Fed Back to Quantitative Easing? Alternative voices against the backdrop of interest rate hikes and inflation

Original author: 0x137, BlockBeats

Russia-Uzbekistan conflicts, rising energy, Fed rate hikes, and the collapse of Japanese government bonds. In less than a year, the global macroeconomic background has undergone a major 180-degree change. change. Faced with the complex macro situation and the Fed's tough attitude of "not stopping inflation", most people have extremely negative sentiments about the economic situation in the next few years.

Among the many macro analysis voices, there is one that is different. In Luke Gromen's view, the Federal Reserve will soon end the process of raising interest rates and return to quantitative easing, while Europe and the United States will also usher in sustained high inflation in the next 5 to 10 years. Luke Gromen is the founder and CEO of FFTT (Forest For The Trees), a macro data analysis company that uniquely aggregates large amounts of public data and finds bottleneck areas in economic development.

Luke's views seem out of place compared to the generally pessimistic market sentiment, but when we look closely After understanding his argument, it seems quite reasonable. In this article, the BlockBeats author organizes the framework of Luke's views and presents the reasons why "the Fed must reverse".

Intersection

The current complex and changeable global economy is something that most investors have not experienced. Luke also admitted in an interview that the current international macroeconomic environment is his The scariest and most complicated thing I've seen in 27 years in the business. But in general, Luke believes that there are two main problems in the global economy today: sovereign debt, and energy supply.

High sovereign debt of western countries

After the Internet bubble burst in 2000, Western governments represented by the United States created a new real estate bubble and transferred the debt problem to the banking system to compensate A demand shock from the stock market. After the real estate bubble burst in 2008, policymakers created a new sovereign debt bubble and transferred debt to the sovereign country level to cover up the demand shock caused by the sub-credit bubble of real estate banks. Since then, the sovereign debt bubble has been the backstop of all economic growth.

Luke believes that we are currently experiencing the first Western-centric global Sovereign debt crisis in the country, and when the sovereign debt bubble bursts, there is no higher-level counterparty to transfer the debt, so it can only be passed on to the national currency.

In the past 40 years, we have witnessed many sovereign debt crises in emerging markets, but We haven't seen anything like it in the developed world since the end of World War I. Economists Reinhard and Rogoff co-authored the study "From Financial Crisis to Debt Crisis," which examines sovereign debt crises over the past two centuries. During this 200-year period, 98% of countries with a debt-to-GDP ratio of 130% defaulted on their debt, mostly in the form of persistently high inflation. The U.S. debt-to-GDP ratio is now around 129%.

At present, the only special case, that is, the country that has not yet defaulted on its debts, is Japan. But we have also seen that the current Japanese government bond market is facing tremendous pressure, and the Bank of Japan is still trying to maintain the upper limit of Japanese government bond yields.

"Cheap Energy Peak"

Accompanied by the global sovereign debt bubble, there is an energy crisis that cannot be ignored. Luke called it "Peak Cheap Energy". This is not to say that oil and gas resources are running out, but that the marginal cost of finding and producing each barrel of oil and gas is increasing. In other words, the days of cheap oil and gas are over. However, due to the high leverage in the global economic system, what is reflected in the valuation of various assets is a more stable and cheaper energy supply, which is completely opposite to the actual situation.

Energy can be seen as "nature's discount rate" inescapable and inescapable. However, Western countries, especially the United States, make the government and economy excessively dependent on marginal consumption, marginal GDP growth and even marginal tax revenue brought about by cheap energy, and build the economy on the basis of rising asset prices.

Complex overlay

The current macro environment is such a unique period: unsustainable sovereign debt bubbles, energy prices facing upward inflationary pressures. At the same time, the accelerated development of the process of "de-globalization" has also brought continuous upward pressure on inflation. And tensions between the U.S., China and Russia are fueling the fire.

