“Printing money is like alcoholism. The good effects come first, but if you do too much of it, the bad effects come later. “ – Milton Friedman
Economic restrictions & lockdowns are breaking down supply chains. There are already shortages & long wait times for some products. The mass push for Environmental and Social Governance in investing is only accelerating, putting upward pressure on prices for energy, goods and services, and governments and central banks have truly expanded money printing and debt burdens beyond comprehension.
Let’s do a quick update of some of the issues as this may be the most important influence facing investment portfolios today. Some of this will be in point form.
In my view, we are already seeing early signs of what will eventually prove to be a meaningful increase in inflation, and this process is likely to play out over the next few years.
Most of us have already noticed a rising cost of living, much more than the government-calculated Consumer Price Index (CPI) numbers are admitting.
Some of our more senior friends have said, “well we don’t spend much money anyway”, but even they now have been seeing rising food costs, home heating, driving, maintenance, taxation and other costs. We all see it, but business owners, you know the people who create every job in the world (including government jobs) and fund every service known to man, are feeling it the most, as the cost of inputs and labor are going up and up.
If the current restrictions & lockdowns were the only reason, then perhaps we could see a light at the end of this tunnel. But the ESG push and government and central bank irresponsibility have no end in sight.
Most can understand how a lockdown of an economy, or even parts of it, can cause price pressures. People can’t go to work, production facilities can’t open, people can’t travel. These restrictions understandably create problems with supply chains.
The ESG push is something many may not yet appreciate. ESG (Environmental, Social and Governance) investing refers to a class of investing that is also known as “sustainable investing.” This is an umbrella term for investments that seek a long-term impact on society and environment. This is not necessarily about clean energy which I’m for just as much as the next person. But the idea that we can create long term positive impact on society and the environment through a careful selection of which mutual funds we buy, is the biggest scam perpetrated on a well-meaning but unsuspecting public by the financial industry, ever.
It’s a big claim, and I won’t do the explanation justice here as it would take a book, but if ESG investing had serious meaning, why are the holdings of “ESG” focused funds pretty much the same as any other?
It’s not a surprise that U.S. Securities Exchange Commission (SEC) has started a review of “socially responsible” funds due to ‘potentially misleading’ claims. Inaccurate or incomplete disclosures by funds and companies have been uncovered in this unprecedented move which suggests there might be abuses that have gone unaddressed. Again, this is no surprise.
On March 16, Tariq Fancy who served as chief investment officer of “sustainable investing” at the Blackrock, the world’s largest asset manager, explained in USA today that, for starters the practice has little impact on reducing greenhouse gas emissions, if that is your concern. ‘It’s moving deckchairs on the Titanic’ and “Green investing is ‘PR spin’”.
He wrote: “The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multi trillion dollar arena of socially conscious investing is being presented as something it’s not. In essence, Wall Street is greenwashing the economic system and, in the process, creating a deadly distraction. I should know; I was at the heart of it.
As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.”
This greenwashing is profitable though as funds flowing into “ESG” sector doubled to over $1 trillion in 2020. Please do not misunderstand me, my comments are not about promoting profits over the greater good. Frankly, if it was, I would get in line and tout it like most of our competitors, because it is an easy sell. But I could not live with myself. Instead I’ll take career risk to tell you the truth. By accomplishing nothing but creating a new line of sales for the fund industry, this push starves capital from sectors where it is most needed and would be used more efficiently.
The idea of being aware of where you are invested is legitimate, but when money on this scale is forcefully redirected to pursue efforts that do little or nothing for the stated cause, the inefficiencies end up hurting the weakest and poorest the most. They always do.
But this note is not about ESG, it is about inflation by my firm view is that ESG forces are helping create the next global supply crisis given lack of capital available to finance long-lead material projects in a world where hydrocarbon usage will continue to grow for decades. A supply crisis of this magnitude could have devastating economic impacts, again hurting the poor the most.
The most powerful force for rising prices is of course in the definition of inflation. Inflation is blamed on many things. But it has only one root cause: It is a monetary phenomenon. Inflation occurs when the quantity of money increases faster than the quantity of goods. Again, I don’t want to get into a debate about what is “money printing” or “QE”, or “velocity of money”. The fact is that money, and or money equivalents are rising faster than the quantity of goods.
Monetary aggregates have always been a formal way of accounting for money, such as cash or money market funds and are used to measure the money supply in a national economy.
