Taps Coogan – December 3rd, 2020
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Regardless of what one thinks should theoretically happen vis-a-vis inflation and deflation, Mr. Boockvar points to a growing pile of data that shows that inflationary pressures are building: rising food prices, PMI survey responses, rising housing prices, rising transportation costs, etc… As Mr. Boockvar argues, this is important to markets because the moment that central banks are no longer fighting deflation, the favorable cost-benefit analysis of endless stimulus evaporates, and so does the case for high valuation multiples predicated on that stimulus.
The real head-scratcher for investors is this: if inflationary pressures rise too high and force the Fed to tighten policy, that would presumably tank markets and subsequently the economy. But falling markets are highly deflationary, eliminating the inflation problem and allowing the Fed to return to stimulus, starting everyone back at square one. All the while, the repeated stimulus leads to over-indebtedness which is structurally deflationary.
If that seems like a inescapable loop, that’s exactly why inflation has been falling for 35 years and the Eurozone and Japan have been unable to get out of the negative interest rate trap despite years of stimulus far in excess of the Fed’s.
Seemingly, the only way out of that deflationary loop would be if central banks promised (and markets believed) that they would continue delivering stimulus even if inflation rose above target. Coincidentally, that is exactly what the Fed is now promising to do.
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