When we add all these macro factors together, we can piece together a very interesting The toxic macroeconomic environment, the future is becoming more and more difficult to predict, and the market volatility is also increasing. This situation is very difficult for retail investors or institutions.

Is it reasonable to raise interest rates?

The topic "Is it reasonable to raise interest rates?" contains another important argument of Luke , mainly focusing on the two issues of fiscal balance and supply chain improvement.

"Tax Bubble"

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Net Capital Gains (Net Capital Gains) plus taxable IRA distributions are important drivers of US Personal Consumption Expenditures (Personal Consumption Expenditures), while PCE accounts for two-thirds of GDP. Therefore, once the PCE starts to decline, it will be difficult for GDP to rise. When the debt-to-GDP ratio exceeds 125%, this will easily lead to a sovereign debt bankruptcy crisis.

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Since the financialization of the United States in the 1980s, the growth of asset prices, especially stock prices, has become a key driver of marginal consumption and GDP, as well as tax revenue growth. A significant source of net income. Therefore, if the sovereign debt crisis is to be prevented, the Federal Reserve cannot allow the stock market to fall for too long.

But on this issue, the views of most investors and mainstream media are as follows: It's true that higher interest rates have raised the US government's interest expense significantly, but compared to overall tax revenue, it's only a few percentage points above the roughly 12% share that doesn't matter at all.

This is indeed the case in terms of data, but Luke thinks it is reasonable to analyze the rate hike only from this perspective There is a huge problem with sex:

First of all, to get rid of the severe impact of the new crown epidemic, the Fed The Ministry of Finance implemented an unprecedented fiscal stimulus policy, which indirectly or even directly created the "tax bubble" we are seeing now. However, with the tightening of fiscal policy and the increase of interest rates, tax revenue will drop rapidly and substantially.

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Secondly, this huge "tax bubble" will cost nearly 70% on social security alone. Over the past decade, spending in this area has grown at a consistent rate of around 5% to 6%, well above the growth rate of U.S. GDP. In addition, since the outbreak, the U.S. Treasury Department's spending has been increasing, even more so after the Fed raised interest rates, reaching nearly $1 trillion a year.

We do a simple calculation: the current US tax revenue is about 4 trillion US dollars, social security Accounted for 2.8 trillion, the fiscal expenditure minus 1 trillion. When you add up these figures, you will find that the US government can only barely achieve a balance of payments in the presence of a "tax bubble". And that's not even counting defense spending, which is 20 percent of the tax revenue, and when we add that government spending, we have a fiscal deficit.

That is to say, in the past six months, the United States has relied on the multi-decade record Inflation rate, barely maintains balance of payments at the social level. At the same time, the $4 trillion "tax bubble" will quickly shrink in the event of a recession and falling asset prices, dragging the United States into a sovereign debt crisis.  

In Luke's view, facing such a predicament, there are only three ways to go:

1.The Federal Reserve once again turned on the "money printing machine" to avoid default on national debt.

2. The Fed continues to raise interest rates, turning the dollar into a "seller's market". It would also push the dollar higher and drag down other markets. At the same time, as interest rates rise, the U.S. government will also be hit by the double attack of "borrowing costs" and "tax bubbles."

3.The government has cut fiscal, welfare and defense spending. And this is absolutely impossible from a political or economic point of view.

Looking at it this way, it is obvious what the Fed will do in the future. Turn off the tap before the debt crisis. The reason why this has not been done, Luke used a word to explain - "Lightweight". In his view, whether it is Washington or the Federal Reserve, the "short-termism" thinking influenced by the regime has dominated. For them, the current number one task is to control inflation. This is a political demand, and other consequences will not be considered for the time being. It was the same when the "opening the floodgates" two years ago. Only when the mathematical problem of "1+1=2" finally appeared in front of us, did everyone look for the next step to deal with it.

Supply Chain Issues

"Supply Chain" is also a term that has been hotly discussed among macro investors recently. In Luke's view, there are also big problems with the Federal Reserve's attitude towards its domestic supply chain.

