At the time of the Mark devaluation, during the economic… [+] crisis, in the Weimar Republic (Germany), 1923, the basement of a bank was overflowing of money. (Photo courtesy of Getty Images/Albert Harlingue/Roger Viollet)
Getty Images/Roger Viollet
The default rate on bonds and loans has declined dramatically in recent months. This should come as no surprise, given the government’s stringent monetary and fiscal policies in response to Covid. That is very encouraging news, but we must not forget that the economy remains largely reliant on government expenditure, with the Fed continuing to buy around $120 billion in Treasuries and mortgage-backed securities (“MBS”) each month. Still, cheap money is allowing more businesses to meet their debt obligations that might otherwise be facing Chapter 11 bankruptcy. Debt defaults totaled $104.2 billion in the first half of last year, compared to only $8.5 billion in the first half of 2021. According to J.P. Morgan, this is the lowest level of defaults in the first two quarters since 2011. J.P. Morgan anticipates a minor increase in defaults in the future, but volume will likely remain significantly lower than average for some years.
Low default rates have traditionally signaled a favorable time to invest in post-distressed companies, and although that is still likely to be the case, it is more crucial than ever for investors to thoroughly assess the risks before making such a move.
Nonetheless, the financial industry has recently performed substantially better. Low interest rates, flexible monetary policy, and the government essentially handing out cash have reduced distress and improved bank balance sheets. Because of their better balance sheets, all of the major banks passed their June stress tests, allowing them to begin making substantial stock repurchases and increasing dividends.
The possibility of inflation is a corollary to all of this “good news,” and it’s uncertain how it will play out at this stage. Starting with the boom, the Great Financial Crisis, the oil crisis, and now the pandemic, it appears like we are moving from major catastrophe to major crisis, with each one demanding a larger money-printing bailout.
Bailouts like these inevitably lead to inflation since they are simply a technique of monetizing the government’s rising debt, which it cannot otherwise repay. If you don’t want to pay it off, you’ll either have to default or monetize it through inflation by printing more money. This is the main reason why the US dollar’s purchasing power is a fraction of what it was a century ago.
“How do we go back to normal?” is the major question now. Unfortunately, there is no simple solution. Investors caused a big market selloff the last time the Fed tried to get out of this game by hiking rates slightly and decreasing its monthly asset purchases, driving the Fed back into the market to restart buying.
As we’ve already stated, the bill for all of this monetary and fiscal wrangling will eventually be due. Few politicians in Washington, especially those seeking re-election, will have the moral guts to turn off the tap. If the free money stops flowing, there will almost likely be a market meltdown, which no politician wants to take responsibility for. Inflation’s creeping loss of purchasing power, on the other hand, is lot easier to bear from a political standpoint.
The status of the housing market is one probable predictor of greater inflation. As people left cities, home values have risen, while mortgage rates have remained at record lows. This has sparked worry about the emergence of a new housing bubble. However, sales of new homes (down -5.9% m/m in May, partly due to higher building supply costs) and existing homes (down for the fourth month in a row) were also down in May. It’s possible that as vaccination rates rise and panic fades, people are reconsidering their desire to flee, indicating that we’ve reached a peak, or it could simply be a short pause.
However, any discussion of housing must ultimately return to the government’s role. Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) are the two biggest buyers of mortgages in the United States, and both have been in state conservatorship since 2008. It’s almost as if the Fed is sustaining the entire home market by buying $40 billion in MBS every month. While this may benefit banks, you have to wonder how much demand for mortgages there would be among private investors if the Fed stopped buying.
What Can We Do to Return to Normalcy?
Government spending as a proportion of GDP has hovered around 33% since the 1970s. By 2020, it had risen to nearly 46%. Returning to some kind of “normal” will necessitate a dollar-for-dollar move away from huge government spending and monetary accommodation and toward a private-sector-driven economy. That implies greater spending, savings, and exports will be required.
According to the Bureau of Economic Analysis, the pandemic has likely resulted in an increase in savings, which nearly tripled in the first half of 2020, from $1.59 trillion annually in the first quarter to $4.69 trillion in the second (“BEA”). This was by far the largest savings rise in contemporary history. It remains to be seen whether this trend will continue.
We still have a long way to go in terms of consumption. According to the BEA, personal consumption expenditures (“PCE”) grew marginally in May. The $2.9 billion rise, on the other hand, represented a gain of less than 0.1 percent. The fact that it represents a 0.4 percent loss in Real PCE cancels out the slight win. The PCE price index gained 0.5 percent for the month, excluding food and energy.
The economy appears to be booming at a breakneck pace, aiming to compensate for the lockdowns of the previous year. As evidenced by the large queues at airports over the Fourth of July weekend, people are returning to travel. United Airlines has announced the purchase of 272 big aircraft from Boeing and Airbus, allowing the airline to sell more First Class and Economy Plus tickets and expand capacity by 30% each flight in the United States by 2026.
While that purchase reflects a revived enthusiasm for travel and leisure, it is also a sign of growing inflation. We must consider all signs, not simply Bitcoin or gold prices. We must keep an eye on the general state of the economy. Airports are busy, restaurants are full, highways are congested, and it appears like most people are paying more for everything.
Everything is active and functioning at full capacity in an overheated economy, as we are experiencing now. Because there isn’t enough infrastructure to handle the demand, everything’s price rises. There is plenty of liquidity and cash on hand, but there isn’t enough productive economic capacity to absorb it all.
Inflationary trends are likely to persist. Because of all the newly produced capital looking for a home in the market, we’ll undoubtedly see more meme stocks and other forms of disruptors. To make the most of these exciting times, investors must be both more cautious and more receptive to new ideas. Keep an eye on things because the return to normal will bring both opportunities and risks to investors./nRead More