Each week the Federal Reserve reports various measures of the US dollar money supply.
One of these, M3, was the total quantity of dollars in circulation. I used the term “was” because on March 23, 2006 the Fed stopped reporting M3, explaining as follows the reason for their decision:
“M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.”
Oh, ok then sounds plausible right? The Federal Reserve says that M3 is no longer needed, and that M1 and M2, which only measure part of the total quantity of dollars, are sufficient.
M1 is a narrow measure of the money supply that includes physical currency, demand deposits, traveler’s checks, and other checkable deposits.
M2 is a calculation of the money supply that includes all elements of M1 as well as savings deposits, money market securities, mutual funds, and other time deposits. These assets can be quickly converted into cash or checking deposits.
But if these measures are sufficient, why have they recently discontinued those reports as well?
In 2021 the US Federal Reserve is going from reporting these numbers weekly, to reporting an ‘adjusted’ version of them, monthly.
Without even checking, I’m 100% certain that the explanation will have something to do with improving the accuracy, better this or that, etc. etc. I was born at night, but not last night.
A brief look shows that M1 has increased about 450% to over $18 Trillion in just the last 18 months!
The broad-based M2 has been growing at double-digit-percentage rates for several years — M2 is up by 25% in the past year — yet we are supposed to believe that reported price inflation (Consumer Price Index) is still hobbling along under 2% a year.
The Monetarist, Milton Friedman described it like this.
“Inflation is just like alcoholism. In both cases, when you start drinking or when you start printing too much money, the good effects come first, and the bad effects only come later. That’s why, in both cases there is a strong temptation to overdo it. When it comes to the cure, it’s the other way around. When you stop drinking, or when you stop printing money, the bad effects come first, and good effects only come later. That’s why it’s so hard to persist with the cure.”
Milton Friedman Discussing How Inflation Happens Show: 2 minutes
“Inflation is created in one place, and one place only, here in Washington.”
Milton Friedman Understanding Inflation: 13 minutes
Last week, Fed Chairman Jay Powell said he has given up on the money supply as an indicator of the economy and inflation.
“Inflation is not a problem for this time as near as I can figure. Right now, M2 [money supply] does not really have important implications. It is something we have to unlearn.” — Jay Powell, Fed Chairman
In 2019 New York Fed Chair John Williams said: “We know how to deal with inflation,” Sure you do. The ex-Fed chair, Paul Volcker (1980) had to raise short-term interest rates to nearly 20% to defeat inflation but the current regime would be too scared to raise them above 2% as they’ve let things go too far.
We shall see if this is a temporary condition or not, but it seems nearly impossible to me for it not to continue. For those finance types who would argue that the crushing load of government debt and potential defaults is an overhanging deflationary pressure, I generally agree. However, I would ask what exactly do we expect politicians and central banks to do if the cracks start to show? Become prudent fiscal managers of our resources, or just prime the pump further while the system breaks down around them? They are truly inflationary alcoholics, using Friedman’s terminology.
Some of our most successful investments in the last 9 months have been in the area of commodities, from metals, to energy and now (hopefully) agriculture. The chart below, by Bank of America shows that the returns to investing in commodities have been challenged for much of the last 40 years. Currently we are starting to see that trend change, perhaps meaningfully. We’ll see how long it lasts, but fighting those trends is not something I want to do.
This is the one subject that keeps coming up time and time again, this debate between inflation and deflation. Instead of looking back and seeing a difficult past for commodities, being able to adapt, whether we are in an inflation or a deflation environment, is arguably the most important ability that everybody with a portfolio needs to have.
Fighting yesterday’s war will not lead to victory. If you think there’s any chance of inflation becoming a clear and present danger going forward, then many investors are going to have to absolutely reevaluate their entire portfolio, because I suspect there aren’t many portfolios in the world today that are set up to do well in an inflationary environment.
Common sense tells us that increased government spending, borrowing, regulatory and tax burdens, subsidies, and income redistribution cannot possibly strengthen the economy, and can only weaken it. Lockdown economics and inefficient investment programs will only serve to exacerbate the suffocating burden of Big Government.
It’s hard to imagine a worse scenario than inflationary monetary policy coupled with anti-growth policies, but that’s the risk I am seeing today. We are investing accordingly.
Peter Schenk, CMT, CIM | Portfolio Manager