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Fiscal Policy for an Uncertain World

By Vitor Gaspar, Sandra Lizarazo, Paulo Medas, and Roberto Piazza As public debt rises to record levels, countries need to calibrate fiscal policies to…

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This article was originally published by IMF Blog

By Vitor Gaspar, Sandra Lizarazo, Paulo Medas, and Roberto Piazza

As public debt rises to record levels, countries need to calibrate fiscal policies to their own unique circumstances.

Vaccination has saved lives and helped economic recovery in many countries, but uncertainty remains high amid new virus variants. The pandemic will leave a lasting mark on inequality, poverty, and government finances, our latest Fiscal Monitor finds.

With the pandemic, global debt in 2020 jumped by 14 percent to a record high $226 trillion. This figure includes both public and nonfinancial private sector debt. The latter will need to be monitored carefully, as excess private debt can eventually turn into higher public debt.

The pandemic will leave a lasting mark on inequality, poverty, and government finances.

Public debt now amounts to $88 trillion, a value close to 100 percent of GDP. In 2021 and 2022, public debt is expected to decline by about 1 percentage point of GDP each year; after that, it should stabilize at about 97 percent of GDP. As debt rises, countries will need to calibrate fiscal policies to their own unique circumstances, including the rate of vaccination and strength of the recovery.

A brighter spot—but not for all

Country circumstances vary significantly between and within income groups and so do fiscal policies.

In advanced economies, fiscal policy remains supportive of economic activity and employment. In these countries, fiscal policy is shifting away from pandemic emergency and lifelines. It is already moving to public investment to facilitate a green and digital transformation. Some policies will also make economies more inclusive. In the United States, for example, some budget proposals aim to reduce inequality and could cut poverty by nearly one-third.

Fiscal policies are also relevant globally. The large packages announced by the European Union (Next Generation EU Recovery Plan) and the United States (American Jobs Plan and American Families Plan), for example, could add a cumulative $4.6 trillion to global GDP between 2021 and 2026 if fully implemented.

Emerging markets and low-income developing countries face a more challenging outlook as large portions of the population remain unvaccinated in many countries. In addition, the crisis is expected to have long-lasting negative impacts and lead to a reduction in fiscal revenues relative to pre-pandemic trends, especially in low-income developing countries. This will make it more challenging to pursue the development agenda. Already more limited than in advanced economies, fiscal support is waning further due to tightening financing constraints. Governments will need to continue to prioritize health and protect the most vulnerable. Despite economic improvements compared to the worst of the crisis, an estimated 65–75 million more people will fall into poverty at end-2021 than would have been the case without the pandemic.

Risks mainly stem from virus variants and low vaccine coverage. Large debts and government financing needs are also sources of vulnerability. Borrowing costs are already increasing, as central banks in some emerging market economies have started raising interest rates to stave off inflation. Moreover, there is the risk of a sudden rise in interest rates in advanced economies. This would put pressure on financing conditions, which would have an especially detrimental effect on highly indebted and financially fragile countries. On the positive side, greater efforts to accelerate vaccination across the globe would increase growth prospects and boost public finances.

Building resilience, strengthening cooperation

Amid the uncertain outlook and sizeable challenges to public finances, governments need to act on several fronts:

Calibrate policies to the pandemic and to economic developments and prospects. Support should be unwound gradually, and fiscal actions should aim at containing risks to public finances and at preserving price and financial stability.

Prioritize the transformation of the economy to make it smarter, greener, and more resilient and inclusive. This means greater investment in physical capital, education, and social safety nets, as well as more support for retraining and reallocating workers to new and better jobs.

Gradually increase tax revenues where necessary and improve the efficiency of spending. These steps are all the more urgent in low-income developing countries given the prospects for a persistent fall in revenues, which could reduce available financing for achieving the Sustainable Development Goals.

Strengthen the credibility of fiscal policy to create room for further support in the short term without jeopardizing public credit. Emergency spending needs to be accompanied by measures that ensure transparency and accountability. Medium-term fiscal frameworks can reassure lenders that governments are fiscally responsible and lower financing costs.

