Greg Canavan

[8 min read]

Dear Reader,

In late May I sent the following to subscribers of Greg Canavan’s Investment Advisory:

‘I think it’s simply a matter of ‘peak stimulus’ being behind us for now. A huge amount of speculative capital came into the market last year and into 2021 due to global pandemic-related stimulus. But like the pig in the python, it is moving through the system now and having a diminished impact.

‘As I’ve discussed on numerous occasions, “Life at Zero” isn’t all plain sailing. Markets won’t go up in a straight line. There will be frightening pullbacks along the way to higher and higher stock markets.

‘It is these frightening pullbacks that will ensure the authorities do something even more absurd down the track. This will further destroy the purchasing power of currencies.

‘The key to dealing with this is foresight. If you know there is an increased probability of something coming, you are in a better place mentally to deal with it. It also gives you time to position your portfolio for turbulence.

‘To be really clear here, I don’t expect things to go pear-shaped in the broader markets immediately. Major indices in Australia and the US are still in healthy uptrends. This could still take three to six months to unfold. I’m just alerting you to the warning signs.’

Earlier this week, I sent this:

‘This article in the Weekend Australian caught my eye:

“The four major banks are likely to announce $15 billion in share buybacks over the next year, with Commonwealth Bank to kick off the bonanza with a $5 billion deal at this year’s annual result, according to Morgan Stanley.

“Analyst Richard Wiles said in a note that the big four were sitting on $19.5 billion to $28 billion of surplus capital, based on a target common equity tier one ratio of 10.75 per cent to 11.25 per cent.

“Assuming an even more conservative target of 11.5 per cent, the excess would be more than $15 billion.

“‘We expect the banks to take a conservative approach to capital management in the near term given that COVID-related risks remain and the Australian Prudential Regulation Authority’s revisions to the capital framework are not yet finalised,’ Mr Wiles said.

“Despite this, CBA was likely to unveil a $5 billion buyback at the 2021 annual results, with ANZ, National Australia Bank and Westpac likely to follow up with buybacks of $2.5 billion, $4 billion and $3.5 billion respectively at their 2022 interim results.”

‘Here’s a rough rule of thumb…

‘Banks raise capital or cut dividends at the lows and conduct share buybacks close to the highs.

‘The buybacks haven’t been announced yet. But the fact that the banks are now generating excess capital means we’re closer to the top than the bottom.’

As a result, I recommended taking some money off the table in some banking stocks. We’ve been in that rally since October last year.

Here’s the problem that I see…

The Aussie economy is slowing after its stimulus-driven recovery. Yet the ASX 200 continues its climb towards record highs.

It seems to be having the best of both worlds. Resources moving higher because of the ‘inflation trade’ and banks/financials loving the low interest rate environment.

Meanwhile, the bond market is signalling a slowdown.

The chart below shows the Aussie 10-year government bond yield. Yields peaked all the way back in February at 1.85%. This was the height of the ‘inflation is coming trade’. And while that narrative is still intact thanks to a few months of favourable comparisons with last year’s deflationary conditions, the bond market is saying otherwise.

As the chart shows, yields have fallen 40 basis points in the past three months. The bond market is telling you (as I have been) that the inflation is transitory, and the economy is slowing.

Whether that means the market is set to drop from here is another question. The ASX 200 is trading at fresh all-time highs. The trend is bullish. Perhaps the narrative shifts to ‘low bond yields justify higher stock prices’ again.

Who knows? When the mood is bullish, the market will run with whatever narrative suits. But if the bond market is right, in the next few months you’re going to see weaker data and perhaps some comments about weaker operating conditions for companies.

It’s not just Australia either. The US 10-year bond yield is off its highs too. As the chart below shows, US yields peaked at the end of March (about a month after Australia) but now look like they’re heading lower.

