Bill Blain Warns “Financial Asset Inflation Is Now Creeping Into The Real World”
As far as financial blogs go, Bill Blain’s Morning Porridge is – as MacroVoice’s Erik Townsend put it – “one of the most intriguing investment blogs on the Internet”. Readers of Zero Hedge will likely be familiar with his writings. A little over a week ago, as market’s rebounded from the worst selloff in months, Blain wrote “there is definitely a tinge of fin de l’age about current markets.”
Since then, Federal Reserve Chairman Jerome Powell has delivered what Mohamed El-Erian described as “one of the most confusing #Fed press conferences in recent memory, again stalling for time with doublespeak on inflation (still “transitory”) and a job market that has shown a lack of “substantial progress” (because the government is paying people to stay home).
Some have trouble making the connection between inflation in financial asset prices and inflation in consumer prices. But Blain lays it bare in his latest interview with MacroVoices‘ Erik Townsend.
Bill: Yeah, I rather the opinion that inflation is not only here to stay, but the most significant thing that’s going on is we have long term inflation is now being imported into the real world from distorted financial assets. Everybody tells me that there’s no inflation out there. And what we’re seeing is just a transitory spike caused by supply chains breaking down, and things like the chip shortage and people who are anticipating a faster recovery. But what we’re really seeing is all the inflation that’s been generated over the last 12 years of monetary experimentation, quantitative easing, and buying back bonds and keeping interest rates artificially low, that’s generated tremendous inflation in financial assets. And that financial asset inflation is now creeping into the real world.
Later, Blain and Townsend touched upon a structural shortcoming with contemporary markets. The fact that a plurality of the people working in the industry today don’t even remember the financial crisis, let alone what’ 70s-style stagflation might be like. Fed-backstopped markets are all they have ever known. So, how can they be expected to understand what’s happening?
Erik: Bill, you and I grew up in the 70s. But we were kids at the time. And frankly, the guys that were working in the industry, and were around in the late 60s, when the onset of secular inflation began, they’re all retired. And one of the biggest things I think about is okay, who’s going to be in charge of rounding up all the guys that have been through this before when this secular inflation really hits the tape? What’s the finance industry gonna know what to do? Because I think everybody who knows is gone or retired.
Bill: This is one of the things that really scares me because the reason we’re in this environment at the moment, is a game of consequences. Everything that happens, everything you do today will have a consequence tomorrow. And the big issue for central banks for it as they we are talking about. Central banks have been experimenting with monetary policy, since the great financial crisis began in 2007. And in 2009, they came up with this brilliant idea that they could kickstart the economy with ultra low interest rates. And they would get money to flow into the economy by buying back bonds, which means that investors would sell their bonds and then use that money to invest in the real economy. But that’s not the way that trading works. We all know what investors did was a curse. They sold their bonds to central banks, and then bought more bonds to sell to central banks. And they used money from that to buy more bonds to sell to central banks. And this is what caused massive inflation.
Later, Blain added that he sees a “great divide” between people older than 40, and those who are younger. The issue is that “if you’re younger, uou tend to think that value is all about the price set by the market.”
In financial assets, the path of that happening was very simple. Interest rates started to fall. As a result, people saw that the yields and bonds were unsustainably low for their investment purposes. So they started going what we call yield tourism. And they started buying equity. Remember, equity is a much higher risk market. And they started buying so much equity, the equity market went up, and the dividend yields and equities also came down. That has been the consequence of ultra low interest rates, massive inflation, in financial assets. But here’s the critical thing that started 12 years ago. Now, 12 years in financial markets is an incredibly long time. The result is there’s practically nobody under the age of 35. In this city, in what we in the UK called the city but the world calls global finance, who understands investment markets, where it’s not completely normal for central banks to be repressing interest rates and distorting yields through their monetary experimentation and quantitative easing.
