Joye: Ware the inflation wrecking ball

Another nice piece today from Chris Joye on the bizarro world of ZIRP in which we find ourselves:

By fiddling with risk-free rates, governments can manipulate all asset prices, which is tempting when politicians are searching for short-term wins. So in addition to lowering overnight cash rates to levels never seen before – they are near zero or negative in America and Europe – central banks have printed more than $10 trillion of fresh money to buy government bonds of all maturities.

Beyond artificially inflating bond prices, lowering risk-free rates and boosting asset prices, this also conveniently cuts sovereign debt servicing costs, which perversely only encourages governments to leverage up more.

Two of the most important questions for portfolio construction today are how savage the adjustment will be when governments withdraw from wholesale market manipulation and what could trigger this event

…The trigger will probably be the return of wage inflation in the US and China feeding into global prices. I suspect central banks will get behind the curve and allow history to repeat itself with our own 21st-century Volcker moment.

One day, sure. But not this cycle, and perhaps not the next, either. The lesson to bear in mind is that of Japan. The world has a vast dearth of demand, or a an oversupply of production, depending upon your perspective. Capital circulates much more easily than labour, arbitraging the entire planet to keep costs down, most of the Western world and China are sinking into a demographic mire, we’ve just installed several decades worth of global commodity capacity and then there is the huge global debt overhang.

These are structural headwinds to inflation that will last decades. Central banks and governments will try and even succeed briefly to reflate but the downtrend for prices and yields is set.

Given there will be no interest rate “normalisation” in post-crisis economies, inflated financial asset prices (equity and bonds) are the rational new norm, not necessarily “irrational” or “bubbles”.

Ironically, the same cannot be said for the assets in those economies yet to make the adjustment to the widening deflationary circumstance.


  1. “Ironically, the same cannot be said for the assets in those economies yet to make the adjustment to the widening deflationary circumstance.”

    You mean Real Estate?

  2. Totally disagree. You are commenting on the symptoms of previous governance failures which have resulted through an unfettered pandering to the corporate class as consequence of the apotheosis of trickle down economics.

    This false paradigm is now becoming clear and a new global narrative is permeating the media / political and commentary of our societies.

    The abject refusal to accept the insidious attack on the working class and poor thinly viewed as austerity by the incumbent LNP is clear and concise evidence of this paradigm shift.

    The truth is that the absolute dedication to corporate welfare and almost ubiquitous punishment of voters / consumers is finished. Governments around the world are becoming aware of this, and those that aren’t will simply be replaced.

    Greece is a tipping point. And make no mistake the UK, France, Spain, Portugal are all about to join them. The US has had a respite through cooking the books (as has Australia), however the thing which saved them, the shale boom, is about to collapse.

    The response is going to be a shift away from corporate compliance, A.K.A. fascism, towards democracy.

    The cost of living all over the world has reduced the entire western middle class to subsistence living. Week to week treading water barely keeping afloat with the only genuine sense of wealth from an inflated house price which they will never realise any capital.

    Inflationary figures like employment figures are entirely bogus. Totally cooked. The COST OF LIVING now requires TWO full time top end wages and even then a life time of debt servicing will not see the burden resolved. Only 40 years ago a single middle to low income earner could buy a house, university, health, educate three children and retire at 60 debt free having paid off their house in 10-15 years.

    Good income earners are struggling to balance food, utilities, mortgage, health, education on a weekly basis frequently having to chose between them. Debts are for life with many facing the prospect of never paying off their mortgages.

    There is simply no choice, none. Western societies are either responding to the corporate usurping – Iceland, Greece, US (tax on foreign corporate wealth), China anti-corruption, or they are steadfastly refusing and their economies are spiralling into the abyss – Canada, Australia, UK.

    As even Macrobusiness has stated – it will only take a single economic shock to push the Australian, and world, into a new global crisis – and that crisis is absolutely coming in many different vectors – most probably shale oil collapses leading to credit problems and a resurgent oil price.

    INFLATION is an absolutely IRRELEVANT METRIC as is UNEMPLOYMENT. As Matt Taibbi, Krugman, Stiglitz and others so frequently extolled – the danger the world is facing is a corruption of reliable, honest information and data.

    Looking at inflation instead of real costs of living is the most insidious, ridiculous economic folly of the 21st century. The wholesale attack on the politics of data, the ABS and those who speak to the truth will be our very undoing.