First, the Fed sees the supply chain as a short-term cyclical problem. As mentioned above, this thinking is influenced by the US election cycle. From a cyclical perspective, it makes sense to address supply chain problems by inducing a recession. Because as long as the demand is reduced, the supply side can restore balance.

But policymakers did not take into account the current debt crisis in the United States and how such an operation would trigger The possibility of a sovereign debt death spiral. As the U.S. dollar appreciates, U.S. companies will also be severely affected. You must know that the business cycle is the opposite of the US dollar. When profits fall and production and borrowing costs rise, American companies are likely to be forced to lay off workers and increase the unemployment rate. began to appear. The high unemployment rate also means an increase in fiscal expenditures, forming a vicious circle.

Secondly, the existence of supply chain problems actually has strategic value for the United States. Since the 1980s, due to financialization and the need to protect the petrodollar system, the US government has always taken the protection of the interests of the bond market as an important goal in policy formulation. This has also greatly harmed the interests of the American middle class, working class, and even the United States itself. Both national cohesion and manufacturing capabilities are far worse than before.

Longer term, the US needs a supply chain issue because it stimulates investment. This means that policymakers must make it clear that they will liberalize inflation and the dollar, and stimulate industries, manufacturing and other areas to drive GDP growth. But it also means that the government must give up the interests of protecting the bond market.

To get out of the sovereign debt crisis, the United States needs sustained high inflation, and the government must step back and let bondholders bear the loss. But entrenched short-termism has prevented policymakers from confronting that choice, as any sign of persistently high inflation would throw bond markets into turmoil within months. For example, a few weeks ago, there was a "No Bid" situation in the mortgage securities market, and the liquidity indicators in the treasury bond market were also in a suboptimal state. At this time, the Fed will have to step in and implement the yield curve control policy. The result is also high inflation and a weak dollar.

About Energy

Since the conflict between Russia and Ukraine, energy prices have been rising all the way, which indirectly triggered a series of hawkish actions by the Federal Reserve. After the Western government decided to sanction Russia, Luke was the first to point out that Russia can play much more cards than Western countries, and he has also received a lot of attacks on Twitter for this. From policy makers to the mainstream media, we hear that Russia’s GDP is smaller than that of a US state, so Western sanctions are a surefire win.

This is a very low-level error. We know that Russia is rich in oil and natural gas resources and is a major country for energy exports. According to statistics, it takes about 25,000 man-hours to produce a barrel of oil, which means huge value to the global economy. Let’s do a simple calculation again: If the global average man-hour is worth $10, then every barrel of oil produced can bring about $250,000 in value to the global economy, which is almost a “physical characteristic” that cannot be ignored and changed . So when we take Russian oil and gas out of the market, the situation we see is very different from what Western policymakers imagined.

At first, the logic of Western countries was to cut off Russia's income by banning Russia's energy. To be sure, if the world remains polarized like it was after World War II, then such sanctions would work quickly. But in today's multi-polar world, countries such as China and India are already important trading partners of Russia. Therefore, what we have seen is that although Russia's shipments have fallen sharply, due to the shortage of supplies in the energy market, oil prices have risen sharply, and Russia's energy revenue has even created the highest level in history.

Natural resources such as oil and natural gas are the "first principles" of social economy and the cornerstone of the economy. Its impact is far greater than the economic numbers, measured by GDP, displayed on our mobile phone screens. This principle is generally valued among Asian countries, especially reflected in the response to the situation in Russia and Ukraine. But it is a pity that Western countries don't seem to care about this "simple truth". We even see crazy remarks about "restricting the price of Russian oil" and "sanctioning Russian gold" in the mainstream media.

When we look at this issue from a relative perspective, we will find that the West, especially European countries seem to be engaged in "collective suicide". We know that countries such as Germany and France have energy trade with Russia, and previously hoped to further increase energy imports from Russia through the Nord Stream pipeline, in order to get rid of the high price of natural gas imported from the United States and achieve a certain degree of energy independence. Instead, it is now proactively seeking sanctions to ban imports of Russian gas.

