“We are a long way from 1970s-style inflation,” Scott Minerd said. The data does not support the view that inflation is non-transitory, he said, despite what some people, including hedge fund manager Paul Tudor Jones, are claiming,
Scott Minerd is the chairman of investments and global CIO of Guggenheim Investments. He spoke to investors via a webinar, titled Macro Outlook, on June 17.
Minerd spoke a day after the Fed met and was critical of its statements. He said, tongue in cheek, the Fed has clear objectives that it “makes up as it goes along.” He called the Fed’s meeting one of the “finest events of obfuscation” he has seen.
Inflation is coming from used cars, hotels, and air fare, he said, and those prices will approach a “terminal value.”
We are seeing a reversal already in materials such as lumber. The means of production, like the sawmills that produce lumber, will become more efficient, increasing supply and reducing prices.
“This is Adam Smith’s invisible hand at work,” Minerd said, “increasing supply to bring prices back to equilibrium.”
But what about the huge growth in money supply?
Minerd was trained as a monetarist at the University of Chicago. He cited money supply growth and inflation spikes following the last two world wars that proved to be non-transitory. Inflation followed World War I, he said, and was abated by economic growth. Following World War II, money printing accelerated and there were price controls and financial repression, which stayed in place until 1951. There was high inflation, he said, but not skyrocketing yields, and that inflation was short-lived.
Money supply has had a huge spike following the pandemic, Minerd said, but its trajectory will slow, like it did during and after World War II.
There were shortages of goods following World War II and excess savings, as there are now. But those pressures went away when the economy adjusted to peacetime, he said.
“Everything we are seeing is exactly what we expect in a post-war environment,” Minerd said. “There is no evidence of a systemic rise in inflation, or that interest rates are reversing course from the bull market in bonds.”
Minerd said he has seen the end of the bond bull market called at least four times: in 1986, 2001, 2008 and now. Each time that call was wrong.
It would be good if the Fed tightened sooner, according to Minerd. “It would reinforce the view that the Fed would be an inflation fighter,” he said.
He said the price action that followed the FOMC meeting suggested that yields will fall. “We are not worried about an imminent spike in interest rates,” he said.
Minerd discussed a regression analysis his team has done, which looked at the relationship between the debt-to-GDP ratio and the “terminal” Fed funds rate (the final rate following a series of Fed rate hikes). Following the global financial crisis, the model estimated that the terminal Fed funds rate would be 3%, and the Fed stopped hiking at 2.5%. Following the same methodology today, the terminal rate will be between 1.7% and 2%, depending on how debt is measured. If the Fed funds rate was raised to 2%, Minerd said it would stop companies from being able to borrow. Those companies “at the margin” would have debt-servicing problems that would force layoffs and trigger a recession.
Except for the pandemic, every post-war recession was due to the Fed raising interest rates, according to Minerd. Until the Fed raises rates, he said, any thought of a recession is off the table.
That bodes well for stocks over the long term. “But we are vulnerable to a correction in the near term – the next six months,” he said.
Minerd said 1.15% is the “fair value” yield on the 10-year Treasury, and there is a good shot of getting below that in the next six months.
Were it not for the reverse repo facility, he said we would have negative short-term rates. The money market industry is suffering from too much liquidity and it cannot offer negative rates. There was a five-basis-point increase in the reverse-repo rate in the last week that effectively subsidized money markets, Minerd said.
Why is Minerd so sanguine about inflation? It comes down to demographics, debt and technology.
Demographics favor deflation, since our workforce and population growth are slowing, which is what happened to Japan. Debt is deflationary since its servicing costs limit the public and private sectors’ ability to spend.
Technology is the big story, according to Minerd. The total output of the economy is above its pre-pandemic peak, when unemployment was at 3.5%. It is now at 6% and the labor pool has shrunk, but despite that we still have higher output. That is because there was an acceleration of the implementation of technology, which improved efficiency and productivity. That is deflationary, which is what happened in the 1920s with the introduction of automobiles, electricity and the railroads.
The fundamental underlying foundations of inflation, from a monetary, short-term statistical, and long-term fundamental perspective, all lead to the conclusion that inflation is not the problem, Minerd said.
“We are in high gear, our economy is sound, and we are not going to have a recession,” Minerd said.
In the long run, though, the U.S. faces “really, significant inflation,” Minerd said. That will happen in the next decade. Minerd doesn’t know what the catalyst will be to trigger inflation, but the U.S. is building a lot of structural problems, with overloaded government and private sector debt, and monetary policy that encourages speculation and malinvestment.
“All of this one day will come home to haunt us,” Minerd said.
The only response will be more debt and lower interest rates. Eventually, there will be a threat to our currency; it could come from China, cryptocurrencies, or the vulnerability of our payment system. If hackers can take down the Colonial pipeline, he said they can take down our payment system, which would erode credibility in our currency and would “trigger a wholesale flight to gold or other safe havens.”
The more indebted we become, the more vulnerable we become to exogenous shocks. The San Francisco earthquake of 1906 set off the panic of 1907, because of a huge demand for credit to rebuild that city. If the pandemic of 1918 had happened with our present debt load, he said we would have experienced a depression.
“Disruptions with high debt loads increase the potential for great loss of wealth from exogenous shocks,” Minerd said.
“The day of the attack on the payment systems is coming,” he said, “and it is huge threat.”
Robert Huebscher is the founder and CEO of Advisor Perspectives.
Read more articles by Robert Huebscher
“We are a long way from 1970s-style inflation,” Scott Minerd said. The data does not support the view that inflation is non-transitory, he said, despite what some people, including hedge fund manager Paul Tudor Jones, are claiming,