    The Republican / Conservative war on science and truth is fundamentally a war on anything and everything which does not merely stand its its way, not even not an obstacle, but a war on anything which is not actively assisting it in its self serving myopic vision.

    • Well said.

      A crime of epic proportions was committed in 1998 when ABS removed land prices from CPI, removing any relevance to the household expenditure except to those that have “made it”.

      • ErmingtonPlumbingMEMBER

        Yes Andy

        It was disgraceful to remove land prices from the CPI when so much disposable income is dedicated to servicing real estate debt,…… had that not happened our housing affordability and capital misallocation problems wouldn’t be half as bad now.

        And @ Lev

        Great post brother. Tell me what did you think of that link the other day, the Yanis Varoufakis erratic Marxist piece and the point that he makes about how unfettered capitalism is destined to destroy it self with out a populace, politically hostile to capitalist goals!

        Yanis on Marx……..” When he portrayed capital as a “… force we must submit to … it develops a cosmopolitan, universal energy which breaks through every limit and every bond and posts itself as the only policy, the only universality the only limit and the only bond”, he was highlighting the reality that labour can be purchased by liquid capital (ie money), in its commodity form, but that it will always carry with it a will hostile to the capitalist buyer. But Marx was not just making a psychological, philosophical or political statement. He was, rather, supplying a remarkable analysis of why the moment that labour (as an unquantifiable activity) sheds this hostility, it becomes sterile, incapable of producing value.”

      • Ermington Plumbing, being in London presently, I had the pleasure of reading the Erratic Marxist in newspaper form. It’s a very fine newspaper, The Guardian. I was disappointed with The Times I must say, Rupert has ruined that. I was astounded at the stories of petty crime as far as up as page four and five while major stories about the social housing crisis was back on page 21. And the Daily Telegraph is also in trouble, just look up the resignation of Peter Oborne this week to see what has happened to that once fine journal. The Guardian and The Financial Times remain as quality newsprint. I will buy a copy of The Independent this weekend and assess that.

    • Amen to that.

      I jut hope you are right re. “shift away from corporate compliance, A.K.A. fascism, towards democracy”.

      Sadly I have my doubts the worm is really turning

    • Fine words indeed Leviathan. I am surprised you didn’t title your rant “Workers of the world, unite”. How you could write a précis on the demise of western economies and not mention the word “welfare” once, is a literary tour de force.

  3. If interest rates stay low long term as seems likely, then it follows that there will be a viable case for further investment in capital intensive production at lower margins – thereby adding to the oversupply of goods and hence adding to deflationary forces. Such a shift would also be at the expense of new jobs so that demand would stay soft.

  4. Part of me suspects that many of these inflationistas genuinely pine for it. You get the impression that inflation is seen as the righteous punishment for monetary profligacy. And as any zealot will tell you, if a punishment is righteous it will be meted out in the end.

    What is the case for sustained wage gains in the US? If wages start to move, the Fed will hike and the dollar will soar, compounding the appreciation in the real exchange rate. As you note David, this will drive capital elsewhere and growth in output will stagnate/fall in the US and rise outside the US, pushing out the current account deficit, yet again. As anyone who hasn’t had their head up their Pitchfordian ass for the past decade can attest, this state of affairs can only be maintained by credit bubbles in the US, and even then only temporarily.

    We’re in an ice age, folks. Th global economy has problems; inflation is not one of them.

    • The whole idea is to cause the present deflation with ZIRP, in order to have the excuse to purposely produce inflation to cut the real value of debt by two-thirds.
      To see how that works, check the RBA inflation calculator by punching in 1973 to 1983.

      • No way Andy….everything is too manipulated to be able to make any serious investment judgement other than conservation of capital…precious metals for me.

  5. “Given there will be no interest rate “normalisation” in post-crisis economies, inflated financial asset prices (equity and bonds) are the rational new norm, not necessarily “irrational” or “bubbles”.”

    Permanently high plateau?

    If/when EM goes POP – USD shoots higher and AUD goes to 50c – you can say goodbye to either cheap interest rates or the low inflation fantasy

    You cant have both forever – some economies aren’t going to have the luxury of the ‘Reserve Currency’.

    I understand your call too regarding deflation being exported from emerging markets.

    But having just returned from my recent travels around Vietnam and China I can only say that things have been getting decisively more expensive (off a very low base) even over the last 12 months.