Although the international community has provided critical support so far to help alleviate fiscal vulnerabilities in low-income countries, more is needed. The IMF’s recent General Allocation of Special Drawing Rights contributes to international liquidity. Its beneficial effects can be amplified if higher-income economies could channel some of the resources gained through the SDR allocation to low-income developing countries—and in this way, contribute to sustainable development. But with the expiration at end-2021 of the Debt Service Suspension Initiative—which offers a temporary suspension of official sector debt payments for qualifying low-income countries—ensuring the effective functioning of the G20 Common Framework to provide debt relief will be essential to helping the world’s poorest and most heavily indebted countries cope with the continued fallout of the COVID-19 crisis.


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3 Stocks to Buy for Rising Inflation and Slowing Growth

The post 3 Stocks to Buy for Rising Inflation and Slowing Growth appeared first on Millennial Money.
What happened to the stock market’s rally? Through…

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The post 3 Stocks to Buy for Rising Inflation and Slowing Growth appeared first on Millennial Money.

What happened to the stock market’s rally? Through the end of August, both the S&P 500 and Dow Jones Industrial Average exceeded full-year returns in 2020. The S&P 500 even reported 53 record closes through August, putting it on pace for the most record closes ever. 

But we all know stocks can’t go up forever and quite a few investors were expecting a September sell-off. That’s understandable: since 1950, all major indices have averaged negative returns during the month in what’s known as the “September Effect.” In a case of history repeating itself, the Dow Jones dropped 4.3% and the Nasdaq fell 5.3% last month. 

However, it wasn’t a market anomaly that led to the September sell-off, but rather increasing fears of “stagflation”—rising inflation and slowing growth.

3 Stocks to Buy for Rising Inflation

Here are three stagflation stocks to buy this fall.

  1. McDonald’s
  2. JPMorgan Chase
  3. ExxonMobil

McDonald’s (NYSE: MCD)

The inflation-proof, unique business model of McDonald’s

  • McDonald’s (NYSE:MCD)
  • Price: $238.44 (as of close Oct 21, 2021)
  • Market Cap: $180.277B

Although shares are up more than 110% in the last five years, McDonald’s Corporation is well situated to outperform the market in a stagflationary environment. To understand its rare opportunity, it’s important to properly understand their business model. 

Most investors believe the company is a restaurant operator when they are really a restaurant franchisor and, more aptly, a real estate juggernaut. In the United States, approximately 95% of all restaurants are franchised, and those franchises provided 60% of the McDonald’s revenue and a whopping 85% of its margins in the most recent quarter.  

The difference is key when you consider a stagflation environment. McDonald’s charges its partners both rent and a royalty that are paid for in the form of a percentage of sales. According to the Service Employees International Union, these two charges total 15% of gross sales

Gross sales are the key words above. McDonald’s revenue from franchises is based solely on the top number—not on profit. That means the company’s business model mostly avoids the cost of higher labor, food, and packaging in its cost of goods while price increases by its franchisees are directly captured by the company. Simply put, the company is a winner in an inflationary environment! 

McDonald’s doesn’t want its franchisees to suffer and adds value to its restauranteurs in the form of its strong domestic supply chain and buying power. As a result, McDonald’s will be able to keep food inflation in check and avoid stock-outs for its franchisees more than mom-and-pop restaurants. It’ll also avoid food inflation in contrast to grocery store prices, which makes it a more affordable option than competitors and consumer substitutes like cooking and eating in the home.

On a competitive basis, fast food is in a sweet spot during a stagflationary environment. Rising prices at higher-cost fast-casual restaurants will benefit a cheaper option like McDonald’s. 

Full-service restaurants that depend upon more waitstaff and other labor providers will be understandably challenged when pitted against a QSR giant like McDonald’s. Stagflation, as defined by rising labor and product costs along with consumers carefully watching their wallets, puts McDonald’s in a rare sweet spot in the restaurant industry. 

JPMorgan Chase (NYSE: JPM)

JPMorgan Chase is a best-of-breed pick in a strong industry

  • JPMorgan Chase (NYSE:JPM)
  • Price: $171.78 (as of close Oct 21, 2021)
  • Market Cap: $500.923B

Mark Twain once quipped, “history doesn’t repeat itself, but it often rhymes.” If we’re hit with a bout of stagflation, look for best-of-breed financial institution JPMorgan Chase & Co. to benefit from policy decisions. 

