“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
- Milton Friedman
I don’t always agree with Milton Friedman, but he certainly got the relationship between money and inflation correct in the above quote. Unfortunately, inflation deniers rarely see it until after the fact because they are looking for the tell take signs of an increase in supply and demand, rather than a monetary policy driven increase in price.
Now, of course, that isn’t to say that supply and demand doesn’t matter. Certainly, decreasing supply and increasing demand will lead to higher prices as well. But when considering real inflationary pressures in the economy, monetary policy is often the key culprit.
Perhaps the most well-known example of monetary driven inflation is in the Weimar Republic following World War I. By way of background, the Weimar Republic decided to both suspend the gold standard and to fund their participation in the war via debt (unlike France, as an example, which implemented an income tax). As a result, at the end of the war the economy was faced with the toxic combination of a substantial debt burden, low productivity / growth, and the burden of reparations.
Reparations were to be paid in a combination foreign currency and gold. The solution the Weimar government came up with was too effectively print their fiat currency (which they could now do as they were off the gold standard) and buy foreign currency to then pay reparations. As one would expect, rapidly increasing the supply of their currency led to a massive devaluation and an increase in the “value” of things priced in that currency. Sound familiar?
By the end of the Weimar Republic’s inflationary period, a loaf of bread in Berlin that cost roughly 160 marks at the end of 1922 cost 200 billion Marks by late 1923. Hyperinflation, baby! Eventually of course, marks become so worthless that they were actually burned to provide heat in the winter.
It goes without saying that we are certainly not on a path to hyperinflation akin to the Weimar Republic, Hungary following World War II, or Zimbabwe in 2007 and 2008 (recording the highest monthly inflation rate at 7.98^10). But the consequences, and investing opportunities, for increasing the supply of a fiat currency are real. And as Mark Twain famously wrote:
“History does not repeat itself, but it rhymes.”
Indeed.
Back to the Global Macro Grind…
On the topic of inflation, the BLS reported CPI yesterday. My colleague Darius Dale provided an excellent synopsis of the report:
A) Headline CPI: +34bps to 1.0% YoY in JUL
B) Core CPI: +38bps to 1.6% YoY in JUL – fastest acceleration ever
C) Energy CPI: +149bps to -11.2% YoY
D) Core Services CPI: +32bps to 2.3% YoY in JUL – fastest acceleration since NOV ’10
E) Core Goods CPI: +55bps to -0.5% YoY in JUL – fastest acceleration since APR ’11
F) Cleveland Fed Median CPI: +7bps to 2.7% YoY – fastest acceleration since FEB ’19
G) Key Takeaways: We had you well prepared for a Headline CPI print like this with our pivot to Quad 3 and associated bullish bias on Commodities back in early-June. What’s new today is that the 3-month annualized change of Core CPI is now tracking at 3.2% – the fastest rate since mid-2005. What’s I find most interesting about that dynamic is the fact that the Inventory Cycle continued to contract last month AND Shelter CPI – which represents roughly 30% of the CPI basket – decelerated to its lowest level since 2013 at 2.3% YoY. As such, it can and will be argued that this surge in core inflationary pressures is being driven in large part by supply chain disruptions. All told, our US GROWTH and INFLATION models are currently tracking -82bps below and +64bps above Wall Street economist consensus for 2H20E, respectively. We think the initial reporting of Phase 3 data over the next 4-5 weeks will catalyze a reconciliation process that is unfavorable for 3Q20E and CY21E earnings expectations for HIGH-BETA CYCLICALS. Regarding that last point, the reporting of Phase 2 data has been as positive for the earnings revisions as we initially thought it would be back in APR/MAY. As such, we have a high degree of confidence that we’re setting up for meaningful negative revisions cycle to the extent we are proven accurate on our Phase 3 = Quad 3 view.
There are a lot of reasons that one could discount government reported numbers, but, if anything, they probably understate true inflation in the real economy. It’s hard for inflation deniers to deny the fact that CORE CPI accelerated at its fastest rate ever. In the Chart of the Day, you can see this rapid “reflation of inflation” graphically. Burning the buck has economic consequences!
Before I sign off for the morning, I’m going to leave you with one my favorite inflationary stock picks from our research team. Yesterday my colleague presented a deep dive on $FVAC, or Fortress Value Acquisiton Corp. FVAC recently merged with MP Materials, which is the owner and operator of North America’s largest rare-earths mineral mine. Van Sciver sees a number of favorable tailwinds for the name, which include:
- Increasing US tensions with China;
- Flows into ESG funds;
- Growth in alternative transport powertrains;
- Lower carbon energy investment; and
- Macro forces like accelerating inflation.
Conservatively he believes, and admittedly management will have to execute, that fair value is in the $14 - $31 range per share, which is well above the current stock price of $11.90. If you are an institutional subscriber and would like to speak to Jay or review his deck, please email .
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 0.49-0.69% (bearish)
SPX 3 (bullish)
RUT 1 (bearish)
NASDAQ 10,703-11,178 (bullish)
Tech (XLK) 108.95-116.16 (bullish)
REITS (XLRE) 35.07-36.88 (bullish)
Utilities (XLU) 59.47-61.85 (bullish)
Financials (XLF) 23.52-25.59 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 217 (neutral)
VIX 21.33-29.08 (bearish)
USD 92.57-93.94 (bearish)
Oil (WTI) 39.98-42.98 (bullish)
Nat Gas 1.88-2.39 (bullish)
Gold 1 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
