The Illusion of Safety
"We mustn't lose touch with those moments of history, which are really quite chaotic and volatile… The idea that the worst thing that can happen after 2% inflation is 3% inflation, I would argue against that.” -Peter Warburton
Peter Warburton visited Fielder’s office several weeks ago when he was in New York from London. Peter wrote Debt & Delusion in 1999, identifying the stresses in the financial system that culminated in the 2008 credit crisis. The book is hauntingly prophetic. Peter is a true independent thinker. Few have thought more deeply and creatively about money, credit and inflation than Peter. His unique framework leads to some highly contrarian views. They may or may not prove correct, but they deserve serious consideration and debate. Excerpts from Peter’s comments follow below. You can listen to the full conversation HERE.
The Illusion of Safety Peter: “What I'm suggesting is that we're not on a stable course by any means. Although interest rates are low, and a lot of borrowers will feel relatively comfortable... I think it's an illusion. I think that we're storing up a lot of credit that potentially can go wrong.” A Dangerous Muscle Memory Peter: “We've been very conditioned by low inflation. We've been very blessed to live through a period of low inflation. But we mustn't lose touch with those moments of history, which are really quite chaotic and volatile. So I don't want to rule out there being a time when the price level changes really quite dramatically… Effectively, like pressing a reset button, it means that those pension assets may be worth 30% less… The idea that the worst thing that can happen after 2% inflation is 3% inflation, I would argue against that.” End of the Party Peter: “The conjunction here is also that we've stoked up a very hot labor market, where potentially wage inflation could break out to the upside in a way that certainly is not commonly expected… If you are a struggling company and you're paying those wages, then your ability to service your debt is going to go the other way. So I think we're much closer to a new default cycle. And I think that potentially that could cause a lot of distress. And if there are other forces bringing the global economic cycle to an end (Frank: like trade wars), then an adjustment in the price of credit and credit spreads could greatly aggravate the adjustment process.”
Average Hourly Earnings
The Fed/Markets Get Side-Swiped Peter: “If I'm right that wage inflation still has more progress to make; if I'm right that the structural forces of inflation will keep core inflation high… then the Fed will be in a very difficult position. It would be biased to confirming (market expectations of) lower rates, whilst at the same time facing pressures (to raise them)... So I think that the Fed will be in a real bind potentially sometime in the next six months…” “Why have the global stock markets had a very good first quarter? Well, it's basically that liquidity conditions improved in a way that that was not anticipated… But what I warn is that some of these factors, which have boosted liquidity and helped to make risk-taking more attractive, that they could turn on a dime. And so I think this is a very fickle time to be involved in equity markets right now.” “Revolutionary Change” The World as We Know It: Peter: “There is the happy agreement around what the central bank does to control inflation, what the government does to control its budget… I could see that sort of framework being torn up… This setup is just not working for a large enough majority -- or even a majority -- of the voting citizens of our democracies.” A World We Haven’t (yet) Known: Peter: “We're vulnerable to elect parties and policies which are very experimental. But they're experimental in a different way to the ones that we had after the financial crisis. (During the next) downturn or corporate debt cycle ... I think whatever subsidies come out of federal government - whatever protections come out - they'll be directed to the citizens, not to banks or institutions. What we're talking about is a liquidity experiment of some sort that makes regular folks feel a lot better - but whose systemic implications could be quite drastic. … In other words, that we leave behind the world where the central banks are the masters of the universe - the guys in charge - the fulcrum of the system. We basically relegate the central banks. We disregard their recommendations, we disable them and their executive functions, and we basically say, 'We're going to run the show. We're going to spend the money that needs to be spent, and we're going to build the bridges. We're going to pay the workers, and we'll deal with the consequences somehow.'” The Rest of the Story You can listen to our full conversation with Peter Warburton HERE. Peter shares his thoughts on the following questions:
In his dystopian scenario, what could this mean for investors?
Would stocks do poorly ... or well?
What types of companies would fare best/worst in such a scenario?
If you have any additive or contrary thoughts on Peter’s comments, we’d love to hear them. Our best resource is our network of thoughtful investors and friends. As always, please reach out if you’d like help in thinking through the optimal allocation of your own capital in these uncertain times.
Yours in the Field,
Frank Byrd, CFA Stephen Korn, CFA PS: You can learn more about Peter Warburton's research firm at Economic Perspectives.
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