EC Inflation, Money, And Supply Bottlenecks

The 2020 monetary tsunami launched a global boomerang effect with three consequences: Emerging market currencies plummeted against the dollar because their central banks “copied” the U.S. policy without the global demand that the U.S. dollar enjoys. The second effect was a disproportionate amount of money flowing to risky assets joined by more flows to take overweight positions in scarce assets.

That excess money made investors move from being underweight in commodities to overweight, generating a synchronized and abrupt rally. The third key factor is that extraordinary measures typical of a financial or demand crisis were taken to mitigate a supply shock, generating an unprecedented rise in money with no added credit demand. More money in scarce assets is not a price increase, but a decrease in the purchasing power of money.

What is the risk? The history of money since the Roman Empire always tells us the same thing. First, money is aggressively printed with the excuse that “there is no inflation.” When inflation rises, central banks and governments tell us that it is “transitory” or due to “multi-casual” effects. And when it shoots up, governments present themselves as the “solution,” imposing price controls and restrictive measures on exports.

That is why it is dangerous to pursue conglomerate stocks as an inflationary bet: because when price controls and government intervention increases, margins collapse.

The risk of stagflation is not small, and the so-called value stocks are not a good bet in this environment. In stagflation, commodities with tight supply dynamics, gold and silver, high margin sectors, and bonds of stable currencies support a portfolio. However, most sectors underperform, as we saw in the 70's, where the S&P 500 generated very weak returns, significantly below inflation.

What can be different from other episodes? Only a drastic reaction from central banks can change it. However, the question is: Will central banks tighten policy when government deficits are soaring and even a small increase in sovereign yields can generate a debt crisis? Will they react to what is clearly — as always — a monetary inflationary process?

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