For the past couple of years or so, Financology has been circling one core economic and financial theme. We’ve looked at it repeatedly from multiple angles, but not really connected them to highlight their common core. Here we’re going to review it again, to tie them together into a single 360° view, and because it is so, so critical for understanding the economic environment we’re in and how to invest successfully through it.
One such angle is the idea that investment assets do not exist outside the world of inflation and that rising asset prices are every bit as much a symptom of inflation as rising consumer prices. Quiescent consumer prices do not excuse easy money policy. We recently fleshed out this theme in It’s Been Inflation All Along.
Another angle is the relative valuations of financial and real assets. Or more precisely, things which are used as investment assets and which derive their value from future cash flows versus those with current utility value, like physical commodities. On the basis of relative valuations of stocks versus commodities, we were able to observe at the beginning of this decade that the relationship had gone far out of whack and predict they would revert in the 2020s. See our analysis in Outlook for the 2020s and Commodities & NonUS Stocks, where we cited the following chart.
We complemented this valuation analysis with a more technical view via our Synthetic Systems computer model. At the beginning of 2017 this model first predicted the 2020 appearance of rapidly rising commodity prices and consumer price inflation, via the rising Copper plot:
Two years later in 2019, it continued to project soaring commodity prices and inflation in 2020-2021.
It again highlighted the emergence of rising commodity prices at the beginning of 2021:
There are some important corollaries to this. One is that the narratives the corporate media treat you to on a daily basis are grossly misleading. Prime among them is the fallacy that inflation has been caused first by Covid-induced “supply chain disruptions” and then by Russia’s invasion of Ukraine.
Wrong. The cause of inflation predated both Covid and the Ukraine war. If it didn’t, how could Financology have seen it coming as early as 2017? As its designer, I can tell you with absolute certainty that Synthetic Systems knows nothing about viruses, pandemics or war. None of our fundamental analysis foresaw either of those developments either. The cause is really bad economic policy, especially among the world’s central banks. Financology has said so outright and repeatedly. The false narratives promoted by the media are worse than useless, or these same media would also have been able to see this coming. Covid and the war are scapegoats for the miserable failure of US government policy to do anything but enrich the powerful at the expense of the welfare of the general public. If anything the responses to them – reckless monetary and fiscal policy – have only accelerated the problem. For instance in its response to Covid, the Fed hammered interest rates down to zero and printed trillions of dollars, ostensibly to “support the economy”. That has been all but forgotten in most current reporting on the inflation crisis.
Do not trust media narratives that blame spooky alien nanobots or foreign powers for our economic problems. They’re Made in the USA.
Another angle of approach is via the Financology Dollar Index. Updated today, here is the latest chart. The big “inflation” news this week is that the CPI has risen 7.9% year over year. Consumer price inflation is accelerating. The dollar is rapidly losing purchasing power in the world of US domestic goods and services. The FDI indicates however that recently, overall, the dollar is if anything modestly increasing in value. Put another way, inflation is not increasing … it’s moving from the realm of asset prices to consumer prices.
The Fed is on the case, but it is years too late. As we have been saying all along, the purchasing power stored in assets cannot exceed the body of goods and services available for purchase. So there is only one possible outcome from years of asset price inflation. Either asset prices must come back down or consumer prices must rise to meet them. Or some messy combination of both.
That’s exactly what we’re seeing now.