Inflation, Interest Rates & Financial Represion
Posted: Wed Jan 13, 2021 1:17 am
I wanted to start a discussion about these topics because of the era we are living in and the actions that it looks like governments around the world will need to take. I'll start by defining some terms, giving some official stats, state some assumptions and lay out a couple of arguments to see if people agree with my research or not.
Inflation
- CPI inflation is a measure of consumer price inflation based on a basket of goods with "hedonic adjustments". Current CPI: 1.6%
- Asset Price Inflation - inflation in financial assets such as stocks and bonds. 15% return on SPY in 2020, 29% return in 2019.
- CPI is widely believed to be slightly under-reported for various reasons. I personally believe it could be more like 3-5% based on things like the Big Mac Index and my own experiences with actual price increases in the US.
- Some economists believe true inflation should be measured and looked for only in commodity prices and that it can take years to filter down into measured CPI.
Interest Rates
- The federal funds rate is the rate at which institutions lend to each other overnight. Current rate: 0.09% (basically zero)
- USA 10 year treasury bonds (UST 10 YR) currently sits at 1.22%
- JPN 10 year government bonds - yield is 0.027%
- German Bund 10 year rate - yield is -0.477% (yes it is negative)
Real Rates
In the USA these are negative (same with Germany). That means you get paid back less in purchasing power for the dollars you lend.
- The actual rate accounting for inflation
- US CPI is 1.6%, and US Treasuries are 1.22% so that would be a negative 0.38% rate of return in real purchasing power
- German inflation is -0.3%. German 10yr treasuries are -0.477%, so they have a negative 0.177% rate of real return in purchasing power.
- It looks like Japan is basically flat or has slightly positive real rates depending on where you look.
Debt / GDP Ratios
- Current US Debt to GDP ratio: 127% (https://fred.stlouisfed.org/series/GFDEGDQ188S)
- Current Japanese Debt to GDP Ratio: 236%
- Germany: 73%
- UK: 100.9%
Financial Repression
These would be measures where governments channel funds from private industry to pay down public debt. Article: https://www.investopedia.com/terms/f/fi ... ession.asp
Features of financial repression
- caps on interest rates (these create negative real yields on assets like bonds)
- government intervention with banks
- direct government lending to specific industries
Where this ends up going
I've been reading a lot of articles and listening to a lot of podcasts put out by folks like Russel Napier, Grant Williams, Brent Johnson and Erik Townsend. It seems that people are having a hard time agreeing on whether or not we are going to have a deflationary or inflation environment in the near term (in terms of CPI), but I believe that most of them agree we will probably get negative real rates and financial repression for some years to come.
One era folks are comparing this to is the post WWII era where there was a lot of inflation, and very negative real rates (nominal interest rates were pegged lower) and the very high public debts were effectively inflated away. This came at the expense of bond holders in terms of purchasing power.
The fed appears to be doing what it can to both hold rates down and foster some inflation. They seem to be accommodative to "helicopter money" in the form of stimulus checks and direct grants to businesses. They seem to be doing QE aggressively and expanding their balance sheets to prop up asset prices, keep bond yields low, and credit flowing freely.
Russel Napier is predicting we get 4% measured CPI inflation sometime this year and deeply negative real rates. I believe he was also expecting both yield curve control (central banks buy long dated bonds to suppress rates) and possibly even US treasury bonds going negative.
https://themarket.ch/interview/russell- ... nt-ld.2323
Portfolio constructions
It goes without saying you want to own no bonds in this environment. You want things that do well with negative rates like precious metals, and you want stocks that will do well with mild inflation. Here is my personal portfolio construction:
- 20% precious metals & miners
- 20% bitcoin
- 10% cash
- 50% equity (pretty evenly split between US, emerging markets, and developed markets, some REITs, some mining stocks, tech stocks, etc)
What do you think?
Do you see any problems with this scenario? What moves are you making? Is my portfolio totally stupid? What do you think the world will look like 2 years from now, 5 years from now, and 10 years from now?
