Mainstream economists and financial experts warned us early
in 2014 to stay way from bonds because the Fed would raise interest rates and
as everyone knows rising interest rates shoot buckshot-sized holes in bond
portfolios. So most people avoided bonds and piled into stocks. Now we can look
back and see that conventional wisdom was wrong; the Fed did not raise interest
rates; inflation remained tame; and bonds returned about twice the money as stocks.
Now the mainstream has dusted off its forecast of rising
rates and is trying again. Surely this is the year the Fed will raise rates and
kill bonds. After all, the Fed has always raised rates at some point in an
expansion. How can it not raise them in this one?
Sometimes, however, things really are different. One
difference is the lack of inflation. Since WWII, the Fed has responded to
rising consumer price inflation by raising rates. Today, the
nightmare waking sweaty central bankers in the middle of the night worldwide is
deflation.
Europe’s rate of inflation barely floats above zero while
that in the US is just north of one percent. The Wall Street Journal’s Justin
Lahart predicted in the December 18 “Heard on the Street” column that the US CPI
could go negative by the middle of 2015 if current trends continue.
One of the reasons for the lack of inflation has been the
collapse in velocity, calculated as the nominal GDP/M2 ratio. Essentially,
velocity explains changes in GDP that the money supply doesn't. Velocity increases
when people spend money as fast as they get it, and slows when they want to hold on to cash.
Consumers are paying down debt and holding cash because 1) they fear the future; 2) they haven’t been able to save enough to rebuild wealth lost in the latest crisis because the Fed has kept interest rates too low. Businesses aren't investing because of 1) high taxes, 2) draconian regulation and 3) the flood of new regulations coming from D.C. makes planning impossible.
The present looks like the 1970's with a major exception. The fruits of the massive anti-business regulations from the FDR era had rotted into stagflation (high inflation with a stagnant economy) by the 1970's. However, the 70's experienced high inflation because of massive government spending on the Vietnam War and for Johnson's Great Society welfare spending. Today the US government has too much debt and deficit to spend as it did then. Also, that was the decade that destroyed confidence in the Phillips Curve, the idea that greater inflation could produce higher employment, and broke the stranglehold of Keynesian economics.
Without a massive increase in state spending, consumer price inflation will not rise as it did in the 1970's. Our future will be like that of Japan for the past two decades - very low interest rates, high government debt, low inflation and low levels of growth. In addition, the US is likely to experience another recession in 2015. So instead of looking for a rate increase this year, I expect another round of QE to try to resuscitate the collapsing economy. That means the best places to invest this year will probably be bonds and emerging markets.
No comments:
Post a Comment