    The Central Banks are pushing hard as hell to create inflation – I am in the camp that says they succeed beyond their wildest dreams – eventually…

  6. Returns go to the wealthiest who:

    a) have a low propensity to consume themselves; and

    b) are reluctant to invest because no-one else has the income to buy the additional output they would create.

    The solution is a Piketty-style global wealth tax which would redistribute from those with low propensity to consume to those with high propensity to consume.

    However, that assumes that those in control wish to see overall growth.

    From a positional/relative status perspective, why would they care if there is never any more growth. As long as they are at the top of the pile (and reasonably comfortable) it matters not that everything is stagnating.

    That is how the human race existed for millennia.

    The modern idea of continuous growth is just that – modern!!

    • Even StevenMEMBER

      I think this is the first time I’ve fully understood one of your posts, Stephen. And oh yes – I agree.

  7. For me the problem is that Assets are not priced in a vacuum it’s all comparative pricing based on net-free-cash-flow and risk. So if Equities are too highly priced then someone somewhere will create even more competition (and with it more Equity style assets), which is the last thing we really need in a demand deficit situation, but it’s logically what you do with ZIRP capital.

    Even the Aussie oligopolies like Coles/Woolies are vulnerable to competition as Aldi is showing us so It really all comes down to the confidence fairy. New business creation starts with a trickle and if successful grows to a torrent…its this torrent of new business that absorbs the worlds excess capital and feedback to consumer sentiment to create positive interest rates.

    Where technology is creating / removing historical advantage we’re seeing new businesses decimate the monopolies of old, Uber is an example of this as is PV solar for residential electricity.

    • Totally agree

      This whole notion of low rates = high PEs is simplistic nonsense

      The PE paid should represent the risk of you getting your money back and the potential size of the payoff.

      Woolworths case in point. People were paying far too much for WOW (treating it like a bond, the yield went sub 4%) and now they’ve lost 20%+ of their capital.

      Further, if the ZIRP exists because demand is stuffed – PEs should be lower/not higher.

      Finally, if ZIRP is creating systemic risks PEs should be lower again.

      Potential for Australian credit bust vs banks trading at all time high PEs, anyone?

      Three years ago a certain investment bank had a very logical (and empirical) graph identifying the historic relationship between rates and PEs.

      It was an upside down smile.

      Punters have thrown this logic out the window now and forgotten equity risk in the stretch for yield.

      Equities are a claim on a very long stream of potential cashflows and their yields should be discounted accordingly.

      This is not currently occurring and the cheerleading is sickening from people that should know better.

      • Even StevenMEMBER

        88888, ‘simplistic nonsense’, eh? Well simplistic it may be, but that IS how assets are priced. Low rates DO push people out the risk spectrum, irrespective of whether you think them simplistic or not.

        I’m no cheerleader. I’m a realist. All else equal, lower risk free rates makes other assets more valuable in comparison. Including equities.

        That does not mean to say the present level of PEs are justified. It could be as you say that the outlook is precarious and equities are going to take a spanking when it goes bad. But as I said, all else equal, lower risk free rates means higher PEs are justified in their own right.

      • I’ve said this before – what are my shares in Zurich doing trading sub infinity?

        I know your textbook / ib pitch book says they are negatively correlated.

        But my argunent is that they have no relevance under extremes.

        Think about it logically – this activity in markets is pushing the valuation of a stream of cash flows higher as the Central Banks are telling you that stream of cash flows is going to become harder to achieve.

        PTM the high PE zero growth stock to get smoked today

        Yesterday it was IIN

        Justifying high PEs in the USA today as EPS estimates have actually gone negative is yet another sign of a top or sell side hope.

        Then again – the NASDAQ and Russell valuation metrics went beyond anything but hope some time ago.

        I’d love to see a liSt of companies that were capped above $10 bn with a PE of 60 plus that actually went to $25 bn and sustained it for five/ten years.

        I dare say it would prove the odds of paying to see the river card here as a bad bet.

        ZIRP or not…

      • Even StevenMEMBER

        You said:

        “Think about it logically – this activity in markets is pushing the valuation of a stream of cash flows higher as the Central Banks are telling you that stream of cash flows is going to become harder to achieve.”

        I say:

        You’ve got the wrong end of the stick. Central Banks are artificially depressing yields in HOPES of stimulating economic activity (in other words to make those cash flows easier to achieve in future). The key word is ‘artificial’.