One difference we have today is that private corporations and consumer debt is also very high. Another difference we have is that pension systems are heavily invested in bonds and our current demographics mean there are many older savers depending on yields on e.g. bonds. We also seem to be in an "everything bubble". Also, if inflation is under-reported that means real rates are even more negative right now.
How does this all play out?
Inflation
- CPI inflation is a measure of consumer price inflation based on a basket of goods with "hedonic adjustments". Current CPI: 1.6%
- Asset Price Inflation - inflation in financial assets such as stocks and bonds. 15% return on SPY in 2020, 29% return in 2019.
- CPI is widely believed to be slightly under-reported for various reasons. I personally believe it could be more like 3-5% based on things like the Big Mac Index and my own experiences with actual price increases in the US.
- Some economists believe true inflation should be measured and looked for only in commodity prices and that it can take years to filter down into measured CPI.
Interest Rates
- The federal funds rate is the rate at which institutions lend to each other overnight. Current rate: 0.09% (basically zero)
- USA 10 year treasury bonds (UST 10 YR) currently sits at 1.22%
- JPN 10 year government bonds - yield is 0.027%
- German Bund 10 year rate - yield is -0.477% (yes it is negative)
Real Rates
In the USA these are negative (same with Germany). That means you get paid back less in purchasing power for the dollars you lend.
- The actual rate accounting for inflation
- US CPI is 1.6%, and US Treasuries are 1.22% so that would be a negative 0.38% rate of return in real purchasing power
- German inflation is -0.3%. German 10yr treasuries are -0.477%, so they have a negative 0.177% rate of real return in purchasing power.
- It looks like Japan is basically flat or has slightly positive real rates depending on where you look.
Debt / GDP Ratios
- Current US Debt to GDP ratio: 127% (https://fred.stlouisfed.org/series/GFDEGDQ188S)
- Current Japanese Debt to GDP Ratio: 236%
- Germany: 73%
- UK: 100.9%
Financial Repression
These would be measures where governments channel funds from private industry to pay down public debt. Article: https://www.investopedia.com/terms/f/fi ... ession.asp
Features of financial repression
- caps on interest rates (these create negative real yields on assets like bonds)
- government intervention with banks
- direct government lending to specific industries
Where this ends up going
I've been reading a lot of articles and listening to a lot of podcasts put out by folks like Russel Napier, Grant Williams, Brent Johnson and Erik Townsend. It seems that people are having a hard time agreeing on whether or not we are going to have a deflationary or inflation environment in the near term (in terms of CPI), but I believe that most of them agree we will probably get negative real rates and financial repression for some years to come.
One era folks are comparing this to is the post WWII era where there was a lot of inflation, and very negative real rates (nominal interest rates were pegged lower) and the very high public debts were effectively inflated away. This came at the expense of bond holders in terms of purchasing power.
The fed appears to be doing what it can to both hold rates down and foster some inflation. They seem to be accommodative to "helicopter money" in the form of stimulus checks and direct grants to businesses. They seem to be doing QE aggressively and expanding their balance sheets to prop up asset prices, keep bond yields low, and credit flowing freely.
Russel Napier is predicting we get 4% measured CPI inflation sometime this year and deeply negative real rates. I believe he was also expecting both yield curve control (central banks buy long dated bonds to suppress rates) and possibly even US treasury bonds going negative.
https://themarket.ch/interview/russell- ... nt-ld.2323
Portfolio constructions
It goes without saying you want to own no bonds in this environment. You want things that do well with negative rates like precious metals, and you want stocks that will do well with mild inflation. Here is my personal portfolio construction:
- 20% precious metals & miners
- 20% bitcoin
- 10% cash
- 50% equity (pretty evenly split between US, emerging markets, and developed markets, some REITs, some mining stocks, tech stocks, etc)
What do you think?
Do you see any problems with this scenario? What moves are you making? Is my portfolio totally stupid? What do you think the world will look like 2 years from now, 5 years from now, and 10 years from now?
One difference we have today is that private corporations and consumer debt is also very high. Another difference we have is that pension systems are heavily invested in bonds and our current demographics mean there are many older savers depending on yields on e.g. bonds. We also seem to be in an "everything bubble". Also, if inflation is under-reported that means real rates are even more negative right now.
How does this all play out?