Just like The Golden Investor predicted in the 2020 case study The Golden Manifesto, the central bank expansion drift of the balance sheet does not come without consequences. It is easy to print money and spill liquidity in the system to suppress interest rates and prevent another crash, however reversing this policy is a more delicate process which asks for patience. As inflation surges in the low-interest rate Western economies, the ECB and FED find themselves in a though position in which raising interest rates would probably dampen inflation but put burden on some highly indebted companies and countries that depend on low interest rates. While the current energy crisis that is a result of in-stable energy supply and the Russian war in Ukraine is responsible for the current awkward financial position, the extreme risks these central banks took the last decade following the financial crisis of 2008 will come to light.
“This time we did the exact opposite, we spoiled excess money supply in the economy
The Golden Investor – Case Study II – 18 March 2020
just to reach our inflation targets and to boost the economy. Nothing has happened, the ten
times higher monetary base has led banks to sit on cash and has only boosted real estate and
stock markets to all-time highs. The Golden Investor is afraid for a Paul Volcker scenario
since this unconventional central bank policy will lead to inflation at the wrong time.”
As interest rates surge low-income groups with low-disposable income could be squeezed out financially, which could cause a wave of economic slowdown as consumer confidence and welfare is still a key stone for most economies functioning. Countries like Italy that are heavily con-stringed with Northern European financial institutions could default on government debt amid this fast-rising interest rate environment as the expansion of the balance sheet of the ECB has finally ended. Bond markets have lost more than five percent of their value year-to-date, this is unprecedented in a bad sense. This paves the way for the next financial crisis that will highlight the extreme vulnerability of the heavily globalized state of most developed economies.
The Wage-Price Spiral Explained
If the inflation stays at this high level, this will need to be compensated in wages. However, The Golden Investor does not believe in the so-called wage-price spiral that suggests that this will cause even more imminent inflation. Yes, this would cause inflation however at the end of the day it is the same consumer that bears the costs of inflation, while companies rarely share excess profit in times of economic up-turns. That being said, wage increases will probably hurt SME’s more than globalized multinational companies which generally have the highest profit margins due to scale and tax advantages. Therefore, policy should be aimed at finding the right balance between accepting higher inflation and dividing the burden between consumer and the corporate sector.
In this environment not much can be gained in financial markets for retail investors. Commodities and energy assets could prove to be a safe-haven and amid falling markets Virtu Financial and Flow Traders tend to generate large profits, just like they did during the corona downturns. Other more passive options that can be considered is leveraging the appreciation of the Swiss franc (CHF) versus the euro and dollar as Switzerland is one of the least energy dependent developed countries.
Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.