Inflation? MEH! Rising Interest Rates? MEH!

I wrote, here 2 weeks ago, how Government Bond yields have been falling and look as if they will continue to do so.  This suggests the Bond markets forecast, at least, falling inflation and, possibly, outright deflation.

Why might they think this?

Well, these are some of the reasons:

  • Aggregate incomes have not been keeping up with living costs
  • The West is increasingly indebted which is not inflationary
  • Many Western countries have multi year lows in price inflation.  Some have record lows.

Another reason is a potential major change in the global economy.  It appears that the Chinese currency, the Renmimbi is falling.  If this continues this would unleash significant deflation for the West.  As Chinese export prices would fall, thus Western consumer prices will fall.

As you see below, the US$ had been falling against the Renmimbi for years.


Not shown but from 2002 to 2005 China pegged their currency at 8 to $1.  By the end of last year, it had risen to c 6 (a c 25% increase in strength).  Since the start of the year, the Chinese authorities have weakened the currency against the US$.

There is building evidence that, investments-wise, 2014 is not 2013.

For years, China’s policy was for a gradually strengthening currency.  This was intended to move the economy from primarily export manufacturing to domestic manufacturing (by means of raising export prices).

China, an overtly planned economy (as opposed to our covert planned economy) realised that its domestic economy, based on investing in real estate, was unbalanced and unsustainable.

To rebalance they have tried to encourage the internal economy by making it more expensive to sell abroad than internally.

The assumption therein is that there is any real strength domestically that can be built upon.  Or was all the Chinese growth just about making and selling goods cheaply for Western consumers?  Increasingly, they were finding there is no strong foundation in the Chinese economy.  And why would anyone expect there is?

It’s a strictly Marxist economy with no political freedoms and vast corruption by the leaders.  Those that say it is a free market are deeply mistaken.

We have been reading, for some while, that the Chinese economy is not so strong as it had been for several years.  So, to try to get back up, there could well be a change of policy under way.  In other words, they may be going back to a weaker currency to encourage exports.

As we know, China exported deflation for some 20 years as our consumer goods became cheaper and cheaper to buy.

It may well be that that exported deflation is returning.  Great for we consumers.  Great for retailers.

Terrible for banks and the Government – who need inflation to keep the status quo.  Falling prices are good for us but bad for them.  Thus, the politicians bailed out the banks and tried to bring in inflation via Quantitative Easing.  The Keynesian economists supported the policies and the media pushed the message.  Of course the reality is what is good for politicians and bankers is the opposite of what is good for us.  One day, people will realise this but it will be too late to be able to do anything to avert another and likely far bigger crisis than 2008.  In fact 2008 was inevitable and they should have let it continue to do its natural (Capitalist) job of clearing out the rubbish in the system.  By stopping it in its tracks the rubbish has got bigger.  For example, the Too Big To Fail Banks are now a multiple in size of what they had been…

So, I continue to suggest disinflation or even outright deflationary pressures are strengthening.

The Western stock markets continue to be lacklustre and this could add further to the pressures.

There is weakness in Western share prices which are not so apparent to those who look only at the Business headlines.  The Small Caps and tech sectors are showing increasing weakness as is the Japanese market and, added to the strength in Govt Bonds, we have reason to expect the major equity markets (eg S&P 500 and FTSE 100) to take a material hit this year.  “Sell in May and come back St Leger’s Day” may well be on the button in 2014.  Certainly, historically, Summer equity investing has proven a wealth reducer.

Look at US Small Caps v Large Caps:


You see that the Small Caps’ valuation has been falling relative to the large Caps, since January – entirely the opposite of 2013 and since the Summer of 2012.

The same has been happening with the NDX 100 Large Cap Tech index.

If this continues then it may develop into what happened in 2011, when the S&P fell c 20% and tech stocks and Small Caps fell more.

As an aside, we are now within sight of an entire year with the UK FTSE 100 not reaching higher levels.  It will be May that we may see that 12 month period.  Hardly positive for share prices.

We remain bearish on Western share prices and bullish on Government Bonds.

2014 looks as if a major reversal of what has been will occur – Western shares down, Govt Bonds and many commodities up.


Nothing in these articles can be taken as financial advice.   Neither Jonathan Davis nor Jonathan Davis Wealth Management will be held responsible for action taken or not taken from reading these articles.

We recommend investors seek bespoke advice before acting.

Copyright Jonathan Davis.

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2 Responses to Inflation? MEH! Rising Interest Rates? MEH!

  1. Anonymous says:

    Hi JD

    Correct me if I’m wrong but looking at some of your articles you seem to suggest “we’re toast” because the debts can’t be paid. Either we have higher inflation and rates or it’s the Japanese deflationary death spiral.

    But UK debt to GDP has been much higher before, about 240% after the second world war I think

    Don’t they usually manage to get out of the problem through a combination of inflation/devaluation (ie theft) and GDP growth?

    Why is this time different?

    • That was Govt debt. Total debt now is far higher at c 500-600% GDP.

      Either base rate goes to 0% and we’re toast or they rise for 2 decades and we’re toast. See The End Game post

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