Let’s imagine that if Russia closes its natural gas pipelines to Europe, once it enters winter, It is not just the European economy that is affected. In high-latitude countries, heating is a necessary demand, even related to the safety of citizens. While dealing with energy supply issues, Europe is also facing a sovereign debt crisis that has plagued it for several years. In this case, the European Central Bank (ECB) will either print money or default, which will drag down the European bond market either way. The ripple effect would reverberate through the US and ripple through global markets within days, if not hours.

Unprecedented, but not without history

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In recent discussions of macro topics, we often hear analogies from the 1940s or 1970s. But Luke believes that the current macro environment is very complex, and no era can provide us with a clear direction of development. Therefore, what investors need to do is to highlight the differences between them on the basis of comparing similar parts.

70s

In the 1970s, Western countries led by the United States experienced a "stagflation period" of sustained high inflation. Ultimately, then-Fed Chairman Paul Volcker raised interest rates to 20%, beating inflation at the cost of nearly destroying the U.S. economy and establishing excellent credibility for the “petrodollar.”

Just like today, the United States in the 1970s also faced the impact of the energy crisis on the supply chain . Because of this, many people regard the Fed's hawkish style as "Volcker's reappearance." But in the overall macro background, there are still many differences between the two.

The structure is much younger than it is now. Second, at that time, the United States had not yet started the process of full financialization, and the debt-to-GDP ratio was only 25% to 30%, instead of over 120% like today. Also, the government is running a deficit of only about 2% of GDP, compared with 12% at the end of last year.

Therefore, the current United States does not have the conditions to adopt extreme monetary policies like it did in the 1970s. In other words, there is inflation in the 1970s, but there is no ability to fight inflation in the 1970s. But despite this, what we hear from the mainstream media and financial institutions is still: raise interest rates, raise interest rates, raise interest rates.

After World War II

Other people take the 1940s as their Base Case. These people do not necessarily invest in bonds, but they are long-term observers of the bond market, so they are aware of the country's debt problem. After World War II, the U.S. debt-to-GDP ratio also exceeded 100%, and the international market no longer chased U.S. treasury bonds, which is very similar to today.

What the Fed did at the time was to maintain Treasury yields through yield curve control and "Flying" the balance sheet and the inflation rate. Over the next five years, real interest rates in the U.S. remained below negative 10%, and the debt-to-GDP ratio fell from about 110% in 1946 to about 50% in 1951. The Federal Reserve also gradually returned to normalizing policy in the following years.

But again, many of the long-term drivers of GDP growth at the time no longer exist. First of all, the United States after World War II was the only "winner" in the West and even in the world at that time, and it was the largest oil producer in the world at that time. American factories and American workers can be said to be "rebuilding the world." But with the rise of China, India, Russia and Saudi Arabia, the United States has lost its advantage in energy and manufacturing. Even so, the United States in the 1940s experienced years of high inflation and negative interest rates before it emerged from the shadow of debt.

, capital movement is not very free. Therefore, the United States can maintain a negative interest rate policy for a long time without causing market chaos. But now it is completely different. As mentioned above, if the bond market smells of persistent inflation, it will immediately become angry. This is why some people often say: "The Fed is cornered", raising interest rates will lead to a breach of contract, and cutting interest rates will lead to a collapse, and both ends will suffer.

After World War I

In Luke's view, the macro environment after World War I is also similar to the current one. After World War I, most countries in Europe accumulated sovereign debt that they could not repay. The six major industrial powers in World War I: the United States, Britain, Germany, France, Russia, and Japan all devalued their currencies in the next 10 years. Among them, the hyperinflation of the Deutsche Mark is the most famous. Countries that have issued international reserve currencies are no exception. By 1933, the dollar had lost about 75% of its value against gold, from $20 an ounce to $35.

