September 2019 – Hyperinflated assets: the worst news possible for my family wealth

A phenomenon is developing over which Central Banks have lost control, and they are ignoring the disastrous consequences it might have for economy. This is especially serious in Europe; the US hasn’t yet reached this point although recent rate cuts could push it to the brink of the same abyss Europe is already facing. The tools Central Banks have been using in their efforts to stimulate economy and consumer inflation (rate cuts and QE, or purchasing Government and corporate bonds) have hyperinflated investment assets on which we rely to preserve our wealth’s purchasing power in the future.

A case in point is Government debt: the German’s bund price is so high that it yields negative returns for up to 30 years; i.e. lending money to the German Government – with the risk associated to making loans to an administration on the verge of a recession – not only does not offer any positive gains but exposes holders to sure loss. In other words, German bund holders have today seized all the gains these assets could yield in the future. No one in their right mind should buy German debt, and purchases are already flagging. The one and only buyer that can continue to swell purchases is the ECB itself; all private investors should completely exit any holdings they have in negative yield bonds and maturities of over 5 years. Be careful not to fall into the trap of buying just because prices are on a hike.

Explaining the how hyperinflated assets damage the economy is relatively easy: GDP growth is fully dependent on consumer spending, investments, public spending, and exports less imports. If one of these drivers is swept away, recession is the consequence. Stimulating consumer spending is not of itself a bad idea, but if you kill private investment in the process GDP will decrease making the bubble burst, the only question is when. The ECB’s only concern is keeping wage earners purchasing power under control and, by doing so, has depleted that of savers and investors (pension funds included). With the same amount of money today you earn half the future yields you would have earned 10 years ago (using the MSCI World Index as an approximate benchmark). In other word, investing is much less attractive than what it was 10 years ago, and it will be even less attractive going forward if Central Banks keep on with their current policies.

Private investment is the main feature that has allowed capitalist systems to generate more wealth than communist systems. In unrestricted economies private capital is assigned to the most valuable projects (both in economic and social terms) and is withdrawn from lower value or utterly valueless projects. When a project loses value, its capital and resources (both human and material) are immediately reassigned. In a planned economy, where there is no stimulus to private investment, low value projects are perpetuated and ground-breaking creativity –so important to social welfare– is stalled.

The banking industry is another case in point: it is demonized, its activity is over-regulated, its losses are socialized, and it is forced to make loans in exchange of barely no reward. The consequence is that Banks only lend money to lower risk projects, whereby money’s multiplier effect vanishes. And this is why Central Banks are unable to increase consumer inflation no matter how  much stimulus they inject in the system.

This huge bubble can burst: 1) as a consequence of political changes (there are signs of disagreement among countries with ECB policy voting rights); 2) because of an increase in inflation; or 3) as a result of private capital starting massive sales of futures on the German bund, severing the Central Bank’s buying hand.

It is impossible to predict whether the first two scenarios will ever take place, but we’ve already seen signs that the last one has indeed already started to materialize. Private capital today has the means to contain prices: selling futures on German bunds allows investors to enter higher priced sale deals today and lower priced buy deals in the future if markets plummet. If this approach is followed in a meditated manner before someone else pops the bubble, we’ll have all the more tools to control portfolio risks. Equity and bond prices will eventually return to normal levels, and those investors and savers who have managed to protect themselves against market falls will be able to again invest their wealth at reasonable – and sufficiently attractive– profits.

What is the best investment criteria in such complicated scenarios? Buy equity of companies that offer attractive profits and growth trends going forward (there are still some out there), sell futures on overpriced assets (Government bonds, stock indices, and low growth defensive shares), buy USD, and keep a high level of cash balances.

Just like in previous bubbles nothing really happens, until it actually does happen. The current one is not so different; it might swell more and last longer than other ones, since this time the ones to blame are the Central Banks, but it will end up bursting like all the rest.