The collapse of asset inflation
will implode all the fiscal and financial promises based on ever-inflating
assets.
Yesterday I explained why Revealing the Real Rate of Inflation Would Crash the System. If
asset inflation ceases, the net result would be the same: systemic collapse. Why
is this so?
In effect, central banks and
states have masked the devastating stagnation of real income by encouraging
households to take on debt to augment declining income and by inflating assets
via quantitative easing and lowering interest rates and bond yields to
near-zero (or more recently, less than zero).
The "wealth" created
by asset inflation generates a "wealth effect" in which credulous
investors, pension fund managers, the financial media, etc. start believing the
flood of new "wealth" is permanent and can be counted on to pay
future incomes and claims.
Asset inflation is visible in
stocks, bonds and real estate:
The sources of asset inflation
are highly visible: soaring central bank balance sheets, credit expansion that
far outpaces GDP growth and ZIRP (zero interest rate policy):
Destroying the return on cash
with ZIRP and NIRP (negative interest rate policy) has forced capital to chase
any asset that offers any hope of a positive yield. As
asset inflation takes off, the capital gains attract more capital (never mind
if yields are low--we'll make a killing from capital gains as the asset
inflates further) which creates a self-reinforcing feedback: the more assets
inflate, the more attractive they become to capital seeking any kind of return.
In effect, gambling on
additional future asset inflation is the only game in town. Institutional
money managers are buying bonds that yield less than zero not because they're
pleased to lose money, but because they anticipate rates dropping further.
As bond yields decline, the
value of existing bonds paying higher interest rises. As crazy as it sounds,
buying a bond paying -0.01% will be a highly profitable trade if the yield on
future bonds drops to -0.1%.
With the cost of borrowing
less than zero once the loss of purchasing power (i.e. consumer price
inflation) is factored in, it makes sense to borrow money to increase
speculative asset purchases to leverage up any gains from future asset
inflation.
Look at how margin borrowing
and stock prices move in lockstep:
The question that few ask is:
what happens to pension funds that need 7.5% annual returns to remain
quasi-solvent when asset inflation turns into asset deflation, i.e. assets
decline in value? Take a look at the S&P 500's rise to the stratosphere
and ponder the monumental losses that would accrue to any institution that
thought asset inflation was a permanent feature of modern life:
There are only two ways to keep
asset inflation alive: one is for central banks and states
to buy up major chunks of all asset classes, i.e. hitting every higher bid
regardless of the risks of such a strategy, and the second is to pay
households to borrow money to chase future asset inflation, for
example, paying households to buy a house with a mortgage:
The insanity of these two
strategies is no hindrance to their implementation. The
collapse of asset inflation will implode all the fiscal and financial promises
based on ever-inflating assets and reveal the unsustainability of the status
quo's strategy of substituting debt and asset bubbles for stagnating real
income.
