— Nov 30, 2021


Little has changed since our update last month.

Inflation continues to rise and the central bankers base position of it being transitory is now clearly suspect.

It is not just short term central bank forecasting that is at stake here; if they get this wrong it may spell the end of the era of influence by central bankers around the world. Politicians will of course need scapegoats and the folly of keeping interest rates where they currently are will be fully exposed.

By introducing (i.e. printing) so much money over the past decade the central banks have ensured that the world is awash with excess cash. This means capital has little value to banks and other savings institutions and therefore they do not need to offer any interest rate to attract it as they would in normal times (before QE).

This removes a central tenet of capitalism, savings. Savings being invested /deployed to those who need it via capital markets is the way capitalism is supposed to work. If people are encouraged to spend rather than save then this has serious implications for capitalism as a whole.

The usual way this has been resolved in the past is creative destruction. Recessions and market crashes get rid of uneconomical ‘zombie‘ businesses and so capital is allocated more efficiently to those businesses that can grow in the future. Economic Darwinism if you like; survival of the fittest.

However the Federal Reserve’s monetary policies have kicked this particular can down the road so many times that all the excess money has continued to find its way into financial assets and other alternative forms of investment. Classic cars, art, stock markets, property, wine etc have all substantially risen in price as a consequence of this excess liquidity.

This has distorted markets and the mechanism of price discovery (ascertaining the true value of an asset) and has massively increased the wealth gap between the rich and the poor.

When there is an excess of capital in the system then the solution is for capital to be destroyed. This is usually achieved through a long grinding bear market like 2000-2003, though higher rates of inflation also help.

The timing of such resolutions is always the hard part. We obviously have inflation running ahead of central bank expectations and starting to destroy capital but when the second leg will emerge is unknowable. We continue to be cautious and ready to move further into lower risk assets and cash if markets deteriorate further.