On and on until the collapse

As before, the bulk of our planet is in a state of limbo between deflation and inflation. However, this situation can change quite quickly due to persistent supply shortages and mountains of freshly created electronic money. What do central banks like the Fed want to do if domestic inflation should exceed the target bands they have set themselves, perhaps even significantly?

In the year of the pandemic, governments around the world launched and adopted fiscal and stimulus programs of unprecedented magnitude, pushing debt levels, already towering by then, to even loftier heights.

At the same time, the Federal Reserve in the United States will probably continue to pump fresh liquidity amounting to 120 billion U.S. dollars (!) into the financial markets over the next few quarters.

At its most recent interest rate meeting, the European Central Bank also committed itself to its QE program, indicating its intention to expand its own bond purchases even more.

Naturally, attention is focused on the international currency markets, where classic export nations in particular cannot afford to see their currencies rise too quickly and too sharply in relation to other exchange rates. From a current perspective, the euro is one of the best examples of this.

There is a lot to suggest that fiat currencies, which are backed by nothing, are in a kind of endgame, which Brazil’s former finance minister, Guido Mantega, warned would set in as early as 2010.

A look at emerging markets shows that nations such as Argentina, Turkey, India, South Africa and even Brazil seem to be finding it increasingly difficult to convince international investors that their fiat currencies are stable.

With the Bitcoin market in Turkey completely falling apart following the recent ban there, many Turks and Turkish women will now be asking themselves what investment alternatives are available to keep their own savings from losing further purchasing power and to dump the Turkish lira.

Countries like Venezuela have already gone through this process following the onset of hyperinflation. Meanwhile, the broad masses on the ground have become impoverished, while the flight from the South American country is accelerating.

In the eurozone, too, savers and bank account customers are now feeling the effects of financial repression first hand, as most commercial banks are now passing on the ECB’s minus interest rate to their own customers. As long as this was not the case, many probably did not want to admit it.

People, especially savers, seem to be becoming more and more aware, even if it is a slow and creeping process, that money deposited in accounts is probably better spent acquiring real products and tangible goods for its current equivalent value, instead of continuing to succumb to the hope of maintaining the general purchasing power of domestic money.

Hardly anywhere else than on America’s markets for used vehicles can this development be better observed at the moment from a global point of view. Month after month, prices for used vehicles on these markets are rising to new record highs.

Lumber prices are also climbing to ever loftier heights in America, while similar observations can be made around the globe in the food sector. On the part of official government representatives, the threat of inflation – naturally – continues to be downplayed.

On the contrary, they are adding fuel to the already blazing fire by spending program after spending program, as if there were no tomorrow. The fact that, at least in the United States, the beginnings of a planned redistribution program – from top to bottom – are discernible, remains so far rather an exception.

For example, the Biden administration recently announced its intention to raise the capital gains tax in the U.S. from around twenty percent to 39.6 percent for annual incomes of more than one million U.S. dollars.

If the Obamacare obolus is added to this calculation, the capital gains tax in the USA would climb to 43.4 percent, and in the states of New York and California even to well over fifty percent, while stock exchanges such as Hong Kong have meanwhile raised their stamp duty.

Slowly but surely, a trend reversal is emerging – at least in the USA. And it’s moving away from the financialization of the economy to an imposition of government spending programs reminiscent of the New Deal in the 1930s. It gives the impression that the Biden administration will make its wealthy citizens pay for this.

Added to this is the plan to raise U.S. corporate taxes back up to 28 percent, which would apparently only be enforceable if the G20 countries showed their willingness to harmonize the tax systems prevailing in these climes, as instigated by U.S. Treasury Secretary Yellen.

Translated, this means something like, “we here in America are broke, and we desperately need money from all possible channels – so pull along to maintain the U.S. dollar’s status as the world’s reserve currency and “save” the American consumer market from severe slumps that would catch up with everyone else in the world itself.”

Whether the rich, and especially the big corporations like Apple and Amazon, will also go along with plans of this sort? Nothing definite is known, at least not so far. If you just look at current charts on the development of the American money supply, you can see that this little game cannot go on forever.

