Inflation, Deflation And Mean Reversion by Russell Napier from the Ben Graham Centre Conference
- Key to mean reversion of CAPE- changing inflationary expectations
- CAPE and Q drive capital creation and are reflexive
- Technology is key but it is never as positive for non-inflationary growth as it seems
- Deflation or inflation rising through 4% will reduce valuations
- Equities can adjust more rapidly than bonds
- Deflation comes next and sharply lower equity prices
Deflation in the age of QE
- ‘Inflation is always and everywhere a monetary phenomenon’- Friedman
- We do not live in a fiat system as so many countries manage/fix their currencies to others
- For EM’s external surpluses dictate monetary policy
- In fiat systems money is created by commercial banks and not by central banks
- Demographic trends mitigate against credit and money creation by central banks
Smaller US deficits and EM deflation
- For almost two decades a widening US current account deficit was the basis for Bretton Woods II
- Earned surpluses allowed liquidity creation and stable exchange rates in EMs
- Since 2009, EMs have borrowed surpluses they did not earn
- The round trip of capital creates liquidity in EMs
- A country with insufficient surplus and liquidity can deflate or devalue and China is particularly vulnerable
The shrinkage in the deficit is structural
- The shale oil and gas revolution means fewer US dollars in the hands of foreigners
- Chinese manufacturing wages have risen 3x since end-2007 in US$ terms, US hourly wages just 12%
- The baby-boom generation is degearing and saving; and this means less consumption and fewer imports
- If the US is to run structurally smaller deficits. then Bretton Woods II is unfit for purpose
- EMs will deflate or devalue; either will bring a global deflation
Conclusions
- The size of the US current account deficit is a key driver of global liquidity but it is not growing
- Structural reasons – shale oil and gas, rising Chinese wages, baby boom degearing – stop the deficit growing
- The de-gearing of the baby boom generation restricts the effectiveness of monetary policy
- EMs, particularly in Eastern Europe, have borrowed too much in foreign currency.
- Six years after the launch of QE we get deflation anyway and a move to government action
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