Insights for advisers, by advisers

Capacity constraints, not money printing, are real inflation threat


The Inside Network welcomed financial advisers, asset consultants, and family offices from around the globe for its first Equities and Growth Assets Symposium this year. At a packed-out event, some of the brightest minds collaborated and discussed the challenges and opportunities in equity markets at a time when the world is seen to be entering uncharted territory.

The first speaker was Professor William Mitchell from the University of Newcastle, who coined the term “Modern Monetary Theory.” Mitchell gave his insight into the evolution of fiscal and monetary policy and what it means for investors. He also gave his pragmatic view on inflation.

Mitchell began with a direct statement relating to inflation, that caught everyone’s attention; “the mainstream narrative is incorrect.” The inflation scare-mongering simply doesn’t match reality, he said. According to Forbes, the “2021 inflation scare is another series of false alarms going back several decades.” Inflation is near a decade-low and well below the 2% level the US Federal Reserve is targeting. The conditions for rising inflation, such as a expectations of rising prices and tight job markets, are totally absent. It’s more a case of investors fearing the fear of inflation itself, Mitchell said.

In Japan, interest rates bottomed decades ago and investors are not fearful of inflation, but rather deflation. Japan’s economy is a great example. It’s no secret that Japan has an eye-watering amount of public debt that is about twice the size of the country’s gross domestic product, and it’s tipped to rise thanks to the coronavirus pandemic. The Bank of Japan has been buying up Government debt since early 2000.

This fiscal year alone, the issuance of new Japanese government bonds (JGBs) will be about ¥112 trillion ($1.34 trillion) — the highest-ever, and more than double the previous record of ¥52 trillion seen in fiscal 2009, when the global financial crisis hit the country. Japan’s total debt is set to exceed 220% of GDP with longer-dated maturities still outstanding.

Markets were doing a Chicken Little impersonation, said Mitchell, screaming “all hell will break loose – yields will rise, and the Government will be insolvent in months.” But this never eventuated. What happened was that the Bank of Japan held interest rates at zero for decades. In fact, Bank of Japan Governor Haruhiko Kuroda recently hinted that the central bank would continue its negative interest rate policy after 2023.

And guess what? There was no inflation despite all the brouhaha. On the contrary, the central bank has been fighting deflation and has kept rates on zero for quite some time. Mitchell explained that inflation is a function of reduced supply. He highlighted an example of a “widow-maker” trade in which a group of young bond traders tried to make their names by selling-short bond yields. They’ve consistently lost billions. What they didn’t learn, Mitchell contended, is that the central bank can control yields for as long as it wants and how it want.

Mitchell’s main message is that “Bond markets can play only if the Government wants them to play.”

And there’s a lot of truth to his statement. The Federal Reserve, for example, has the tools and power to control inflation when and where necessary; even if that means holding rates at zero until employment goes up. Mitchell dismissed the “fictional world” that paints a ridiculous picture of central-bank bond-buying equating to Zimbabwe’s hyperinflation.  Mitchell explained the main reason for hyperinflation in that country was a collapse in the supply side. Nothing else. “What’s going on with fiscal deficits has nothing to do with ‘printing money.’ This is just a throwaway term. Nevertheless, much of the media still spins a good story using Venezuela and Zimbabwe as examples of hyper-inflation. However, these aren’t valid ways to show real inflation.”

What our economy is really up against, he said, is a real resource constraint. Mitchell finished his talk by saying, “if we spend too much, it places negative pressure on prices. With a 13% labour utilisation rate in Australia, there is massive under-capacity.

“One thing there is not is any hint of inflationary pressures. There simply are no structural forces from which one can conclude that there are any inflationary threats at all,” he emphasised.

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