What Causes Inflation?
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First, an update:
Last year, we at Consilience Asset Management added a Macro-Economic component to our Relative Capital Flow Model*. Using market action, through a process of reverse engineering, we seek to identify which macro-economic climate is being represented in the market at any given time.
This is an important addition to our discipline as central banks across the globe are attempting to unwind decades of monetary expansion. As this unwinding occurs, it could have significant ramifications for the financial market. Thus, there is an increased need to monitor this process and the corresponding macro-economic result.
Below are the ratings of securities in the five scenarios that we are monitoring:
Inflation – Neutral,
Deflation – Neutral,
Stagflation – Neutral,
Recovery – Positive,
Financial Crisis – Neutral.
The above scenarios reflect the current Capital Flow* composite rating of the securities that have historically generated positive returns in the above economic environments.
In addition, our Global Macro Indicators* are as follows for the seven asset classes we invest in for our clients:
Global Equities – Neutral,
Global Bonds – Neutral,
Commodities – Neutral,
Gold – Positive,
U.S. Dollar – Neutral,
Real Estate – Positive,
Cryptocurrencies – Neutral.
Now, to this month’s report:
Over the long term, the price level (inflation) is a reflection of the money supply. The last four years have provided a near-perfect demonstration of that fact.
We can see it by overlaying M2 (the most accurate measure of the stock of money we have) with the price of commodities purchased by producers (which are unchanged in quality and not subjected to government adjustment schemes).
The result shows the direct relationship.
Rates on the 3-month T-Bills declined just as we would expect.
Since the end of the financial crisis, the Federal Reserve has continued to expand the money supply in an effort to engineer a return to higher levels of economic growth. The hope remains that the trillions of dollars spent during the pandemic-driven economic shutdown will turn into lasting organic economic growth.
Although it did little to spark organic economic activity, the problem is that the artificial stimulus created a surge in inflationary pressures, that has outlived the stimulus-related spending benefit.
The problem is that the steps must include dramatic spending cuts, meaning 1 to 2 percent of GDP for starters or about $280–500 billion, which is not even on the table today as this would be suicide for any politician.
Everyone should be worried about the idea of September rate cuts and a re-emergence of monetary stimulus. Of course, everyone would welcome lower rates on mortgages and credit cards. But with that comes a loosening of money aggregates and a genuine risk of restarting the inflationary fires.
This, while the soaring US budget deficit is increasing by $1 trillion every other month… a topic that has become almost taboo in the current political environment, perhaps because neither presidential candidate has any plan or clue how to normalize the trend. But if it’s not addressed and curbed, the US runs the risks of fiscal collapse and the loss of the dollar’s reserve status.
According to the US Treasury Dept., in July US tax revenues were $330.4BN, far below the $573.1BN in government outlays... resulting in a monthly deficit of $243.7BN. This was the second largest July budget deficit on record.
How can the US, which is now $35 trillion in the hole, justify this kind of irresponsible spending? According to recent Federal Reserve and US Treasury reports, interest on US debt is currently the second biggest government outlay at $1.2 trillion. They estimate this will surpass social security and become the single biggest US expense before the end of 2024 at $1.6 trillion…
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