In 1979, a year in which inflation ran 11.3%, President Jimmy Carter appointed Paul Volker to run the Federal Reserve to “slay the inflation dragon.” Volker’s Fed did the unthinkable, pushing federal interest rates briefly above 20% (mortgage rates reached as high as 18.5%)!

While it’s unthinkable to believe that rates will have to be raised anywhere near that level, what is clear is higher rates help banks across the board. 

Conceptually, it’s easier to think of banks as “spread managers” in their core banking functions. They pay depositors interest on their short-term checking and savings accounts, while lending the money out at higher rates for longer-dated car, home, and personal loans. 

The difference earned between these two rates, or spread, is what’s referred to as net interest income. Because rates tend to rise more with duration (length of loan), banks generally benefit from rising rates as the net yield expands.

For the last few years, the exact opposite has occurred, and JPMorgan has seen its net interest income continue to decline. In the quarterly report released this week, the company announced that it expects net interest income of $52.5 billion, down $2 billion from the prior year on account of continued falling rates. 

However, in a bout of good news, this figure beat analyst expectations during the quarter as the recent uptick in rates helped results. As rates increase across the board—as they have been in recent months—look for JPMorgan’s net yield to rise and for the stock to benefit. 

Stagflation isn’t all good news for JPMorgan. Slowing economic growth could hurt both the company’s corporate and personal loan portfolio, if loan defaults pick up, along with non-interest activities like IPO and bond underwriting. The latter of which is becoming increasingly important: as of the recent quarter, non-interest revenue was 56% of JPMorgan’s total top line. 

However, the bank has its pick of the best borrowers with strong personal balance sheets. As such, JPMorgan’s loan portfolio will hold up significantly better than regional and local banks. 

As a bank, the company will mostly be inoculated from rising costs due to global supply chains and other input cost increases. The financial sector should do well in an inflationary environment, but JPMorgan remains a best-of-breed pick in the sector.

ExxonMobil (NYSE: XOM)

ExxonMobil still has room to run

  • ExxonMobil (NYSE:XOM)
  • Price: $63.12 (as of close Oct 21, 2021)
  • Market Cap: $265.402B

Let’s get this out of the way: ExxonMobil’s execution has been lacking for years and shares now sit 20% lower than they did a decade ago. The company has been faulted for being slow to embrace green energy and doubling down on fossil fuels, which have become more expensive to extract and discover while prices remain stagnant. 

The last few years have seen the limits of Exxon’s myopic strategy. In the last year, management had to issue billions in debt just to pay its dividend and maintain its status as a Dividend Aristocrat. Even so, it still lost an embarrassing board proxy vote against small activist investor Engine No. 1, despite the latter only owning 0.2% of Exxon shares. 

Still around? Good. Against that backdrop, you might not expect that ExxonMobil is one of the best-performing stocks in the S&P 500 this year as shares have advanced nearly 50% year-to-date (on top of a juicy 6% dividend yield). 

The company is taking advantage of the recent reversal in natural gas and oil prices, both of which have doubled in the last one-year period. Commodity producers like oil have a long history of being able to outperform in an inflationary environment and this time is no different. Simply put: your pain (at the pump) is Exxon’s gain.

There are reasons to believe oil prices will remain elevated. As noted earlier, the stagflation of the 1970s derived from oil shortages and price spikes when a faction of OPEC countries decided to embargo exporting oil to the United States for political impact. 

For different reasons, OPEC again decided to limit production for price stability last year amid plummeting demand. While there has been some agreement to raise production levels, OPEC appears to want to keep prices at higher levels to make up for lost revenue during the pandemic. 

The winners under this scenario are the large integrated majors like ExxonMobil that can take advantage of all facets of rising prices for oil, gas, and the various chemical distillates. In the second quarter the company reported a $4.7 billion profit—a significant improvement over the $1 billion loss in the year-ago period. While its debt level remains elevated, it appears Exxon is out of the woods and will be able to continue paying its dividend.

It’s unlikely ExxonMobil will experience the negative effects traditionally associated with stagflation. Normally, a slowdown in economic activity would result in less demand for oil, but the pandemic wasn’t a normal economic environment. America and the world will continue to reopen and resume travel, which should rise from current lockdown-era levels even if the economy slows.  

