attacking his central bank governor to cut interest rates/print money, while he (in times of peace and with record low unemployment) carries out fiscal expansion. On the other hand, American society is showing increasing openness to the views of left-wing politicians who support the MMT.
Years ago, many thought QE would cause inflation, but they did not get it right. The printed money did not get out of the economy. All that happened was that investors exchanged their government securities for other assets. He indirectly stimulated the economy by pushing up asset prices, which made the rich feel even richer, but their marginal propensity to consume is low. MMT will be completely different from this. Here, a wide section of society will receive income directly, which will significantly increase consumption.
Yet, if these processes take place here before the eyes of any investor, they will surely be built into their expectations, asset prices, right? In my opinion, no. And the main reason for this is that today there is a relatively large consensus that we are living in an era of disinflation, the main danger being deflation. This strong opinion is based on the experience of the last 10-20 years and is theoretically well supported by structural processes.
There are three main arguments for persistently low inflation: globalization, technology, demography. The first is beginning to be questioned by the US-China trade war. This has indeed been an important factor in the disinflation process of the last 30 years, but – as the chart below shows – it now seems to be reversing. If I look at the depressed price of container ships, the market says it will last.
I do not dispute technological development, but it has always been with us, even in times of low and high inflation. Technological development reduces the absolute level of inflation, but to explain persistently lower inflation with it, than it was in the past, the development would have to be much faster than it used to be. I see no evidence of that.
Finally, demography is what I think is the most misunderstood argument for low inflation. The point of the theory is that society will age globally, which will cause less consumption, i.e. there will be a shortage of demand. Although the elderly buys less in stores, they spend much more on healthcare products and services. Moreover, to an exponential extent since most life-cycle medical expenditures have been incurred in recent years. And health services must also be carried out by someone. In fact, what matters is how many dependents must be taken care of by a working aged citizen. This is measured by the dependency rate. Which is at its lowest point globally in these years! So far there have been more and more employee on a given number of dependents, and from now on there will be fewer and fewer. I would not envision permanent deflation in this process.
So overall, in my opinion, investors (and central banks) today underestimate the risk of inflation because they focus too much on the rear-view mirror and do not notice the change in fundamentals. Of course, this will not be recognized from one day to another, but in the coming years, market players may receive more and more impulses to make a difference.
A significantly rising inflation rate would cause huge damage in savings. Fixed-rate bonds would immediately go through significant impairment. Rising interest rates (opportunity cost) would also make equities less attractive, in addition to which profit margins tend to come under pressure, so a fall in stock markets would be significant.
While real estate is seen as a real asset, which is true in the long run, soaring inflation would cause them a lot of damage in the short to medium term. This is because the lack of interest rates is currently making real estate extremely attractive, raising its pricing to historic highs. From all this, the market should step back due to the rising interest rates, which the central bank would have to raise drastically if it wanted to curb escaping inflation. Moreover, all these asset price drops would probably lead to a recession in the world economy, as there would be a huge loss of wealth in society relative to GDP.
In this environment, I know of an investment instrument that would feel good: gold.
It can then play a significant stabilizing role as part of a savings portfolio. Therefore, in my opinion, it is worthwhile for any investor to think about holding gold or raising its proportion in their portfolio. Not right now, because the precious metal seems out of date in the short term, it has rallied a lot because of the sharp decline in yields over the past few months. But gradually it is worth buying smaller adjustments. In the Columbus Fund, we also keep more gold than before.