Of course, the political situation faced by Western countries is far less bad than that of Germany at that time. In contrast, it has more similarities with some Latin American sovereign debt crises in the 1980s, 1990s and since 2000, but then again, what these countries issue is not an international reserve currency.

What does it mean for investors?

So, although each era has similar parts to the present, almost every Each case has its own unique variables. However, if we observe carefully, we will find that in most of the cases mentioned above, the bond market has not ushered in a "Happy Ending". Although investors have no losses on their books, their asset values have been greatly depreciated.

Secondly, once a country falls into a sovereign debt crisis, the original economic problems can easily be replaced by political change. For example, today, when Western countries are heavily indebted, they still have to "beat inflation" as their primary political task, creating the biggest drop in U.S. stocks in 50 years; Fighting Inflation" and so on. The biggest feature of politicization is instability and volatility.

The most typical example is the price of Mark against gold during the hyperinflation period of the Weimar Republic in the last century fluctuation. With the mark as the denomination unit, gold eventually rose to one trillion marks. But even so, when you look closely at the monthly price action, there are frequent, large ups and downs. This is because during this period, many people were affected by the political wind and sold gold many times to buy Mark. As an investor, if you use leverage to go long on gold during this period, you will lose nothing within a month.

The End Game

" "End Game" is also a recent buzzword. Will the Fed continue to be hawkish or slow down slowly? If QE is resumed, will inflation reappear? And as stated at the beginning of the article, Luke's End Game is: the Fed will soon be forced to stop raising interest rates, lower interest rates, and implement more quantitative easing to alleviate the US fiscal deficit.

We can observe that since the 1970s and 1980s, the Federal Reserve has raised interest rates every time . A notable feature is that each rate hike is lower than in the previous cycle, and then the Fed will turn on the money printing machine again. In the face of high oil prices, European countries and California have introduced targeted fiscal stimulus.

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In Luke's view, due to the influence of energy and sovereign debt, international geopolitics will also undergo great changes in the next six months. As mentioned above, both Europe and Japan are facing severe energy and debt situation. After the temperature turns cold, it must rely on the support of "American allies", either to provide energy support, or to implement QE and purchase European and Japanese government bonds. But these two issues are very difficult even for the United States itself, which also creates a potential possibility for Japan and Europe to "shift camps".

At the end of the day, what is unfolding before our eyes is an "asset war" between the West and Russia balance sheet race". Obviously, the situation in Russia is much better than in Europe and the United States. Not only does it have enough gold, but it also has a lot of energy income every month, and the West can't do anything about it. Just a few weeks ago, Biden made a special trip to visit Saudi Arabia in the hope that OPEC could increase energy production in order to reduce oil prices and ease inflationary pressures.

As mentioned at the beginning of the article, in terms of the debt-to-GDP ratio of the United States, it has reached The degree of "either inflated or violated". Of course, it is difficult for us to predict whether the US dollar as the world's reserve currency will become a special case, but relying on sustained high inflation to ease the debt crisis is not without precedent in the United States. And if there is no default, it means that the bond market's 40-year "good old days" are over. Therefore, in Luke's view, the Federal Reserve and the European Central Bank are likely to stop raising interest rates in the next three months, return to the era of quantitative easing, and accept the chaos in the bond market.

In terms of views on various assets, Luke also talked about his own thoughts in an interview . He believes that until the Fed "reverses", the dollar will continue to strengthen compared to other currencies, while commodities, energy and gold will also perform well. As far as Bitcoin is concerned, although the current market regards Crypto and technology stocks as a deal, Luke still believes that Bitcoin will soon separate from the stock market and go out of an upward trend more like gold.  

Of course, this does not mean that investors can unscrupulously long gold, bitcoin and other assets. As mentioned above, in an extremely political economic environment, don't use leverage to fight volatility. You don't want to be the second "Looser" who is long Weimar gold.

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