Commentary: Paul Ebeling on Wall Street, Inflation Alert


Last Week’s Action

Stock indexes are consolidating, the economic data impresses, as headlines focus on new China Virus cases in the wake of massive new testing.

Last Friday was Quad Witching expiration, and we saw leaders continue to lead. Perhaps other sectors will now start to contribute to the uptrend.

Technical Analysis:

Technically, the indices are in consolidation mode, the S&P 500, the DJIA and SOX were flat to a bit lower. The S&P 400 and the Russell 2000 Index marked similar action. The RUTX posted a Doji at the 10 and 20-Day EMAs.

NASDAQ and the NASDAQ 100: The NAS and the NAS 100 showed a lateral slide just below their recent all-time highs, they are both hanging over the old highs.

HeffX-LTN’s overall technical outlook for the major US stock market indexes is Neutral/Bullish with a Very Bullish bias.

Inflation Watch

The Big Q: Will inflation follow The China Virus War?

The Big A: The China Virus had been dubbed a War, and like a conventional War, it is reshaping economies and demanding huge increases in public spending and monetary support. It will certainly bring about far bigger public debt and central bank balance sheets. This does not mean that this long debt cycle must end in inflation, but it is possible.

The economic impact of C-19 coronavirus is different from that of a Big War. Wars restructure economies and destroy physical capital. C=19 coronavirus has shrunk economies, by suppressing both supply and demand that depend on close human contact.

The immediate impact looks strongly deflationary: unemployment has soared, commodity prices have collapsed, much spending has vanished and precautionary savings soared.

Consumption patterns have changed so much that inflation indices are looking meaningless for now.

For over 10 yrs people have argued that expanded central bank balance sheets are harbingers of hyperinflation. Some knew this was wrong: the
expansion of central bank money offset the contraction of credit-backed money.

Broad measures of money supply had grown slowly since the Y 2008 crisis.

But this time it really is different, because in the past 2 months, US M2, a measure that includes demand, savings and deposits for fixed amounts of time, and Divisia M4, a broader index that weights components by their role in transactions, both show large jumps in growth.

So, the combination of constrained output with rapid monetary growth forecasts a jump in inflation. But it is possible, though not likely in the US, that the medical malpractice chaos has lowered the velocity of USD circulation. I will not forget the unexpected surge in inflation in
the 1970’s when the prices of most fine things 2X’d and interest rates capped out at 22%.

This could happen again

There are 3 reasons why inflation might surprise on the Northside:

1. increases in public debt ratios much greater than the 20-30% expected,

2. a big jump in the interest rates needed to keep economies operating close to potential output, and,

3. fiscal dominance, meaning the subordination of the central bank to
government demands for cheap finance. Wall Street likes Cheap Money.

On the points

Charles Goodhart of the London School of Economics argues that huge structural changes are coming. The deflationary environment created by
rising Chinese exports and globalisation is over. Wage pressure will increase. When the surge in spending fuelled by fiscal and monetary largesse spills over into inflation, it will be viewed as temporary, or just welcome, as the real burden of debt is eroded.

Among the beneficiaries of this erosion of the real burden of debt will be

Politicians will be extremely angry if central banks raise interest rates above the growth of nominal GDP, and force fiscal retrenchment beyond that needed to curb the huge fiscal deficits created by the crisis programs.

Popular resistance to a repetition of the public spending cuts that came after the financial crisis will be intense.

So, too, will be resistance to the higher taxes needed to shrink the fiscal deficits as full employment is restored.

Governments will then demand cheap central bank finance reinforced
by other forms of financial repression, including capital controls.

They will be justified as a desirable expression of national sovereignty.

This is not inevitable; governments should finance all their debt
at today’s ultra-low interest rates with the longest possible maturities.

The future is uncertain, as The China Virus chaos has created some features of a War economy causing the chances of inflation to have risen. The Key is to hedge against it, not bet on it.

Have a healthy week, Keep the Faith!

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