The speculators and central bankers continue to hope they have seen peak inflation. Every data release defies their expectations. Every week the speculators and their representatives talk up the likelihood of recession, but each week, the data refuses to comply with their hopes and dreams.
They believe they require a recession, in order to ensure that inflation has peaked, because they believe that inflation is caused by either costs being pushed higher, as a result of supply constraints, or else by demand being pulled higher by the economy growing too fast. What they really mean is wages growing too fast, both causing the rising demand, and the rising costs, hence the frantic demands of politicians and central bankers for wage restraint, amidst rampant inflation, even though wages have lagged the price rises.
They are wrong, and recession does not mean an end to inflation, as the periods of stagflation, including periods of hyper inflation demonstrate. Weimar Germany is a case in point. They think they need inflation to have peaked so the rise in interest rates can be halted. But, its not higher interest rates that bring down inflation, its reduction in the supply of excess money tokens, unless that happens, inflation continues to rise, and nominal rates along with it. In a crisis, when production suddenly begins to stop, interest rates hit their highest levels, precisely because firms demand money, not for investment, but as currency, i.e. to stay afloat and pay their bills, at any price. The speculators demand a recession to bring down inflation and interest rates, because they want asset prices to stop falling, and start rising. They will be disappointed again.
But, the answer to that question is no. We have seen big declines, but they have been orderly, whereas in a capitulation, there is disorderly selling of assets, primarily those that are most liquid, and allow speculators to get their money out to cover their needs, specifically margin calls, i.e. debts. There was disorderly selling in 2008, when I noticed that the price of oil in futures markets dropped significantly out of the blue, which was an indication of speculators, and specifically banks and financial institutions, selling what they could, quickly, to obtain liquidity, as what turned out to be the credit crunch that sparked the financial meltdown began to bite. What we have seen, so far, is a slow motion crash, but that also reflects the old description of crashes that they happen slowly at first, and then all at once. Asset, prices have fallen significantly, but they have, so far, fallen in an orderly manner, simply because they were so inflated to begin with, and could fall by such amounts even without getting back to the previously astronomical levels of only a couple of years earlier. So, we have not yet seen capitulation, or anything like it, and nor have we seen the biggest financial crash in history. That is to come.
As far as the data is concerned, last week, saw Spanish inflation rise to over 10%. In France it rose to 5.8%. In both cases that is ahead of forecasts, and is the highest since 1985. Eurozone inflation, as a whole, rose to 8.6%, way above the 8.1% of the previous month, and the predictions of a rise of 8.4%. Yet, the ECB has only just begun to stop its QE programme, even then with a promise to continue it, by buying the bonds of peripheral economies to try to prevent yield spreads expanding, and creating a repeat of the Eurozone Debt Crisis of 2010. They have not even begun raising rates, to take them even back to zero, and propose to raise by only 25 basis points when they do! An actual reduction in liquidity looks even further in the future. No wonder the Euro is falling sharply against the Dollar, bringing with it future imported inflation.
As I reported last week, the US data for durable and capital goods orders came in strong, again defying all of the demands for a recession by the speculators, and their agents. A lot was made of the fact that, in the US, the Core PCE Deflator, which is the Federal Reserve's preferred measure of inflation failed to rise. However, when they were predicting that inflation was to be only transitory, they used a “Trimmed Mean” measure of the PCE deflator. Looking at that, although it fell in April, it snapped right back again in May, and now US inflation measured, on this basis, is at its highest since 1990.
These movements, one month with another, are reflected in the other US data, which suggest that some is down to the fact that various lockdown era restrictions are still in place, though not on the ridiculous scale as in China, and various other constrictions, including those from supply constraints, not to mention the phenomenon of the rise in the Quit Rate, as more confident workers leave their jobs to take up better ones in an environment of labour shortages. So, the US continues to create new jobs at a prodigious rate, and the ratio of job vacancies to unemployed workers continues to be above 2, but the number of new jobless claims rose slightly, but is still only at 229,000. The number is also subject to significant revisions.
The picture was also reinforced by the latest US ISM Manufacturing Survey data. Bloomberg reporters noted the data, and described it as indicating weakness, as its headline talks about a “slump” in orders. But, the fact is that most of the survey showed the indicator to still be in expansionary territory of over 50. Moreover, the Chair of the Committee, responsible for the survey, Tim Fiore, who has access to all of the background to the data, argued the opposite.