Instead, the biggest argument against ExxonMobil is that the company missed the boat on embracing clean energy and new technologies like EVs will impact future results. While admittedly this would be a positive for the environment and climate change, the simple fact is a shift away from fossil fuels will take much longer than most people expect. 

In fact, the International Energy Agency estimates that the global demand for oil could rise to 104.1 million barrels per day in 2026, up 8% from 2021 levels. And even then it isn’t that demand will crater. Instead, experts forecast a plateauing and slow decline from 2030 onwards. This gives ExxonMobil ample time to pivot to new means of energy production. And the company has the scale and knowledge to buy or build a clean-energy business. 

That 70s market

Stagflation might sound funny, but the consequences are serious. The word is a portmanteau for slow/sluggish growth, aka stagnation, and inflation. This condition doesn’t happen often—most recently in the 1970s—but the latest conditions are hinting at a return. 

After the consumer price index rose at a 5% (or more) annual clip for four straight months, Fed Chair Jay Powell admitted inflation has been elevated longer than anticipated. At the same time, growth forecasts continue to be downwardly revised, most notably by Goldman Sachs—its third consecutive month of cuts.  

In a nutshell, stagflation is bad because policy choices are limited. Normally, inflation and economic growth move together, which makes policy choices directionally in alignment—under stagflation, they aren’t. This makes policymakers choose between raising rates to beat inflation, which further limits growth, or letting inflation continue to spiral in hopes the economy will pick up. 

If history is any indication, stagflation could continue for the foreseeable future. The stagflation of the 1970s was driven by a “supply shock” of steepening oil prices (at that time, we were more dependent upon imported oil). The good news is that we now produce more oil and natural gas domestically (see: stock No. 3), but the downside is we manufacture much less of everything else we consume. 

The import supply chains broke during the COVID-19 pandemic and we’re now in a situation where thousands of ships full of goods are piling up at ports. Therefore, our “supply shock” isn’t just oil but everything else and it’s unlikely our Federal Reserve can fix this through monetary policy, at least in the short run.  

Stagflation Returns 

We’ve established that stagflation is terrible for the economy, but what about investing? 

As you might have noticed, stocks don’t always follow the economy (the pandemic being a recent and salient example). Economic activity fell off a cliff while the stock market exploded. Meme stocks like AMC Entertainment and GameStop continue to struggle operationally but have seen their stocks “moon” as message board traders buy shares hand over fist.

Unfortunately, stagflation isn’t one of these times. The chart below gives returns for the S&P 500 during the years 1973-1982, generally known as the stagflation era. At first glance, the S&P 500 returns are on the lower side with an average yearly return of 3.6%. 

Considering inflation during the average year was 8.8% during that period, the real return (read: returns above the level of inflation), this was one of the few long-term periods in American history in which stocks did not beat inflation. 

If one considers inflation as the “hurdle rate” of returns—which makes sense because the key reason to own stocks is to offset the impact of inflation—the stagflation era was a terrible period for stock returns. 

Put another way: the S&P 500 not only underperformed its long-term growth rate of 10%, but shockingly provided negative real returns in half of the decade!

If you feel stagflation will continue, it’s clear you must be smart with your investments. At a high level, it’s a good idea to avoid stocks that are highly exposed to global supply chains and economically sensitive companies unable to pass along rising costs to consumers. 

This is why we recommend these companies with strong brands and revenue models aligned with inflation. They could be savvy investments for our stagflationary times.

The post 3 Stocks to Buy for Rising Inflation and Slowing Growth appeared first on Millennial Money.

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Precious Metals

Why Authoritarianism Must Prevail

Why Authoritarianism Must Prevail

Authored by Robert Wright via The American Institute for Economic Research,

Freedom anywhere is a threat…

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Why Authoritarianism Must Prevail

Authored by Robert Wright via The American Institute for Economic Research,

Freedom anywhere is a threat to authoritarianism everywhere. That is why authoritarians must destroy all freedom and why liberty lovers, and even the merely “lib-curious” (liberty curious), must not just resist blatant authoritarianism, but reject it in all its guises. The fate of the nation, and the world, again hangs in the balance.

