Author Topic: Monetary expansion leads to assets prices increases instead of consumer prices  (Read 858 times)

Mael

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Hey,

I've been thinking about this note from a french economist  :
https://research.natixis.com/Site/en/publication/2OE7qJ9lpcWLT05l21BHRQ%3D%3D?from=share

He basically says he believes monetary expansion is causing bubbles in stocks and housing markets instead of inflation in consumer prices like it used to, and that it is a tax on those who buy these assets.
I am concerned as I am still building my stache and buying stocks every month. What concerns me is that I am not sure we can rely on data from 1870 like cfiresim provides or on the 4 % rule, as central banks changed the rules of the game when they needed to increase their balance sheet after the subprime crisis because they reached the zero lower bound on the rates.
I still feel that keeping a decent savings rate and putting all those green employees to work by buying stocks is the best course of action, but I don't know what to think about this idea that monetary expansion that is happening now is a tax on those that buy assets, and whether we can still rely on the last 150 years of data with these changes of monetary policy. The risk of central banks reducing their balance sheet and causing bear markets seems new to me. I'd be sad if it happens when I need to sell stocks to live. I still think that we are better off living in the present than in the past ... as long as earth copes with climate change.

I'd really like to know what the MMM community thinks about that.

MaŽl

celerystalks

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Raising asset prices is not necessarily a bad thing.

It keeps interest rates low which results in lower borrowing costs.

And high stock prices allow companies to raise capital through equity transactions.  The number of shares of stock for any given company is not static.  After the IPO, a company can issue more shares and sell them to the market at the market price. The company is essentially selling a piece of itself to do this, so it benefits existing share holders if the price is high rather than low.

Allowing businesses to raise capital cheaply facilitates business growth which expands the means of production and helps bring products and services to market cheaply. High asset prices is a signal that the market is being well supplied.

High inflation in consumer prices is not a good thing since it squeezes people at the margins of society the most.  It also usually precipitates higher labor costs which reduces the profitability of companies.


DalioGold10

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This is my view as well, i.e. the central banks acquisitions of financial assets has led to inflation of these assets (today S&P 500 crossed the 3,000 benchmark despite the highly uncertain economic reality of 2020 and even 2021) and avoidance of a prolonged bear market in stocks (which might return if we see COVID-19 second wave in fall or heavy bankruptcies and defaults in the coming months) .
As of today, estimated future returns for stocks are low relative to history due to high valuations (driven by low interest rate and central banks intervention).

How can you continue to invest and still sleep well at night ?
Diversity away from heavily stocks portfolios. Your portfolio should include fairly allocations to managed futures, gold and other alternative assets. I would stay away from the usual "financial advisors" who preach for 90% to 100% stocks portfolios due to their income producing nature. Sure, this is the best idea as stocks is the best performing asset class but this happens over decades. If a 1929 bear market happens again, you will not be able to enjoy your hard earned money for a long time.

The role of a diversified portfolio is to allow assets classes to have weak to even low correlations in order to reduce volatility and still deliver a decent return. Please google the sequence of withdraws risk and notice this is a nightmare for retirees having their portfolio heavily invested only in stocks and bonds (there were historical periods when bonds were highly correlated to stocks).

With respect to the 4%, withdraw rate, my take is that we should aim for a higher nest egg, i.e. around maybe 30x of our annual expenses and not just 25x.

waltworks

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People have been saying this for more than 20 years. They may or may not eventually be right.

Invest for the long term, pick an AA you are comfortable with, and set/forget. There's no magic alternative out there that is a better bet.

-W

EscapeVelocity2020

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It's been an interesting ride since QE took off in 2009.  Unfortunately, it was so successful that it is now the favored tool of the Fed.  On one hand, it 'saves value' by staving off economic collapse and liquidity issues becoming solvency issues...  but the article is right, there is an unintended consequence of moral hazard - businesses that are failing (and many that should fail) are getting showered with money which mostly enriches the already rich.  It also slows the creative destruction that makes for a vibrant, exciting, resilient economic landscape.  Although the 90's had an internet bubble created by low rates, there was a lot of innovation and risk-taking.  The 2000's, with all the bubbles and high markets, has struggled to produce anywhere near the market innovations and small business opportunities of the past. 

But there's not much you can do about it as a young person trying to reach FI.  Maybe invest more in yourself and build up passive income streams as opposed to relying so much on historical total return and bond yield.

LoanShark

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Interesting thread. The "TINA" acronym comes to mind - There Is No Alternative.

Maenad

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High inflation in consumer prices is not a good thing since it squeezes people at the margins of society the most.

Exactly. I have no problem being "taxed" in this way, after seeing what my working-class parents dealt with in the early 80s.

As to the validity of historical data... maybe? I started investing in 1997 when I got out of school and started working, so I've seen a lot of "this time it's different", both on the upside and on the downside. I've seen a lot of people claim that they had the One True Answer, and most of them were dead wrong.

If you're early in your journey, your focus should be on finding an asset allocation that lets you sleep at night, increasing your income, and cutting expenses. Look up mitigation strategies for Sequence of Returns Risk, and pick one. I'm using a bond/cash tent, for instance, which is paying it's way quite nicely since I retired in March and this has been an... interesting spring.

For some perspective, look over all that has changed in the last 50 years. Now realize that your retirement will have that many changes in it. The article you referenced may be correct, and the Central Banks may change things again 5 years from now and it'll go back to the way it was. Many of these things can't be predicted or controlled by little people like us, so try not to spend too much time worrying about it.

