To The Moon

It is not a recession that is putting pressure on prices. Nor is inflation the major culprit this year. Prices are under pressure because there is less liquidity. The years of abundant liquidity are over. That was the period when central bankers promised that interest rates would remain low for much longer. Last year inflation was still able to rise without interest rates following, but this year the money tap is closing in several respects. First of all, of course, central bankers raising interest rates. Last week the ECB raised interest rates for the first time in 11 years and next week the Federal Reserve is going to raise them by 0.75 per cent to 2.25-2.50 per cent. Besides this qualitative tightening, there is also quantitative tightening. Since the Great Financial Crisis, buy-back programmes have followed one another. Under the motto of quantitative easing, first the holes in the financial world were plugged and when it turned out that this did not increase inflation, central bankers dared to go all-in during the corona crisis. But that money did reach the real economy and that is the basis for today's inflation. Central banks' balance sheets have increased sharply in all those years, but the peak is now behind us. From now on, the balance sheet total is going down, in the United States by 95 billion dollars a month.

 But it is not only central bankers who are taking money off the table. The government itself is also a negative factor. A year ago, there were still large stimulus packages because of the corona crisis. Now that this is over, liquidity is drying up here too. Biden will soon be a 'lame-duck president', which means that no more stimulus measures can be expected for the next two years. Europe has been hit even harder than the United States by the current liquidity crisis. For the first time in a long time, Europe has a trade deficit, a direct result of the high price of oil. Where in the past we could pay for oil in euros, soon we will be able to pay in dollars. But we still have to earn those dollars first. Given the relatively high wages in Europe and the absurdly high energy prices, the competitive position of the eurozone has deteriorated. Moreover, German industry could be wiped out by Putin in a short space of time by stopping supplying energy.

Furthermore, liquidity in the world has been worsened by the strong dollar. The US central bank is the de facto central banker of the world and when the dollar strengthens, there is much less room for monetary stimulus in the rest of the world. Remarkably, emerging market central banks have been on time this time by starting to tighten well ahead of the Fed. Moreover, the starting position is much better than during the Asia crisis. Furthermore, these markets also benefit because the Americans (together with Europe, Japan, and Switzerland) have used their currency as a weapon. By cutting the Russians off from the dollar, euro, British pound, Swiss franc and yen liquidity, these currencies (apart from the dollar as a reserve currency) are suddenly also no longer attractive to Arab oil sheikhs and Chinese billionaires. The Chinese had already chosen Vancouver as their base of operations years ago. Not because of the weather, but more because they assumed that the Canadian rule of law could offer protection against the Chinese government if it came to it. It is striking that the Western world has become more like China in this respect. The rules under which the Russians are being dealt with are unclear and lack a legal basis. Moreover, it seems that Russians are being punished collectively, which takes us back to the Middle Ages. We are increasingly being governed by supranational institutions which at least have the perception of having some democratic legitimacy. Nor are we allowed to say everything anymore due to a combination of polarisation, the woke culture and sometimes simply censorship. The rule of law is the basis for the free market economy, but the differences in society have become so great that the rule of law no longer seems to work for everyone.

Liquidity is much less visible than inflation or a recession. Europe is probably already in the middle of a recession and next week we will hear whether there will be a technical recession in the United States. After the contraction in the first quarter, there is hardly any growth in the second quarter. If there is also a contraction in the second quarter, then according to the definition (two consecutive quarters of contraction) there is a recession. That recession is then not much more than a press release and not deep enough to fight inflation either. Yet there is a striking consensus that inflation rates will fall over the next two years. There are several possible explanations for this. It may be that they are not measuring properly and that those surveyed do not really believe that inflation will fall. It could also be that everyone is convinced that inflation is related to supply-side distortions. Of course, it may be that they expect a severe recession, but we do not see that reflected in stock market prices or earnings expectations. It may be that they expect only a small increase in unemployment to be enough to bring wage growth under control, but it may also be that market participants have not had any experience with inflation over the past 40 years. In that case, there could be a cognitive bias whereby the more recent experiences (the past 40 years) are best remembered (simply because we lack the collective memory of the previous generation).

The negative impact of liquidity may cause many economic signals warning of a recession to be overestimated. It remains remarkable that the consensus assumes that inflation will have fully normalised to 2 per cent in two years' time. This is despite the fact that interest rates are still extremely negative in real terms, that inflation has now been high enough to cause a wage-price spiral and that both a recession and a longer high inflation scenario have not been factored into stock prices. Expect more interest rate hikes with the aim of causing a real recession, in the United States probably only from the second half of next year, in Europe Putin has ensured that we are already in the middle of it. Meanwhile, inflation remains sticky and it is an illusion to think that the Fed's policy rate will soon peak at 3.5 per cent, after which interest rates will start to fall again. The first interest rate cuts for next year are already on the cards, extraordinary. If that is the case, this bear market rally is understandable, but expectations are probably too optimistic for both inflation and corporate profits.