GDP is Easy, Financial Markets are Hard
Coming tomorrow--Inflation of What?
I don't know about you, but I find markets today much more complicated than the GDP economy. There, we know that people will one day be vaccinated and go back to work. And we know that people have stuffed a sh!t-ton (technical term) of cash under their mattress and they are going to spend a big chunk of it.
What makes financial markets more opaque today is the warring forces at play; on one side the Fed is fire-hosing money all over the place, which should make prices go up. On the opposite side, everybody has become a speculator (this morning my yellow Labrador, Douglas, tried to hit me up for a margin loan--I told him to come back when he has collateral) and interest rates can't stay down forever.
That’s not good because almost all big economic problems originate in the balance sheet, not the product accounts. No surprise there, we have assets valued today at 15-20 years of GDP. They all have to be owned by somebody—more or less willingly—all of the time. That makes relatively small changes in private asset demand have huge impacts on stock prices, bond prices, property prices, commodity prices, and the prices off everything traded in secondary markets, much of which are good substitutes for the products the durable and capital goods industries are producing every month. To make matters worse, from time to time financial markets freeze up, by which I mean that they switch from a regime where credit is allocated by risk-adjusted returns to a less efficient regime where credit is allocated by non-price rationing.
Today, the big topic is inflation and interest rates, something I have literally been studying for a half century. The talking head community seems to have made done a pirouette from the view that prices will never rise again to giving advice on the “inflation trade.” (#sarcasm). Tomorrow I will write a short piece on what I think is the central issue—inflation of what? Hint, it’s not the CPI that matters.
Dr. John
Great discussion, thank you! Can't wait to read your next post. On CPI, I couldn't agree more. It's not just a discussion on the items within the basket and how they are measured, a much more important discussion might be how it relates to people. Since it's an aggregate measure it affects different parts of society differently. If your paycheck is above $1M per year, do you really care how much you pay for a burger, how much you pay for insurance, college tuition, food, rent? Not really, and housing price inflation works in your favor because you own assets and real estate.
When someone is barely making $15/hour, inflation is real, possibly closer to 10% given the discrepancy between wage increases and the real cost of living. The trend of rich vs poor has been going on even before the last financial crisis but it has accelerated this past year. A good illustration is the disconnect between the stock market and the so-called eye test - the real economy. This sort of disconnect can only last so long. Something has got to give at some point.