To the extent that any freedom persists, authoritarian diktat can be subverted, albeit at a cost. History is rife with examples of bizarre entities, like nonbank banks (I kid you not!), rent-a-banks (ditto!), and gold caches, designed to work around branching restrictions, usury laws (maximum interest rates), the criminalization of holding gold, and sundry other attempts to limit financial freedom. (See my Financial Exclusion for details.)

To squelch “undesirable” activity, like increasing bank competition, voluntarily lending/borrowing small amounts of money at rates commensurate with the attendant costs and risks, or trying to protect one’s family against fiat money inflation, government must outlaw the workarounds too. To get their way, statists must suppress all unapproved activities, which ultimately means forcing would-be innovators to obtain permission before they can lawfully engage in any new activities.

Consider, for example, recent calls to allow the IRS to monitor essentially all bank accounts in the country. Maybe Americans will accept it, if, as claimed, the power is only used to enforce current tax laws. But if tax rates rise appreciably, as it seems they will, given the current administration’s policy goals, or if the transaction information is used for partisan political purposes, or to shame or coerce people into buying this, or not buying that, Americans will begin to search for workarounds. To the extent that the workarounds prove successful, government will be forced to outlaw the workarounds too.

For instance, if workers ask their employers to pay them in Federal Reserve Notes or Bitcoin because they believe that the transaction costs of making payments in those media will be less burdensome than giving some party hack access to the most intimate details of their lives, the government may well force employers to pay workers only in USD and only via bank transfer. It might even ban cryptocurrencies entirely, or at least try to.

Workers might then make one payment per month, to a “bill paying service” that for a fee will pay their bills for them, out of its one, giant bank account. Oh, but that sounds like an unregulated bank taking uninsured deposits so those services will have to be suppressed as well, or perhaps replaced by the central bank.

People may then begin paying everything by credit card, and even direct their employers to repay their credit card issuers directly. Next thing you know Uncle Sam will want to see your credit card statements too. Ditto PayPal, Venmo, and any other fintech apps used to make or receive payments. Thus a seemingly innocuous request to see bank accounts for tax purposes becomes the excuse for full-blown financial repression. This will, as always, hurt the poor the most.

Employers might work around those laws, along with the tax code and vaccine mandates by converting their employees into volunteers and donating payroll to a nonprofit charity with the singular mission of ensuring that the “volunteers” receive “donations” that happen to match the value of their former compensation. Imagine the chaos if every employer simultaneously did that! Government would have to respond by tightly regulating, if not outright outlawing, charities and volunteer work. Our liberty would be truly lost at that point, and again the poor would suffer most.

Corporations shouldn’t be taxed, but they are. Many of the largest have engaged in (international) tax arbitrage by adroitly shifting headquarters, production facilities, and charters between different states, provinces, and countries. Governments are now fighting back by establishing a global minimum corporation tax. How long before some entity begins to offer oceanic or orbital (then moon, then Martian) charters as tax havens? Soon after, though, private space flight and oceanic colonization will likely be banned or heavily restricted.

Everyone should be aware that if an international gold ETF issuing bearer shares, (a sex worker-owned substitute for OnlyFans), a parallel university system, or anything else of import that runs against the woke or statist grain begins to gain commercial traction, regulatory hammers will swiftly bludgeon the innovators into compliance, or out of existence.

Were that all! When statist solutions to perceived “problems” create real problems, the call inevitably goes out for yet more government. When pressed about how to pay for UBI (various universal basic income) schemes, for example, schemes that are purportedly needed to solve a nearly nonexistent income disparity “problem,” proponents will sometimes argue for the establishment of a Sovereign Wealth Fund (SWF, or a giant investment fund owned by a government), the dividends and realized capital gains of which can be divided equally among the citizenry. 

UBI proponents are not sure where the money to fund the SWF will come from, or if it is a good idea to concentrate all that economic and political power in one decision maker’s hands, but if you want to see their true colors, ask them why individuals cannot simply invest their own money for themselves. Turns out that elites believe that most Americans don’t know how to invest properly, in the “right” (which is to say Left) companies. So look for a push to outlaw individual investment in favor of a SWF-funded UBI, or at least a narrowing of choice to SEC-approved ESG funds. You may still own something in 2030, but it seems increasingly unlikely you will be happy.

America and the rest of the West have been sliding down the slippery slope of statism for so long that they are now rapidly approaching the precipice that ends in rock bottom. Will liberty be crushed and a new dark age commence? Or will the masses then finally see governments as the problem, rather than as the solution?