        Even though long term market yields are indicating we are entering a long term low inflation, low growth environment (consistent with your argument), at least some of this is due to CB action on the short end, which is artificial, and therefore not an unbiased indicator of ‘cash flows being harder to secure in future’. Yes, being artificial, I am aware a reversal of the CB’s position on rates will have a correspondingly adverse effect on valuations. But in the meantime PEs should experience modest expansion relative to their previous levels.

        Your argument essentially boils down to ‘company earnings will decline, and keep declining whilst yields remain low’. I disagree.

      • My argument boils down to:

        You are paying too much for already goosed earnings and your payoff is asymmetrical. I hate those bets.

        Yields are globally artificially compressed across the curve – not just the short end.

        Marginal buyers in many equities are a result of financial repression – I am happy to bet against that crowd rather than try and front run their flows.

        I am lucky to not be forced to play – I choose to play when the payoff appears in my favour.

      • 88888,
        I reckon that’s true. Low rates = higher valuations is completely simplistic and actually empirically wrong. Since 08, lower bond yields have not meant higher valuations. US equities have fallen whenever bond yields have fallen (generally). On the other hand, higher expected inflation has lead to higher valuations. to my mind what matters is why bond yields are falling. If bond yields are falling because expected nominal earnings are falling, then valuations should worsen (because discount rates are constrained by ZIRP). If bond yields fall despite no change in expected nominal earnings, say because Yellen or Stevens become more dovish, valuations should improve. So what really matters is the psychology of the CB. Are they cutting because they are pessimistic – in other worlds revising down expected future cash flows of corporates like CBA – or are they cutting because they are in a better mood?

      • I liked reading the back and forth on yield vs equity prices and the “logic” behind the arguments. Let me throw another curve ball by suggesting that this whole post GFC economic @#$%up has occurred because it is now undeniable that China will surpass the US in GDP terms and this reality is shaping equity and bond prices, the various western QE’s are just the process by which business valuations in $USD terms are somewhat maintained/inflated so that the plebs can enjoy the wealth effect and WS can get one last taste of the gravy train before the inevitable equity devaluations take place. In this sense we’re not seeing new US businesses created because everyone secretly knows that the endeavor is pointless, hence we have sky high P/E without new asset creation….it’s all due to us entering the China time warp.

    • CB,

      Where did you get the idea that the technology of PV solar has changed?

      The technology of PV solar has been around for many decades, it is a relatively mature technology and has been for the last decade or longer.

      What has changed is the subsidies that have been paid, the energy source to manufacture them and the shifting of goal posts to support the installation of Solar PVs. The price of PV panels have only dropped significantly because of the enormous subsidies that a particular government has given to its PV manufacturers and the fact that cheap (and dirty) coal is the main energy source used to produce them in that country. Secondly governments, in developed countries like Australia, have provided large subsides to help pay for installation. And finally is the pretence (as evidenced by paying a retail electricity price for the power produced by a solar PV system) that PV solar doesn’t use the power grid when in fact every cycle, 50 times a second, the PV system uses the grid to import power and then export power to help provide a suitable power supply to an unappreciative PV Solar system owner.

      • Sorry I’m a bit late replying I had a rather busy night.

        Wrt PV solar: It’s not particularly new technology except in the sense that the Price point has dropped below $1/W. At this price electricity produced by Solar costs somewhere between 8c and 12c/kwh. Now that’s whats new. Over the period 2004 to 2011 Residential Electricity prices about doubled and PV generated electricity costs reduced to 1/3 combined they result in a factor of about 6 change in the relative cost of PV vs residential grid electricity. Now that change is massive. BTW in the costs I’m mentioning I’m ignoring all the Australian subsidies (I’m not ignoring Chinese subsidies because they usually take the form of land and sometimes building grants so they’re very opaque) To some extent I’m also ignoring the downward cost pressure that was created by the Chinese over building of PV manufacturing plants. So admittedly there are a couple of subsidies (investor and govt) hidden in the costs.

        At the moment it’s true that PV’s excess electricity get exported to the gird and that without that export facility PV would be practically worthless technology, however that is changing and changing rapidly. About 3 years ago I priced a suitable battery system to go completely off-grid the cost (per kwh_cycle) was about 35c to 40c and used lead acid battery technology. Today I can get much better reliability from LI polymer batteries at a storage cost of about 20c per kwh_cycle.

        Combining low cost PV, west facing PV and battery storage can deliver an all up cost of sub 40c/kwh which is actually less than grid electricity when connection charges are added and divided by the actual electricity used. Last I looked regonal Australia was paying 34c/kwh and about $1.50 per day connection charge. Do the math and you get an all up grid cost of about 50c/kwh.