J Boogie

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Can't help but think of dramatic Fed activity as totally screwing over Gen Z and some younger millenials who have yet to get enough of a foothold to have some invested assets, as well as the self-employed/small business employees who never had an opt out 401k contribution set up.

Young people find the best opportunities in cities where they can't afford to own a house, and ok, it's not necessarily a good investment for them anyways - fine. But it's the automatic savings plan that has been a remarkable wealth building device for everyday people for years.

Couple that with the fact that many will have to buy health insurance on their own, which often costs 2-5x what corp employees pay, and you can see the fault lines open up as the years go by. Corp employees will be fine, the few talented and financially savvy entrepreneurs out there will be fine, and everyone else will be check to check for life.





ChpBstrd

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I've been thinking about this for a while now too. The U.S. has a "neat trick" in that it produces the worldwide reserve currency, which is so in demand by the rest of the world that the U.S. can simply produce more currency to float out recessions and prevent depressions and the dollars get absorbed without raising inflation. This has led us to go well beyond the ideas of Keynes, who proposed a balanced budget in the long term. In 2008, the government dipped a toe in asset purchases, taking on billions in mortgages and bonds. In 2020, the government started taking stakes in corporations, dropping helicopter money (which used to be a joke among economists), and giving direct handouts to corporations, particularly the politically well-connected, via forgivable loans, asset purchases, and tax deferrence. This brings up 3 observations:

1) Since the U.S. economy grew at a historically mediocre pace of about 1-3% a year for most of the last 20 years WITH THE BENEFITS of a vast monetary expansion, dramatic tax cuts, falling interest rates, run-up of the national debt, and with massive asset purchases by the government, we can conclude that it probably would have grown even more slowly, or even negatively, without these extraordinary influences. The well-publicized declines in middle-class purchasing power in recent decades would have been even worse. Had the national debt not gone from $5.7T in 2000 to over $25T and climbing in 2020, our GDP might not have increased from $10.25T to $20.5T in that same time. What this means is that the U.S. economy may no longer be competitive enough to maintain a positive long-term growth rate on its own, without fiscal support from the mass-production of reserve currency. Dollars are the United States' main industry and export and we would have had two decades of falling living standards had we not mortgaged the future. This is similar to how a person living beyond their means can continue to live beyond their means as long as home equity lines of credit are available.

2) Purchases of corporate bonds and even shares could be characterized as slow-motion nationalization (still waiting for the howls about communism from the conservatives who were howling in 2008). The Fed tried to start offloading some of its assets and raised interest rates a couple of years ago (quantitative tightening), but the experiment was called off due to the more-severe-than-expected economic repercussions. That is, the economy could not absorb even a modest addition of assets / the removal of liquidity without going into an almost-recession. Think about that. Once the government buys assets in the private market, it cannot seem to sell them without triggering a contraction and declines in asset prices.

3) Inflation, measured as the change in prices of goods and services, has remained modest thanks to (a) imports from countries where USD are in demand, and (b) falling real wages. Inflation will likely remain low as long as those 2 conditions continue to be met. Four months ago, I was thinking that condition (b) might be violated because unemployment was so low and it seemed like a matter of time before wage pressures built. Before that, I was thinking that condition (a) might be violated in a limited way due to the tariff wars. Now I think pressure has eased on both fronts. People outside the U.S. want dollars now more than ever as they watch their own governments print currency. For non-reserve currencies, this often results in rising inflation, but not for the USD. The US will likely experience deflation this year, so everyone wants USD. It's a circular feedback loop. But can it last forever?

Ray Dalio traces these phenomenon to a historical cycle where economically dominant empires fall when they are so burdened with debt that their reserve currencies lose favor. This usually comes after a few decades of complacency, internal division, wasteful colonial wars, and declines in education, diplomatic clout, and military power. Yet, I don't think we can say whether the collapse of the USD as the world reserve currency occurs next year or 50 years from now. This cycle, if it exists, could outlive us all. Similarly, we can't say whether a debt-to-GDP of 200% represents the start of collapse or if it was 100% or if it will be 300%. But if Dalio is right, then the rules that would have worked in the past during an empire's ascendancy (e.g. 90/10 portfolios, 4% WR) might not apply in the new context of imperial decline.




kenmoremmm

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^ 2 thumbs up!

Mael

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Thanks a lot for these very interesting answers and advice.

I googled Ray Dalio and have started reading this webpage : https://www.principles.com/the-changing-world-order/
where the question seems to be well developped.

If the US empire were to go down, it might be good to have enough diversification across countries not to miss the rise of a new empire (hopefully this new empire will take our green employees and let them work just as the US did in the last century). That would go against Buffet remark that it might be enough just to buy US ETF.

I have been overinvested in my domestic stock market because against all advice I felt that keeping gross dividends in tax advantaged accounts seemed better than holding lots of international stocks but losing withholding tax on dividends, and I would have been better off with more SP500 (but I think it's mainly because of the high weight of the IT companies in the US stock market).

I am lucky to have a decent pay with high job security, to have already enough for barebone FI, to own my house (good for me if prices were to go up), close to work, still with a big fixed rate mortgage (good if inflation were to wake up). I guess I am comfortable with my high stock allocation because of my high job security, because I did not set my mind on a specific FI date yet, and because I did not loose any sleep when I saw stocks going down in march and lost years of income (I only felt that it was on sale and wanted to buy more, but not on margin).
Eventhough I might not change anything in my plan, I think that keeping in mind that central banks can have so much impact will make me more humble when I look at my spreadsheet that goes as far as 2070's. I guess I will try not to forget to live and enjoy the present, while saving a part of my paychecks.