As economist Dave Rosenberg wrote in his morning note:

‘Consider how much “bad news” for bonds there has been out there — massive inflation chatter, narratives of how stupid the Fed is, huge increases in commodity prices, what has been a weak dollar, unprecedented fiscal juice, record money supply growth, double-digit GDP growth, visions of infrastructure stimulus, widespread reports of wage increases, booming producer and consumer price data, the vaccination process coming so early and the economy pretty well re-opened. Not to mention all the action in equities, inflationary value-stocks in particular, and the entire risk-on trade. And here we are, with the yield on the 10-year T-note down 20 basis points from the nearby high. All a sign of how much “bad news” for bonds has already been discounted. It’s “in the price.” What isn’t in the price is a second-half growth relapse in the economy.’

Well, bond markets certainly look like they’re starting to price that scenario in.

Stock markets? Not so much.

Just something to consider as most investors remain blindly bullish…

Regards,

Greg Canavan,
Editor, The Rum Rebellion

Inflation Explained
By Bill Bonner

‘Pity the American small business owner…’ writes dear reader HRE:

‘I’m dealing with it as a landlord. Can’t get parts and materials and can’t get labor. Both cost more than ever. Plumbers at $300 per hour. AC guys closer to $500 per.’

Breitbart reports: ‘Small Business Optimism Drops on Labor Shortage and Inflation Worries’:

‘The National Federation of Independent Business Optimism Index dropped two-tenths of a point to a reading of 99.6 in May. This followed three straight monthly increases but was the second straight month in which results undershot expectations.’

And more inflation sightings from our dear readers...

Stephen G:

‘The MSRP of a 1964 Ford Mustang was $2,368 and an ounce of gold was pegged at $35.10, which works out to a little over 66 ounces of gold. Today, 66 ounces of gold will buy you two BMW Z4s, with almost $20K left over. I think this says as much about the destruction of the dollar as it does about gold as a store of value.

‘I also remember buying gasoline back in the early ’60s for right around 20 cents a gallon. I remember being struck by the fact that a gallon of gas and a pack of smokes were about the same price. So two silver dimes would buy a gallon of gas in 1963. And, guess what, two silver dimes will still buy a gallon of gas — with change — back in some parts of the country. And that’s just going by the spot price of silver, not the huge premiums being charged on eBay and most other sellers.’

Fred T:

‘At the real day-to-day level, inflation is rampant. We get Chinese on Thursday nights. Last Thursday, when I picked up the order, I got a severe case of sticker shock. They had raised the price of their entrees 40% — from $9.99 to $14. Unbelievable. They said their food costs have skyrocketed. Trust me, it is not transient. The price will never be reduced.’

And Goku V:

‘Take a butterfinger. In 1978, it was 4 ozs and cost 10 cents in a vending machine in grade school. By 1993, it was down to 3.4 ozs and cost 25 cents. The last time I saw one, it cost $1.69 and was 1.51 ozs.

‘Take the snack pack of butterfingers. When they came out, they were 10 oz bars for 99 cents. At their cheapest, they were 12 x 1 oz bars for 88 cents at Walmart. Today, they are over $3 and are down to 6 x 55 oz bars. Do the math!’

Confusing and misleading

Here at the Diary, we don’t really care what things cost…how much people earn…or what interest rate they get on their savings.

All that matters is that these figures be true. Then people can take the ‘information content’ of the prices and make their choices.

The trouble — speaking as though we were a serious economist — is that today’s prices, wages, and interest rates all lie.

The information content — bent and distorted by the Federal Reserve’s fake money — is false. It confuses us. It misleads us. It creates bubbles and BS.

Here, we make a small effort to straighten it out.

False argument

Many times in these pages, we have pointed out that a new car or a new house is much more expensive today than it used to be.

But the price alone — twisted up by the feds — tells us nothing. We have to adjust it for ‘inflation’.

We can do that, as our dear reader did above, quoting the price in real money — gold or silver.

Or, we can figure it out in time — how many working hours it would take to earn enough to purchase said house or car.