        This is why I’m saying that the grid monopoly over played their hand (by over pricing their product) and technology took advantage of the situation to create a cheaper “equivalent” alternative. PV in this sense is parallel infrastructure investment that only serves to devalue the grid infrastructure the cheaper it gets the less valuable the grid connection monopoly becomes…taken to the limit this results in a death spiral for grid providers, as a result it’s highly likely that we’ll see legislative changes that compel residences to pay for grid connection irrespective of their desire to connect. This goes to the heart of Australia’s problem of legally locking in monopoly inefficiency (Taxis being an excellent example, Airport is another and toll roads is a third).

        BTW: If the grid overplays their hand there is nothing to stop residential customers throwing a cable over the fence so that my cheap excess PV gets sold to my neighbor. I guess its even possible that greenfield developments could include a parallel local grid for PV power “sharing” all technically possible.

      • CB interesting.

        So, again, it comes down to cracking the commodity, plug and play, storage problem.

        Once that is done, it’s goodnight Irene for the grid providers (for residential and possibly SME)

        I only need 7 days storage here, 14 possible (East Coast low event coverage)

      • @tmarsh

        It’s a lot more complex then that because the true value of the Grid is that it can provide as much electricity as the consumer could possibly want. On a very hot day in Jan it’s not uncommon for McMansions in western Sydney to consume over 100Kwh of electricity 90% of this will be consumed by their AC in an attempt to keep the house cool. This so called “absolute peak” load and is what accounts for most of the grid upgrades over the last few years. These upgrades ensure that everyone can suck this much electricity without the wires simply fusing.

        Ok so if you install say a 6Kw PV system (that’s a big system), on this same hot day in Jan you might generate 30Kwh of electricity, if you’re lucky, however there is no way known that you’ll get anywhere near 100Kwh. If you want the same house temperature then you’ll need to have about 4 times the AC / house energy efficiency of the typical McMansion. Doubling the AC efficiency is easy if you have a good heat sink (such as geothermal system) and doubling the insulation is also possible but both of these changes are necessary if you want to be able to go off-grid.

        What I find most interesting is that with only these changes in building insulation codes and some limitations on low efficiency AC, most of the recent Grid upgrades would be completely unnecessary. I find it amazing that we argued endlessly about Carbon tax but failed to take the most basic baby steps to enable consumers to reduce their electricity use. Sure Pink-bats was a scandal but it didn’t need to be!

        Bottom line: if average consumers can modify their needs so that 30Kwh is their absolute peak daily demand then PV + storage becomes a viable off-grid solution for anyone with a sunny roof…maybe this reality is well understood by the electricity industry and is already negatively shaping building efficiency…what do I know

  8. There is now $3.6Trillion of the global debt that is trading at negative interest yields.

    Surely people can see how ridiculous the situation is when interest bearing securities bear no interest?

    Low interest rates in extremis destroy capital and result in deflation.

    • The point is – there is now infinite cash available for corporate needs – none for humans.

      The collapse of civic society into unfettered feudalism is complete. There is no doubt where we now reside.

      Humanity has devolved back into the darkest recesses of history – and all we wait for is the final, inevitable response.

  9. ErmingtonPlumbingMEMBER

    Too much money being gambled and horded in the pretend economy, 10 trillion of QE handed out to the investor class to maintain a “wealth base” most of which will never be spent.

    I say put those “created” trillions into the real economy through free universal education, health, aged and child care.
    That will give, low interest rates and deflation a “real” kick in the arse!

    This should be the ONLY way new money is allowed into the economy, let the free market and capitalism work around that

  10. “central banks have printed more than $10 trillion of fresh money to buy government bonds of all maturities”

    Yes you could look at it this way or you could say instead that the central banks have lent their governments $10 Trillion to spend on government programs. The $10 Trillion that has been injected into the real economy by the governments, circulated once or twice and then been drawn out into the hip pockets of the super wealthy who are not spending it and thereby not re-injecting it back into the economy to circulate again. They are accumulating it in offshore locations, a bit like the Chinese central bank is accumulating US dollars.

  11. The inconvenient reality of the inflationary wrecking ball

    “These sorts of deals show how strong the current interest from overseas buyers is in Australia as a place to live and as a long-term investment hold,” said Curtis. “The catalyst here, which was missing last year, is the weaker Australian dollar.”