Tyler Durden
Fri, 10/22/2021 – 21:00

Author: Tyler Durden

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The ‘Maestro’ Is Why Jay Powell Keeps Seeing (inflation) Ghosts

See, this is backward. And while it may seem overly pedantic, getting it right is actually a crucial insight (lack thereof) into pretty much everything….

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See, this is backward. And while it may seem overly pedantic, getting it right is actually a crucial insight (lack thereof) into pretty much everything. Its purpose is to maintain a different sort of money illusion (the original relates to how workers focus on nominal rather than real levels of compensation). This other money illusion relates to the hidden nature of money itself.

We’re told central bankers are it, therefore everything must be related to central bank monetary policy. If the dollar’s falling, the Fed accommodated. If it’s rising, Fed tightening. Rates go down because, everyone says, Jay Powell bought bonds. Yields go up because of rate hikes after the bond buying is over.

You go to the bathroom in the middle of the night, the FOMC must’ve voted for it.

It all goes back to before Greenspan, though it was the “maestro” who most clearly articulated the gross illiteracy and unsupported conceits behind much of Economics.

CHAIRMAN GREENSPAN. It’s really quite important to make a judgment as to whether, in fact, yield spreads off riskless instruments—which is what we have essentially been talking about—are independent of the level of the riskless rates themselves. The answer, I’m certain, is that they are not independent.

Risky spreads are, according to this view, in a sense controllable from monetary policy even from only the short end. Why? Because all riskless rates, Greenspan also said, were nothing more than a “series of one-year forwards.”

It was, in theory, all so easy and neat; the Fed from its single position could conduct all the instruments in the symphony as it wished, however and whenever wished. Thus, maestro.

Why, then, all the constant “conundrums” and “inflation puzzles” ever since? Dear Alan said he was certain, and he’s certainly been wrong.

The yield curve is no series of one-year forwards, nor are risky spreads utterly dependent upon hapless Economists at the Fed (see: swap spreads, as a start). Those at the Fed instead have repeatedly shown they have no idea how even short run interest rates work (see: SOFR) which means they can’t be literate in money like economy.

What do they do?

Influence public opinion via financial media. To wit:

The unquestioned assumption embedded here is palpable anyway; nominal rates are rising (“worst year for fixed-income since 2005” BOND ROUT!!!!) because inflation is “hot enough.” Reported like its some foregone conclusion, this inflation certainty dictated to the bond market via a suddenly hawkish Federal Reserve.

This is, at best, incomplete; most often, just plain backward. Thanks, Maestro. 

Had the yield curve behaved recently like it had earlier in this same year, this would be plausible. The yield curve, on the contrary, is performing very differently negating any chance for this to be the case.

Bond yields aren’t reacting to anything; they’ve helpfully sorted CPI’s for us all along. As I wrote earlier today, the yield curve has expertly, consistently interpreted the money Economists and central bankers can’t understand so as to accurately predict – for longer than a century – what is and will be inflation.

This often leads to conflict; central bankers say it’s one thing and bonds declare another, often the opposite. This differing viewpoint not just a post-2007 development, either, also noted today, bonds vs. Economists has been a one-way contest going back before 1929.

Our current case, therefore, very much like previous cases.

A flattening yield curve, conspicuously so, is the bond market recognizing: 1. It isn’t inflation, just transitory price factors, meaning lack of heat in the economy; 2. Policymakers repeatedly have shown they have no clue how or where to even begin figuring one way or the other; 3. Because they are clueless, they have likewise displayed a consistent tendency to make egregious forecast errors, such as 2018 or 2013; 4. Therefore, very much independent of the Fed, bond yields are instead disagreeing with Powell’s mistake by pricing a scandalously flattening yield curve with nominal rates already contradictorily low (tight money).

Bonds – not the Fed – have already sorted the inflation question. The problem is, as usual, the answer isn’t to the liking of mainstream Economics which can only interpret yields from the “certitude” of Greenspan. In that sense, inflation is a foregone conclusion. In the dream-world of media, the theme this year is solidly inflation. In monetary reality, unambiguously deflationary.

Just in time for Halloween, Jay Powell is back to seeing ghosts.


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