Submitted by Lindsay Politi of One River Asset Management
Ghosts of Investments Present
Cold Sweat: “I’m a trader, not an economist,” I said to the PhD, “so you know monetary theory better than I. But I know what it feels like to wake up in a cold sweat when a big trade goes wrong. The extreme confidence that leads traders to super-size a trade flips to abject fear when that conviction wavers and we realize we’re way too big.
Central banks (and numerous large investment strategies) went all-in on secular stagnation. They confidently plowed trillions into the idea. Now they want out and the exit is far smaller than they’d imagined. They lay awake. They’re not controlling the trade anymore; the trade is controlling them.”
Reality:
- Macron thought he had policy options. Reality was quite different. A decade of failed, painful austerity narrowed his tolerable policy options. Whether or not Brussels has heard the message, Macron has: austerity is dead.
- Draghi believed he would have choices. But years of asset purchases and negative rates failed to produce an expansion sufficiently robust to allow for policy normalization. And now the economy is slowing with rates at -0.40%.
- Powell inherited a legacy of choices, consequences. His predecessors left him with mission impossible. Yet he thought the massive tax stimulus had given him policy options. But reality is quite different.
Arguments: Hobson theorized that internationalism is an extension of secular stagnation. Declining domestic demand and capital returns led to a search for new markets. International returns were high due to political risk. So the economic elite lobbied national governments to expand their international influence to secure their foreign investments. Hobson thought the benefits of free trade failed to account for the expense of national governments protecting private investment abroad. Today’s debates about nationalism versus internationalism are old. And historically, a retreat from internationalism has signaled a shift away from secular stagnation.
Relationships: “So QE leads to inflation?” asked the CIO. “Perhaps, but that’s not the interesting relationship,” I said. After 10yrs of these policies, inflation now controls QE. Central banks explicitly or implicitly must respond to inflation, some with little flexibility. So inflation controls their reaction function far more than they control inflation. As they embark on quantitative tightening and the great unwind of the QE bubble, inflation will determine the fate of the $20trln+ central bank balance sheets and, by extension, the path of financial markets. That’s why, over the coming 5-10yrs, inflation will be the most important market variable.
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