This is compounded in many areas by far too low inventories, supply chain problems, in some cases massively rising transport costs, and growing demand for certain raw materials and consumer goods in the industrialized countries.

The current situation on the markets for used vehicles in the United States succinctly demonstrates that, in the face of currently sharply rising prices, there has not (yet) been a buyers’ strike – quite the opposite. This development certainly does not bode well from the perspective of general confidence in the domestic currency!

The Purchasing Managers’ Indices (PMIs) received over the past few months support this view, as U.S. manufacturers have no difficulty in passing on their climbing purchase prices to their own customers at home.

Instead, an accelerating run on a whole range of consumer and durable goods can be observed in the USA, which naturally has an inflationary effect. Once people have the feeling that they would rather purchase products immediately – instead of waiting any longer – an inflationary spiral could be set in motion.

Let’s return to the emerging markets. Here in particular, many nations are struggling with inflation, which is rising sharply in some cases, mainly as a result of rising import prices due to persistently depreciating currencies.

Let’s look at Mexico, where consumer prices rose by 4.7 percent in the month of March alone, according to official figures. Meanwhile, the general price trend has overshot the Bank of Mexico’s own target rate of three percent.

Among the products most affected by the price increases were food products such as eggs and flour, in addition to natural gas and gasoline. Climbing commodity prices are now eating into end-user prices.

A good example is corn prices, which have risen by an average of 75 percent over the past twelve months. Wheat and cereal prices have also been climbing steadily since last summer.

In Mexico, this trend translated into a three percent increase in tortilla prices in March compared to the previous month. This is compounded by the fact that the Mexican economy contracted by 8.5 percent in 2020 as a whole, marking the sharpest economic downturn since the Great Depression of the 1930s.

In the meantime, it is beginning to emerge that price developments appear to be unaffected by this. Instead, the Mexican economy, which is no longer deflationary due to supply bottlenecks across the board, is likely to have contracted in the first quarter of the current year.

The Bank of Mexico’s monetary policy room for maneuver is getting smaller and smaller due to an emerging stagflation (or “contraction inflation,” caution, it is my own choice of words). The central bank cannot cut its own policy rate again in this environment.

Rather, the Bank of Mexico could soon be forced to raise its key interest rate, as happened last week in Russia, where, from the point of view of many observers, a key interest rate hike of no less than fifty basis points (0.5 percentage points) was completely unexpected.

In Brazil, too, a similar development had already occurred about three weeks ago. Inflation, which was rising sharply in many areas, prompted the Brazilian central bank to raise the domestic key interest rate by 75 basis points (!) to 2.75 percent. Locally, this was the first interest rate hike in the last six years.

According to the central bank, Brazil could raise its key interest rate by a further 75 basis points as early as May if inflation cannot be contained. Such a scenario can certainly be expected, as interest rate hikes only have an impact on consumer price development with a certain time lag.

In March alone, the Brazilian consumer price index climbed by 6.1 percent according to official figures. This means that inflation in Brazil has now also exceeded the maximum inflation target of 5.25 percent set by the central bank.

No good news is coming in from the Brazilian producer price front either, after prices in this important sector climbed in the month of February at the fastest pace since data records began.

On a monthly basis, producer prices in Brazil gained a handsome 5.2 percent in February, while on an annual basis there was a 28.6 percent (!) increase. In addition to commodity products from the domestic mining industry (+87.6 percent on an annual basis), the food sector also made a major contribution to this development with an annual increase of almost eight percent.

It is self-explanatory that in Latin American nations, the poor, who form a majority, are hit particularly hard by these price increases.

It must therefore be expected that the protests that last flared up across the country in 2007 and 2017 could soon be repeated. This is especially true if gasoline and food inflation cannot be brought under control.

However, it does not look like that will happen at the moment, as gasoline prices in Mexico have climbed by an average of thirty percent over the past year, while diesel prices in Brazil have risen by a good eleven percent in the last month alone.

