Notes From Underground: Coal for Some Stockings?

If you’re only looking at the headlines from the past 48 hours, there is something major going on. First, on Friday afternoon Bloomberg reported that the G-7 finance chiefs are planning to discuss inflation as prices soar and the Financial Times followed on Saturday about the U.S. Democrats pushing the Federal Reserve for tougher action against inflation. These two stories are everything that we at NOTES FROM UNDERGROUND have been discussing since the Dems’ poor election showing last month.

The White House polls — and thus the political operatives — reflected that inflation concerns were going to be the biggest issue for all Democrats in 2022, which is why there was a sense of urgency to use SPR and release oil to drive headline energy costs down. It’s the classic political ploy to appear to be doing something. What’s next? Wage and price controls?


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This situation, though, reflects the ACADEMIC response of running inflation HOTTER FOR LONGER TO ENSURE MORE JOBS AND MITIGATING THE PAIN OF INCREASED DEBT TAKEN ON BY HOUSEHOLDS, FIRMS and GOVERNMENT OVER THE LAST DECADE. It was the work of Kenneth Rogoff and Carmen Reinhart back in 2012 that theorized that running higher inflation for a few years would be a positive thing to repair financial balance sheets. This idea became de rigueur and as the COVID pandemic led to more debt as unemployment grew, Fed Chair Jerome Powell utilized this theory to promote the concept of “flexible adjusted inflation targeting” at Jackson Hole in 2020. If inflation had run under 2% for many years it would be justified for price rises to exceed 2% for quite an extended period of time in an effort to smooth out the average. Unfortunately, the political calendar is not the reality in which the economic theorists reside .

The G-7’s VIRTUAL meeting that takes place Monday is critical as there are five central banks releasing policy statements this week: the FED, SNB, BOE, ECB and BOJ. We have argued that there needs to be COORDINATION among the major G-7 economies in order to prevent a MASSIVE DOLLAR RALLY if the FED were to end its QE program as a solo endeavor. A dollar rally would place an extreme burden on dollar debtors around the world, especially those who borrow in dollars but earn in an alternative currency. It seems the G-7 has adopted this and wants to coordinate ahead of the meetings this week as all the banks are key promoters of MASSIVE ASSET PURCHASES. Listen to what transpires in this virtual meeting of G-7 finance ministers and central bankers as IT CAN FOAM THE RUN WAY FOR ENDING THE GLOBAL QE PROGRAMS.

The use of FORWARD GUIDANCE as a key policy tool has painted the central banks into a corner that they can only escape by coordinating the end asset purchases. THE MOST HAWKISH OUTCOME OF THE FED THIS WEEK WOULD BE TO END ALL PURCHASES OF SOVEREIGN DEBT AMD MBS AS IT WOULD MAKE ALL OF 2022 FED MEETINGS LIVE FOR RAISING RATES. Powell’s FORWARD GUIDANCE PROMISES WERE THAT THE FED WOULD NOT BEGIN TO RAISE RATES UNTIL TAPERING OF BOND PURCHASES WAS COMPLETED.

Powell needs to end the support for asset markets, which have been the key beneficiary of QE policy. In Powell’s role as minister of justice he has maintained that large scale asset purchases were supporting jobs for those who were unemployed “through no fault of their own.” The latest jobs data reveals that the emergency of unemployment ended and now the need to slow the rise of prices for basic necessities has become the most important challenge to better the lives of those on the lower rung of the economic ladder. Is the stock market ready for an abrupt end to large asset purchases? WHO CARES?

Jim Bianco raised the question in our most recent podcast. When the FED shifts its policy who will be the most harmed, BOND HOLDERS or STOCK HOLDERS? Jerome, the White House is hoping you deliver COAL TO THE OWNERS OF EQUITIES FOR THEY HAVE HAD AN INCREDIBLE RIDE. Besides, if the central banks coordinate this endeavor, they may be seeing success in nine months just as so many elections are taking place. Remember, the U.S. cannot go at it alone. The markets Sunday night OUGHT to be volatile as they try to prepare for a busy week of central bank policy outcomes.

***ECB President Christine Lagarde will have a difficult time if there is coordinated ending of QE. When she first assumed the position, Lagarde made a major faux pas by proclaiming that it was not the ECB’s job to keep sovereign debt spreads in order. Italian and Spanish debt got crushed, causing her to proclaim she was misunderstood. Watch the European sovereign debt spreads as an indicator of a sea change for the central bank because the current levels of the spreads between German debt and all the weaker states will not be able to be sustained.

Another negative outcome of FORWARD GUIDANCE is Lagarde will lose control if the ECB stops its buying unless it agrees to only buy the weaker countries, which would be a violation of its mandates and the Lisbon Treaty. There is a lot at stake in the global financial system but waiting longer will not resolve the difficult challenges. Are those equity investors ready for their coal?

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