Price INflation – Debt DEflation

When you play with fire, you risk getting burnt.

The next few months are going to be some of the most interesting in financial markets for many decades. The Federal Reserve (and other central banks) have printed trillions of dollars, pounds, euros and other currencies in an effort to mitigate the economic lockdown effects of World War C (the global Covid19 flu pandemic). In addition, governments are borrowing and spending like there is no tomorrow, to hell with the consequences. The Fed, especially, wants to see consumer price inflation rise (in its deluded belief that falling consumer prices are “bad”) and is engaging in “average inflation targeting” now, happy to allow consumer price inflation to overshoot its 2% target. (Anyone buying lumber in the last year thinks the Fed can stop wishing for more price inflation.)

This is the main focus for the markets now. Is the rise in consumer price inflation “transitory” as the Fed et al believe, or will there be a structural shift in inflation expectations such as experienced during the 1970s?

High consumer price inflation is often thought as being good for asset prices, like property and metals. Real, physical stuff that should hold its store of value over time. That belief can also apply to the stock market because people think of countries like Argentina and Zimbabwe, where the stock market rocketed higher during bouts of inflation. Milton Friedman said that inflation is always and everywhere a monetary phenomenon. But hyper-inflation, is always and everywhere a political phenomenon. There has to have been a breakdown in society for chaos to reign.

Can that happen in major economies now? We don’t rule anything out, but it still seems a low probability. If, and it still is a big if, consumer price inflation is to take hold in Europe and the U.S., it is much more likely to be a throwback to the 1970s variety. 5%, 10% per annum, rather than 1,000,000%.

The idea of “inflating away debt” is that if consumer prices are increasingly rapidly, nominal Gross Domestic Product increases and, therefore, the debt burden shrinks in relative terms.

However, high (but not hyper) consumer price inflation is not good news for asset prices like stocks. The bond market, which effectively rules everything, will see to it that yields rise, and that means a higher discount rate for equity valuations to work of. All else being equal (which, of course, it never is and why we use Elliott waves), the stock market “should” decline (which just happens to tie in with our Elliott wave analysis).

A declining stock market pressures credit markets and debt deflates.

Take a look at the stock market during the 1970s. A high consumer price inflation environment is not “good” for stocks.