He said there was no sign of fundamental weakness in the data, which simply showed some continuing issues with supply bottlenecks holding back production, along with some previous over-ordering being worked off from inventories. He also saw producer prices rising by over 11% by the year end, or, in other words, at around the current level, meaning no sign of the sharp drops in inflation that the Federal Reserve has predicted, and that the speculators are counting on. He saw no reduction in lead times for orders, or any significant change in the current levels of labour shortages. In conditions of labour shortages, and consequent rising wages, its pretty hard to see any possibility of recession, or even significant economic slowdown.
Yet, on Friday, demand for bonds rose sharply, pushing yields down to an extent that it almost looked like a fat finger trade, of someone placing a large bet, by hitting the wrong keys. Such events have caused “flash crashes” in the past, and I suspect that whatever the reason for this sudden move, it will be quickly reversed in coming days and weeks. The underlying realities remain in place. A big factor continues to be the efforts of the Chinese state to undermine the Chinese economy, by its zero-Covid policy, so as to prevent the huge Chinese financial and property bubbles bursting, and its economy suffering a period of hyperinflation. But, the contradictions from that are heightening with each day. A flood of businesses and financial institutions continues from Hong Kong, not as a result of Xi's attacks on bourgeois democracy, but as a result of the effects of his zero-Covid policy, and business and capital is flooding out to Singapore and other Asian financial and business centres.
The Eurozone is in danger of recession, if it continues to act as US dupe in its relations with Russia and China, as it cuts off its own supply of energy, and undermines its trade relations with China, but the war in Ukraine looks to be in its last throws, as Russia consolidates its grip on the Donbas, despite all of the efforts of NATO imperialism, and the billions of Dollars worth of military hardware it pumped into trying to prolong the war. The latest lesson the Ukrainians should learn, in terms of NATO betrayals, is that of the Kurds who were used to fight ISIS in Syria, and who have now been thrown to Erdogan's wolves, as part of NATO's deal to get Finland and Sweden into its global expansionist alliance.
As Russia consolidates that position, the pressure will be on Zelensky, from Europe, to come to terms, though the US may well see its advantage being served by trying to perpetuate the conflict. The EU certainly needs a settlement and a fast rapprochement with Russia, so as to restore its gas supplies before Winter, or else its citizens face a long cold Winter of rationing, and its industry risks being shut down. I doubt that Scholz will risk that, as his popularity, like that of all other conservative social-democrats, has quickly gone into the toilet.
So, in the second half of the year, we are likely to see a further opening of China, with a consequent effect on demand for primary products feeding into supplier countries' economies, a relaxation of tensions in Europe, with declines in energy prices, and food prices, and increase in disposable incomes for millions of workers, as mass strikes spread across the continent, quickly resulting in rising wages. Indeed, we are seeing the same mass strike waves for higher wages across all continents, from Los Angeles to Seoul, from Columbo, to London, as workers feel the firmer ground of improving economic conditions beneath their feet. Those rising wages will give an additional boost to aggregate demand, and force firms to respond by increasing output further, raising the demand for capital, and causing interest rates to rise further. As I've said before, although central banks will tail, market rates of interest higher, they will also respond to the squeeze on profits from rising wages by continuing to increase liquidity, so that prices continue to rise, so high levels of inflation are here to stay for some time.
The media pundits continue to refer to these conditions as like those of the 1970's, but, as I've pointed out before, these are not at all the conditions of the 1970's or 80's. These are the conditions of the late 1950's and early 1960's. This is the time of the upward trend of the long wave cycle, in which we have the relative surplus population still being used up, wages starting from a low level, and beginning to rise, and with the productivity gains from the previous Innovation Cycle, having been exhausted. We also have all of those similar gains from globalisation, having peaked, for now. Because we are still at a point of wages rising from a low base, we are at a point where profits are high, and so any squeeze on profits is not yet enough to cause a crisis of overproduction of capital, and will instead lad to simply additional extensive accumulation, and rising interest rates.
As I have written before, at a similar stage, in that earlier cycle, there was also a stock market crash – that of 1962. In a recent edition of his Bloomberg Blog, John Authers also refers to that crash, making reference to the similarities to today, including its relation to the Cuban Missile Crisis, and its resolution. Then it was US imperialism placing missiles in Italy and Turkey that provoked a response, whereas today it is the continued expansion of NATO imperialism around Russia's borders that has provoked the response. At the time, it was the worst stock market crash since 1929. Authers says,
“This year’s first half, thankfully over, has been the worst start for stocks since the war — except for 1962.”
