Beyond the tweet - Financial repression? Politics in central banks?

Trying to put a framework around inflation, war risk, interest rate increases...

Last night I stumbled across this tweet and I clicked on the link out of curiosity

While I do not want to write a full dissertation of the post, as probably the post itself is a lot clearer, I really enjoyed the read because it connected a lot of points I have been thinking about in the past months as I am trying to make sense of the economic situation unfolding, and more importantly its implications for me as a citizen and for the business environment I live in. 

I really enjoy when someone helps me put my thoughts in line, and provides me with a structured framework.

The key points of the article that made me go “ahaaa, that’s right!” were:

1. Homeshoring of manufacturing (vs delocalization of the early 2000s). I believe this is a clear trend and besides the very evident chip war between US and China there are many manufacturing efforts that are centered in the West, which is something we were not used to see anymore (e.g. the Tesla gigafactories in Texas and Germany, or the Re:Build Manufacturing efforts).

2. End of the separation between central banks and governments. While nothing has changed from a formal stand point, the Covid emergency resulted in governments de facto calling the shots (“By issuing state guarantees on bank credit during the Covid crisis, governments have effectively taken over the levers to control the creation of money”). We have seen this unfolding in Italian politics or in the German mega guarantee scheme to cover costs of the energy crisis for example.

The most interesting part of the post in my opinion, were the implications of these factors for the near future, the writer has a few points that sounded very reasonable to me:

1. Imvestments will grow in western countries, as governments will have all the  interests to keep spending because debt is "free" (in terms of political cost of having high debt). This is also supported by the first point: there's an objective industrial trend pulling in that direction;

2. Inflation will likely remain high, because government have a vested interest for that to happen as this is the best devaluation tool of highly indebted states. High inflation means devaluation of “real debt”: “Of course nobody will ever say this officially, and most politicians are probably not even aware of this, but pushing nominal growth through a higher dose of inflation is the desired outcome here”.

3. Government will make bad capital allocations, when politics drove capital allocation in the past this always resulted in inefficiencies. Therefore the "bubble" will likely eventually result in poor returns in western countries in a few years, when it's clear the promise did not materialize and cause unemployment and economic contraction. This in the past resulted in a cycle of rigourous reforms (similarly to the Tatcher/Reagan moment);

The conclusion of the article is therefore a bit gloomy: inflation will stay high and this combined with bad capital allocations and resulting high unemployment will not end well for western countries. However, as a Rational Optimist by nature I have some positive takes:

1. Generational switch of wealth - this is basically a de facto transfer from savers (older people/ boomers) to income generators. It's a very good thing considering the current distribution of wealth, where due to financial assets appreciation the gainers of this cycle are surely the boomers. “Savers won’t like it, but debtors and young people will. People’s wages will rise. Financial repression moves wealth from savers to debtors, and from old to young people. It will allow a lot of investment directed into things that people care about.”

2. Inflation is the best argument against war. During high inflationary environments, countries have a lot of internal issues (we need to pay for food or the energy bill) and can't really focus time, energy and money into foreign wars. This should push for diplomatic resolutions of conflicts.

3. Finally a silver lining for Europe. I agree with the author when he says "That means that as an investor, you best invest in jurisdictions where you plan to spend your retirement. To me, that means I don’t want to be invested in China at all, for example." I believe a lot of capital will be allocated to european countries, where the standard of living is a lot higher than other places (at least from an European point-of-view)!

What is your impression? Does this framework resonate with you too? Let me know your thoughts on Twitter @gfoglietta or in the comments!

Giovanni

p.s. happy to hear any feedback on this post or on the writing style. Be kind, it’s my first time!