Watching oil prices surge on Tuesday while Treasury yields continued to decline left many investors baffled, as the market's eagerness to ignore all signs of worrying inflationary pressures could be interpreted as nothing other than vindication of the Fed's ability to bend markets to its will, warping the process of price discovery.
A couple of weeks ago, Eric Peters reminded readers that the Fed's interventionist tendencies have been worsening for decades, though the process accelerated dramatically over the past 15 years. And with US equities at record highs despite the June payrolls report exhibiting more unmistakable signs of wage inflation, Peters sat for an interview with MacroVoices, where he shared his inflation outlook and what it means for markets, while elaborating on why the Fed has no choice but to lead the US down a path of "controlled inflation" to offset the unsustainable levels of debt that have accrued in the US and throughout the global financial system.
The key point to understand, according to Peters, is that while the Fed insists inflationary pressures are "transitory" (no doubt as a mechanism to prevent a feedback loop that could topple markets and the economy by triggering runaway inflation amplified by runaway inflation expectations), in reality, the central bank needs a slightly elevated - but not too elevated - level of inflation to wash away the debts accumulated by the unprecedented peacetime fiscal expansion elicited by the COVID pandemic.
So in that environment where you see a large fiscal expansion supported by an aggressive central bank, with the intent to alleviate the debt burden for society overall. That definitionally you'd have to have higher inflation because the policy objective, actually would be to create inflation, meaning it would be to debase the enormous pile of debt that had come to burden the economy and do that through, you know, through just issuing more debt, stimulating the economy, creating deeply negative real interest rates, and ultimately debasing the currency. So those things just they seemed inevitable. And, you know, I don't wanna say thankful that's how it's played out. Certainly, thankfully for our portfolios. But, I think it's neither good nor bad. It's just was kind of an inevitability.
And the safest way to accomplish this is "controlled inflation."
And so there will be supply responses to these, you know, higher prices in various commodities. And so there will be periods where it will appear that inflation is moderating. But I think you have to stay focused on the policy objective, here. The policy objective is, I think, quite clearly to unburden the economy. And this is not just the US. This is more of a global, this is a global phenomena, really. Certainly some countries are more subject to it than others in various degrees. But the policy objective is to unburden economies from a multi-decade, extraordinary kind of a debt expansion. And the way you do that, is either through a massive deflationary event, which is a huge credit write down, or it is through a, either a short burst of hyperinflation or a longer period of controlled inflation. And I would define controlled by a period where governments attempt to and succeed at engineering, a rate of inflation, that's pretty meaningful, let's call that north of 3%. And at times, it could go up, right now it's higher than that, right? So, but a long period of material inflation, while also keeping interest rates artificially low and well below those rates of inflation. And if you do that for for 10, or 15, or 20 years. Then, you know before you know it, your whole economy becomes less burdened or even unburdened from these debts.
Unlike some Fed skeptics, Peters doesn't expect the Fed will fail - at least not any time soon. He doesn't expect the central bank to succumb to the same mistakes made by the Bank of Japan back in the 1980s and 1990s. Again, Peters doesn't expect that to be the case.
However, over a longer time horizon, a potential threat that could threaten the Fed's ability to enforce stability is that "we just don't know" how much longer "this paper money system" will last. Peters, who is now running investments in crypto, added that cryptocurrencies have a strong outlook in the coming decades.
And so they're running this experiment at scale, in a world of in a world of fear. And yet, we don't really understand, you know, for how long people will have faith in, you know, in this paper money system. We just don't know, I definitely don't know. And I think what happened post 08' was that they were an awful lot of smart people who thought that, once we entered this world of QE, that actually, we would have a huge inflation. And really, the reason for that was because they thought that people would lose faith in fiat and that ended up being wrong. And so what happened was, you know, the Fed did do QE, they bought a lot of bonds, and created a lot of money but that that money just, it had no velocity in the banking system.
Playing devil's advocate for a moment, Peters posited that if he's wrong and inflation truly is transitory, then that would mean oil, copper and other industrial commodities have overshot, and will likely collapse as the demand imbalance subsides. They would be a "screaming short," Peters said - though of course he's confident that a measure of inflationary pressures will persist.
Even as supply eventually rises to meet the increased demand on the commodity front, leading to periods where prices fluctuate, the impact of the Fed's policy will remain paramount, as Peters explains. As we mentioned earlier, the Fed has a responsibility to eventually unburden the world of its unsustainable debts, starting with the US.
Readers can listen the full interview below: