What I find rather fascinating about markets is how at different times investors follow completely different indicators. In the 1970s inflationary environment, investors were captivated by interest rate movements and by consumer price inflation data. Inflation had begun to accelerate in the sixties and reached an initial peak in 1970. Thereafter, there was a slowdown in the rate of inflation until 1972 from where inflation accelerated sharply until the end of 1974. From the 1974 peak, the rate of consumer price inflation was cut in half by the end of 1976. This was followed by a sharp acceleration of inflation until 1980. A similar movement can be observed for interest rates. At the time, investors’ principal concern was inflation and interest rates because it was obvious that rising interest rates would have a negative impact on the valuation of equities. If an investor could invest in safe short-term Treasury bills at 10% or more, why would he buy stocks, which at the time had a dividend yield of approximately 4%??? I also want to make clear that in an inflationary upcycle (as opposed to a disinflationary phase), inflation can recede meaningfully as was the case between 1974 and 1976, which also led to a significant decline in interest rates temporarily. I am mentioning this brief episode in financial history because in the current context we could see that over the next six months or so, the rate of inflation slows down from the current approximately 9% rate and ignite a rally in bonds and equities. But as was the case after 1976, inflation could later accelerate again on the upside and badly disappoint financial asset holders. I would like to add that in the early 1970s, nobody and really nobody expected inflation and interest rates to move up as much as they eventually did in 1979/1980.
After inflation in the US topped out in 1980, a disinflationary cycle followed during which consumer price inflation and interest rates trended down until a few years ago. At the same time, investors’ concerns shifted. Investors’ preoccupation with inflation receded but were replaced by worries about the so-called “Twin Deficits.” The twin deficit investors referred to in the 1980s centered around the rapid increase in the US trade and fiscal deficit, which caused a rapid increase in US government debt. It was accompanied by US dollar strength between 1979 and 1985, a development hardly anyone understood.
In recent years, interventionist central banks have kept interest rates at extremely low levels. Therefore, post the 2008/2009 GFC, investors, strategists, and analysts alike never paid much attention to the growing government debt around the world. If interest rates are at zero, why would anyone ever be concerned about debts? As an economist it is less understandable that the MMT fairytale became an accepted economic theory even among central bankers. After all, had the followers of the Modern Monetary Theory fable just taken 30 minutes of their time to listen to a speech by Milton Friedman in the 1970s about “Myths That Conceal Reality” including the myth of “free lunches,” they would have come to realize that at some point government debts do matter even if the government enjoys the privilege to print money:
Milton Friedman Speaks: Myths That Conceal Reality (B1226) - Full Video - YouTube
Thomas Sowell explained inflation as, “a way to take people's wealth from them without having to openly raise taxes. Inflation is the most universal tax of all.” Furthermore, should a country end up with hyperinflation after it was left for some time in the hands of incompetent MMT “fantasists” then, as Sowell argued, “Hyperinflation can take virtually your entire life's savings, without the government having to bother raising the official tax rate at all.”
But let us not despair. Let us remain optimistic because we all have the good fortune of studying free markets and economics, and as the economist Joan Robinson remarked, “The purpose of studying economics is to learn how not to be deceived by economists.”
With kind regards, and wishing my readers wonderful summer holidays far away from socialists,
I remain
Yours sincerely
Marc Faber
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