Inflation, but when?
The Panel believes that the risk of inflation in the US is now increasing. The Fed has continued with Quantitative Easing (QE) even though private bank lending is now increasing. This could very quickly lead to inflation. The Panel was not convinced that commodity stocks would be unreserved winners as they were in the 1970s – we are too nervous that cash-poor governments may increasingly tax revenues or even confiscate properties.
This is the first time that QE has happened outside times of crisis. Bernanke sees QE as a solution to many problems (not least low employment levels and a lack of GDP growth) whereas originally it had only one role, to offset any shrinkage of private lending contraction so as to avoid monetary contraction. As in so many things currently, this is again unchartered territory.
Whilst the future looks very likely to have an inflationary element, it is possible that deflationary pressures could hold sway for a while longer, driven by a lack of continued growth from China and on-going bank weakness most notably in Europe, before inflation becomes inevitable. However, history shows that once inflation does come, it will already be too late to do anything about it, and that an increase in interest rates in a struggling economy will be painful.
Japan has all the hallmarks of an inflationary environment. There are only a handful of ways of combatting high debt: growth, repression, austerity or inflation. Growth in Japan looks unlikely. Repression has already been tried (the savings system is already full of enforced holdings of government debt), austerity has been shown elsewhere to be almost impossible, so inflation is all that is left. The MoF, BoJ and the politicians all have to agree to monetise the (massive) government debt, and this looks much more likely in the next few months with a change in guard at the BoJ. When they monetise the debt, it won’t be long before the yen depreciates.
China: capital flight
There are real concerns about capital fleeing China, one example being the over US$100bn worth of treasury bills sold by China in recent months. Hong Kong is also leaking money for China. Money used to leave China, go to HK and stop there. It is now moving on through (as seen by the lack of reserves accumulation in HK). Approximately $75bn a quarter is coming out of China.
Anecdotally, we hear that a majority of millionaires in China would like to leave, due in large part to the lack of rule of law (why would you invest for the long term when you might well not own the assets in the long term), but also due to healthcare issues (such as the lack of clean air), and the quality of education available.
At the other end of the spectrum, it is also impacting Chinese students. According to one source, 60% of Chinese students who study overseas do not return. There is a growing dissent amongst Chinese people who have experienced freedom.
Also, is there a lack of investment opportunity there – return on capital is falling. Interestingly, that is also the case in Brazil and India – the other “high growth” investment environments.
There is a genuine danger that the recent growth in China will be a one-off shift rather than an on-going trend. That will be the case unless they re-assess the rule of law and the control of the banking system. It is hard to see these changes taking place seamlessly.
Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.