Either way, the real price comes out at 2–3 times more than it was in the 1970s.

Then the apologists for the fake-money system tell us that we’re wrong. We’ve failed to take product improvements into account, they say. ‘A car today is a lot better than one in the 1970s.’

The Bureau of Labor Statistics actually adjusts auto prices downward to reflect quality enhancements.

But this argument is false. Technological improvements can make a car better (or worse). But they also should reduce the expense of making it.

The two costs — producer and consumer — should change at more or less the same rate. So there’s no reason to think a Ford F-150 should cost more in 2021 than one in 1971.

Higher wages

Another reason you might think today’s car is more expensive than one from 50 years ago is that wages are so much higher.

A person working somewhere on the auto supply chain in 1971 would have earned an average of about US$3.60 an hour. Today, he’s earning nearly US$25 an hour.

But wait. We need to adjust for ‘inflation’.

And when we do that, our colleague David Stockman tells us that the typical employee in the manufacturing sector hit his peak earnings in 1978. Here we are, 43 years later, and his real, inflation-adjusted wages have gone down 6%.

No wonder he wanted to Make America Great Again, he remembered when wages actually went up. He must feel he’s been cheated over the last 40 years, even if he has no idea how the flimflam worked.

And he’s right. However much auto prices have gone up, none of that money went into his pocket.

Cheated again

At the top of the money pyramid, the elites have stocks and bonds. An increase in stock prices — even if it is a phony increase, caused by the Fed’s money printing — can bring them additional wealth.

But most people rely on their time to pay the bills. They sell it hour by hour, week by week, year by year.

And while the Fed continues to buy financial assets at a rate of US$120 billion per month…it has never paid a penny for a working man’s time.

Stocks and bonds go up. Wages do not.

Still, if he works hard and is careful about saving his money, an assembly line worker may build up some capital of his own. Were he to save, say, US$2,000 every year over a 40-year career of putting nuts and bolts together, he would have US$80,000! And then, he could earn interest on it.

Alas, the interest rate has been falsified too. Adjusted for inflation, had he put his money in a savings account in 2008, he’d have less money today than he had then.

This year alone, based on the present inflation readings on US$80,000 of savings, he’d lose another US$2,000.

Cheated again!

Simple solution

And now…with the official ‘inflation’ rate over 5% (annualised, based on the first quarter), the feds are busily figuring out how to keep the scam going.

‘It’s complicated,’ they say…which is surely true, thanks to the many curveballs they’ve thrown.

But behind the complexity is the simple Quantity Theory of Money (QTM). This tells us that the more money is in circulation, the higher prices will go.

When economist Milton Friedman proposed the fake-dollar system (what was he thinking?!), he said the Fed should increase the supply of dollars at a rate roughly equal to the rate of GDP growth.

That way, the quantity of money would go up at about the same rate as the supply of goods and services. No surprises. No shortage of liquidity. No fear of inflation or deflation. And no price distortion.

Oh, happy days!

Simple explanation

Friedman set 3–5% as the perfect rate. But that was when the economy really was growing at a 3% rate.

Over the last 14 years, the real rate of GDP growth — adjusted for inflation — was under 1.3%. So even a 3% increase in the supply of money would be twice as much as it should be.

But guess how much the money supply (the Fed’s balance sheet) grew last year. 5%? 10%? More?

Oh dear reader, you already know. 78%, March 2020 to March 2021. The number is so staggering, we can hardly believe it ourselves.

So let us set aside the plague year as exceptional in every way, and go back to the turn of the century.

Well…since this century began, US GDP has gone up from about US$10 trillion to about US$22 trillion. A solid double.

But the Fed’s balance sheet? Around US$700 billion 20 years ago, if it had kept pace with GDP growth, it would be around US$1.5 trillion today.

Instead, it’s now around US$8 trillion — five times where it should be.

If we were looking for a simple explanation of inflation, need we look any further?

Regards,

Bill Bonner,
For The Rum Rebellion

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