So every single fund manager under the age of 35, thinks this is perfectly normal. And that’s why when I’m out doing my job as an alternative asset investor, I see a great divide between those of us over 40 and those below 40, who’ve got completely different perspectives on what value propositions are. If you’re younger, you tend to think that value is all about the price set by the market as in a distorted market for as anybody over 40, we’re tearing our hair out, and we’re going, what is going on here? How can we accept interest rates being so distorted? Look at the effects, look at the overvaluations, look at the crazy stories that are created. So that point you just made about where are all the old guys. Well, you know, those of us who are who’ve been around the block a few times and the first time I traded treasury bonds back in, I think 1986. I think we were talking then about the beginning of the big bull rally in bonds. Where the year before traders were frightening me with stories about how yields have been 18%. And they were dominant double digits still when I started trading, and now, where are we on the 10 year? 1.2 or something like that. This is a completely different world. And there are very few of us left who remember what it was like.
The conversation eventually turned to one of the biggest topics of the week: the souring financial relationship between the US and China. The problem with China is of course that its economy is so big, that American investors almost can’t risk not having some exposure, given the potential for growth in the coming decades, where it’s economy is expected to eclipse that of the US. Since China’s big pivot back toward capitalism int he 1980s, “they have created a very effective economy very quickly.” What we’re seeing now is “games being played”. At some point, the US and Beijing will likely need to work something out (indeed, Beijing has apparently already realized that its economy still has more to gain than to lose by participating in US financial markets, which is why they have apparently reconsidered their IPO ban).
The success of China is being able to create capitalism with Chinese characteristics, which we all take to mean means that they’re not terribly innovative, and they steal ideas from others. Well, you know, that may be or may not be true. But the fact is, they’ve created a very effective economy very quickly. And what we’re seeing in the market just now is really, games being played, people trying to understand where this is going to go in the future. The Chinese economy is absolutely massive, we know that it’s going to soon be the same size as the US economy and that’s a massive investment opportunity. But the Chinese government takes a very different view, which is why we’re seeing them clamp down, as they’ve done in the last few months.
Just in the last few days, we’ve seen them declare the education companies, which we saw as a massive opportunity to profit from the Chinese market, have been told that they are no longer for profit companies, and they are there to serve the needs for the state. Well, to us that sounds, that’s frightening. We’ve invested all this money in all these free companies, which we expected would be able to harvest enormous returns from the Chinese population who are desperate to send their kids to cramming schools to make sure they get into universities. But from the Chinese perspective, the Chinese realized that they have a whole series of regulatory, and especially social problems to solve. And one of these is the success of one parent family rules that were introduced back in communist times. As a result, you could only have one child, which meant that the Chinese favored having sons who would keep the family name going and provide for the parents as they get older. But the result is China now faces an enormous demographic well, actually two demographic problems. The first is China is getting old before it gets rich and the second is they have a massive imbalance between males and females. They are far more young males then they are young females. So don’t ask me how that occurred. But it was a form of selection that we would have not tolerated in the West. As a result, the Chinese have got to find ways of encouraging families to have more kids. And one of the ways that are going to do that is by removing the threat of ultra high costs of educating your kids by making education free, and at the same time being able to tell the population that hey, look, what we’ve done for you. Education is free, everyone has access.
So when you’re looking at the divides between Chinese capitalism and Western capitalism, you got to try and put it into some form of context. And understand why is they’ve done these things. So I’ve just explained the thing by education, clamping down on FinTech, as they did with Alipay. And the problems we’re now seeing with Tencent, you can explain these in similar ways. It’s about the Chinese Communist Party, making sure they maintain their control and relevance. But for those of us in the West, we’ve got to say, you know, sit back and look and say, can we afford to be not invested in this economy. Now, there’s lots of reasons not to be invested in China, from our sort of social and governance perspective. What they’re doing in Hong Kong opposes what they’re doing to the Uyghurs on the western fringes, POLSAs, their surveillance capitalism is something that doesn’t fit here. But at the same time, there’s lots of things we do that they don’t like either. I suspect the future is we’re going to find an accommodation for China. But it’s a very difficult market, unless you’re really prepared to take the time to understand what’s going on to try and invest in. I hope that all makes sense to kind of gallop through about 400 different points in 400 seconds.
Readers can listen to the full interview below, courtesy of MacroVoices:
Sun, 08/01/2021 – 13:25