The chart comparing the two shows remarkable similarities.
In 1962, the bottom was reached in June, and anyone buying then, would have had a 15% return by the end of the year, though only after the missile crisis was resolved. Even then the S&P for the whole year was down by 11%. So, could a resolution of the Ukraine-Russia War, similarly, result in financial markets recovering? Unlikely, because although, economically, from the perspective of the long wave cycle, conditions are comparable, from the perspective of those same financial markets, conditions are very, very different.
Authers notes,
“Then as now, price declines were led by falling multiples, which had started at an over-expensive level. As the chart shows, the two years look startlingly similar in this respect. Encouragingly, the S&P 500’s price-earnings ratio hit a low on June 29 in 1962. Less encouragingly, the tumble 60 years ago looked much more like a cathartic end to speculative excess, thanks in large part to a true crash in late May. Despite everything, there’s no such clear catharsis this time. Indeed, the exercise if anything suggests that the definitive decline still lies ahead — markets tend not to crash from a high, but when they have already clearly started to head down. Valuation isn’t as excessive as it was, for sure; but it’s hard to argue that it’s now at a robust sustainable level:”
That relation is illustrated in the following chart.
Between 1950 (when the fourth long wave uptrend began) and 1960, US GDP rose by 78.91%, whilst the S&P rose by 253%, and the Dow by 240%. That is by around three times the rise in GDP. The extent to which this crash acted to blow off that froth can be seen by the fact that, in the following ten years, between 1960 and 1970, GDP rose by 97.34%, whilst the S&P rose by only 54%, with the DOW managing a mere 19%. Looking further forward, and illustrating the point I have set out previously that, during this period between 1965 to 1985, rising interest rates led to real terms falls in asset prices, between 1970 and 1980 GDP rose by 169%, whilst the S&P rose by 17.25%, and the DOW, just 1.85%.
In 1950, the S&P stood at 16.93 and the DOW at 200. The speculative froth built up during this period prior to the 1962 crash, from a low level. That is not at all the conditions existing today. Although US asset prices rose during the 1930's and 40's, they only did so to an extent of recovering what had been lost in the crash of 1929. Indeed, it took until 1956 for the DOW to achieve that, even in nominal terms.
But, in the 1980's and 90's, stock markets simply soared into astronomical levels, quite unlike previous such periods. From a starting point of 824 in 1980, the DOW rose to 11,723 in 2000, a rise of 1300%. The S&P rose from 108 to 1469, a rise of 1,261%. And, although the financial meltdown of 2008 brought these levels down by 2010, it was not long before central bank asset purchases using QE, had inflated them once more. By 2014, these previous astronomical levels had been retaken.
In the ten years after 2010, not only did central banks continue to pump liquidity into markets, and inflate asset prices, but, at the same time, governments imposed measures of austerity to restrain economic growth, and so ensure that the liquidity continued to be driven into that speculation, and away from the real economy and capital accumulation, and so pumped up asset prices even further. When even that was insufficient to prevent the underlying mechanism of the long wave forcing its way through, as global employment continued to rise, and began to push into rising aggregate demand, and rising prices, as some of the liquidity forced its way into the real economy, economies were locked down under cover of COVID, cratering economic activity, and again putting that dynamic into hibernation. But, the cost was even greater liquidity injections, now that had to be directed directly into the real economy itself, as income replacement schemes. Asset prices soared again, with the DOW reaching 37,000, almost 350% higher than its 2008 super bubble high, but the inevitable consequence was that, as soon as the restrictions had to be lifted, all of the liquidity flooded out into the commodity price inflation we see now.
In 1962, the crash had only to wipe away ten years of froth that had built up. Today, the financial meltdown that is coming has to wipe away 40 years of froth that has built up, froth that is qualitatively different to that of any previous period. It is why the crash that is coming is going to be qualitatively different too. And, as in 1962, that will not be the end of it. After the crash of '62, asset prices continued to fall, in real terms, until 1985, as a result of rising interest rates. The same conditions, today, mean that a similar period of rising interest rates lies ahead, as wages begin to squeeze profits, as labour supplies fail to grow at the same pace as demand for labour, and so as firms have to finance a greater proportion of capital accumulation from borrowing, whilst also proportionally reducing the amount paid in interest/dividends. That proportional drop in dividends, at the same time as rising interest rates/yields, can only occur via, significant and persistent falls in share prices, which will accompany similar falls in all asset prices.
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