Rising energy prices, in turn, usually lead to price increases in the agricultural and farming sectors. Like Fed Chairman Jerome Powell, officials at Brazil’s central bank believe that this is a “temporary inflation phenomenon” that will dissipate in the long run.

Really? Then why is Brazil’s central bank raising its own key interest rate to such an extent?! Furthermore, based on past observations, it can be argued that once inflation has escaped from the bottle, it cannot be easily put back into it.

This requires, perhaps similar to the development in the U.S. in the 1970s and 1980s, a very sharp increase in the key interest rate (at that time up to twenty percent) to tame this spirit. However, central banks no longer have such leeway today due to towering debt levels around the globe.

In such a case, economies would collapse so severely that it probably wouldn’t take long for dangerous social unrest to erupt. “Caught in the trap, central banks,” as this development could be translated.

Repeatedly, central banks, in the face of their increasingly reckless QE programs, suggested that time was being bought in this way. Time for what? Governments around the globe have so far been too cowardly to initiate the much-needed structural reforms that would have put not only the banking system but also the financial and economic system on a sounder footing (not to mention sprawling welfare states).

Certainly, it would have been a painful process, which would have had to be communicated to the individual populations. However, nothing has happened. Former President Obama had the unique opportunity to initiate this process. Hearts flew to him when he took office.

But instead of making the perpetrators of the global financial crisis pay for their actions, the more convenient way proved to be to simply do nothing or to spend taxpayers’ money en masse on bank and automaker bailouts.

In this way, private losses were socialized, and what is the end of the story? For this, we simply look to Turkey these days, where a bitcoin ban will not do it to stop the ongoing flight from the domestic currency.

Rather, distrust in the Ankara government’s ability to act is growing among both domestic and foreign investors with each passing week. Banning trading in Bitcoins is actually proving to be nothing more than a gesture of impotence, emblematically synonymous with a motto called “Keep it up until the cliff falls.”

Back to the South American continent. While hyperinflation is spreading in Venezuela and Argentina is well on its way to becoming the next country in the region to follow in its footsteps, a number of other South American countries have so far made completely opposite observations.

Starting with Colombia, where inflation officially stood at 1.5 percent in March – less than half the level of a year ago – through Peru (2.6 percent), Uruguay (three percent) and Chile (2.9 percent) to Ecuador (-0.8 percent), there are (still) some significant divergences and differences in the region.

In Argentina, on the other hand, inflation was measured at 42.6 percent on an annual basis in the month of March. However, almost all Latin American nations have had some very painful experiences with inflationary developments in recent history.

Ecuador with the Sucre, Mexico in the 1980s, where inflation climbing above 100 percent expropriated large parts of a fragile middle class. Brazil, too, probably remembers well an inflation of more than six thousand percent in the 1990s.

DepthTrade Outlook

As before, most of our planet is in a state of limbo between deflation and inflation. However, this situation can change quite quickly due to ongoing supply constraints and mountains of freshly created electronic money. What do central banks like the Fed want to do if domestic inflation should exceed (perhaps significantly?) their own set target bands there as well?

It would probably prove prudent to turn the official statements along the lines of “It is only a temporary inflation phenomenon” into their opposite in order to get closer to the truth.

Everyone probably remembers: “There is no intention to build a wall”. From this perspective it might be wise to follow the general trend to exchange lifelong built up savings at the latest now into real goods (no matter, which form, main thing usable and applicable) and/or material goods.

This recommendation applies at least to all those, which should not have begun thereby over the past years yet. Think less in paper and more in things that you can hold firmly in your hand!

Ben Schaack Send an email

Mr. Schaack is a financial analyst, specializing in the commodity, foreign exchange, and crypto markets - with more than 10 years of experience. Besides his business analytics studies, Mr. Schaack works as a journalist - covering finance, economy, and geopolitics. His special interests are focused on inflation hedging and exponential (compound interest) growth. He posts and discusses relevant news on his Twitter account.
Back to top button