Fund manager Tim Davies was one of the first guests on my Fat Tail Investment Podcast. He just popped up unexpectedly at my Saturday breakfast — in The Weekend Australian.
Tim wrote a cracking piece explaining why the central banks will be very quickly walking back the interest rate rises and tough talk on inflation.
It’s an easy case to understand too. There’s simply too much sovereign debt in the world to tolerate higher rates.
Central bankers have a choice: crashing the asset markets and the economy with higher rates or find some other way to deal with the current situation.
They’ll find another way, which will involve financial repression in some form.
Here’s the problem no one wants to address…
We all like to live in a collective fantasy where asset prices rise, and wages are good, but the government can run financial deficits endlessly to pay for everything from healthcare to Ukraine handouts, to first home buyer grants, to subsidising the arts during COVID, to transgender studies.
All these things need to be paid for. But they aren’t, really. They are merely financed with borrowed money.
You only need to look at Sri Lanka to see where that can lead a country. It barely has enough foreign exchange to pay for crude oil or medical imports.
The government in turn prints money to pay for the public service staff, which is driving the basics of rice and cooking oil through the roof.
Australia is not immune to this basic dynamic. Almost all our foreign exchange is earnt through the sale of iron ore, coal, and natural gas — three sectors that are hardly going to be the driving force of the 21st century.
The times are good now, but we are on a borrowed bounty. And we still have a trillion-dollar deficit and more to come!
Each government, Liberal or Labor, craps on about getting the budget back in balance, and then proceeds to meet the reality that voters like their free lunch and don’t want it taken away from them.
And even if the federal government could get a handle on it all, the state governments run their own shambolic finances.
It’s absurd.
But it’s OK! We now have Modern Monetary Theory to justify all this! ‘Deficits don’t matter’, they say. They also add that as an accounting exercise, public debt is a private asset. One wonders what those holding Sir Lankan debt think about that point.
To be fair, some of their basic tenets are true. A sovereign nation can use its currency created at will to finance whatever it likes. A government bond is a private asset.
But most government spending is squandered on non-productive behaviour, not investment for the future.
The MMT crowd also love to point to Japan, too, as an example of how a government can run endless financial deficits and not generate inflation.
They ignore the collapse in Japanese bank credit creation simultaneously that allowed this to happen.
Japanese debt-to-GDP is well over 200%. The central bank owns a staggering 50% of the entire government bond market.
They do this to pin down interest rates. The Japanese Government cannot pay all the interest on such debt at normal market rates.
That’s the future of the West too.
The Japanese yen is down quite badly this year. And no wonder. Japan has a printing press, but it doesn’t have natural resources, and they’re scarce right now and at a high cost.
Japan can print as much yen as it likes, but markets aren’t stupid. They’ll demand more of them for each hard barrel of oil or tonne of wheat.
The net result is a higher cost of living for the Japanese people as the yen declines. Compare that to the Russian ruble, which is up this year, because Russia at least has huge reserves of natural resources.
This hidden asset backing also underpins the US dollar via the petrodollar. The question is: what happens when hydrocarbons are undercut from the world economy via the oncoming freight train of renewable energy?
The US Government has an equally ridiculous US$30 trillion in debt and deficits.
Suffice to say, the fiat currencies of the West can’t hold the system together without further central bank intervention.
We’re going to get — at least in my book — negative real interest rates as they pin down rates and allow inflation to run higher.
This is one reason I find the notion of a real estate collapse absurd right now. Property is a hedge against this dynamic.
Once this situation becomes apparent, the overarching investment goal will be to get out of cash and into hard assets.
It’s also why I don’t think you should give up on physical gold or Bitcoin [BTC] yet either.
And why corporates that rely on commodities for their inputs — like carmakers — can use underpriced debt to acquire real assets inflating in value. For more on that, go here.
Regards,
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Callum Newman,
Editor, The Daily Reckoning Australia
