by Inflation - You should be afraid
Are you scared? I am, and I will explain why you should be too. But remember, I’m just a random student, and to be honest, I have no idea what the f*** I’m talking about here.
Central banks around the world have been undershooting inflation estimates, and the consensus is that they have no idea why it’s happening. The Economist recently published an article deeming that inflation has lost its meaning as an economic indicator, stating that inflation has defied economic theories. The Phillips curve that shows the inverse relationship between inflation and unemployment rate has not been applicable. The low unemployment rate in developed countries should have sparked accelerated price increases.
So maybe inflation is losing its accuracy, and thereby the meaning as an economic indicator, but that does NOT mean we should disregard it. As long as central banks around the world use it as an indicator and one of their top three concerns, we should be VERY concerned as well.
To sum up, central banks have three overall concerns:
- Stable Prices (inflation)
- Maximum Employment
- Moderate long-term interest rates
From an American economic view, all three are acheived (not here to discuss yield inversions or lowish-interest rates, but all in all). These concerns might seem positive, but in my, very inadequate, opinion; it’s super scary.
These are the current facts:
- Central banks Balance Sheets have skyrocketed
- America and others are accumulating more debt
- Interest rates are negative or near negative in developed countries
- SP 500 is trading well above its earnings
The scary part of this equation doesn’t lie in the current economic situation but in the direction we’re able to go in. I have identified four likely directions as:
(1) Central banks choose to continue to use QE.
The reason behind this would be to save or spark economic growth.
– A more extensive QE program would decrease interest rates.
– Globally, negative interest rates would become second nature.
– Even though it hasn’t happened yet, we might see hyperinflation
Effect: Remember how we got out of the Great Recession? If banks ramp up balance sheets, what will get us out of the next recession? We would be digging our hole deeper
(2) Central banks unwind balance sheets.
The reason would be to save inflation.
– If central banks use contractionary monetary policy
– Which would increase interest rates
– Might cause deflation
Effect: It will flood the equity- and bond- markets with crazy supply, and the market demand would not be able to swallow it. Resulting in markets most certainly crashing.
(3) Do something different
If central banks and government start using other measures because monetary policy has proven ineffective.
– Governments start using fiscal policy to stimulate growth
– We are already heavily in debt
– Certainly helping in the (very) short term and might prolong our economic “boom.” Emphasizing prolong.
Effect: By extending this boom, our next recession will a lot worse. Combine this with high levels of debt, and you have a formula for catastrophe.
(4) We let a cyclical recession start.
We are overdue!
– Start using both contractionary fiscal and monetary policy
Effect: We would face a recession sooner rather than later. However, the recession would be shorter, less extreme.
With this in mind, where do we go? In my opinion, we will face a recession or a bear market within the next two years. The longer we postpone it, the more extreme it will be.
Maybe you’re a student like me, and job security is not something that is already obtained. Then the conclusion has to be this: Be scared, be humble, and most importantly; be aware that the opportunities everyone is talking about might not be so plentiful, in the near future.