Ready to combust

[3 min read]

In the last few weeks, I’ve gone to the gym and have worked in the office.

I’ve taken public transport, caught up with friends at restaurants and even attended a work event.

I’ve travelled into Melbourne and I’m glad to see the city is getting its buzz back.

Life seems…almost normal.

When I tell this to my family and friends living abroad, I get this feeling they don’t believe me.

You see, for them it’s been a long winter. They’ve spent months stuck at home, much like we Victorians did during our winter.

They’re itching to go out, see family and friends and have a good time.

But instead they are stuck at home…saving money.

Bloomberg Economics estimates people in the world’s largest economies have accumulated around US$2.9 trillion in extra savings during the lockdowns.

In the spirit of ‘a picture is worth a thousand words’, let me show you an image:

There’s a tsunami of money already out there waiting to hit the street…with more to come. This week in the US, the House of Representatives passed another US$1.9 trillion relief package, to hit consumers’ pockets soon.

This has been one of the main differences from the 2008 crisis. While back then consumers were also saddled in debt, the last time banks cut credit and liquidity disappeared, home prices collapsed and so did people’s wealth. This time much of the money has flowed into people’s pockets.

The big question is, what will consumers do with all that extra money?

Will they spend it…invest it…keep it in their savings account…or use it to pay down debt?

With interest rates at record lows there isn’t a huge incentive in putting money in the last two options. Specially since everything has been going up during the pandemic — gold, bitcoin, stocks, property, you name it.

Reuters reports US households finished 2020 with a record US$130.2 trillion in wealth, mainly from assets climbing and low interest rates. As they wrote:

‘Rising equity markets added $4.9 trillion to household assets in the fourth quarter and rising real estate values added around $900 billion, the report showed. Balances in cash, checking accounts, and savings deposits rose by a combined $642.7 billion in the fourth quarter to a record $14.1 trillion. Household wealth rose $12 trillion from the year-earlier period, and consumers paid off a record $118.3 billion in credit card debt.’

Don’t get me wrong. There’s been plenty of people who haven’t benefited from these increases and stimulus. But point is it’s likely that some or much of that money will keep flowing into stocks and property with interest rates staying low.

And some of that money will likely flow into spending.

It’s why inflation expectations are picking up. As I mentioned before, commodity prices have been increasing.

The big story in the markets for the last few weeks has been that US bond yields have been rising…fast. It’s been rocking the markets.

And consumers are also expecting prices to rise. In a survey by the Federal Reserve Bank of New York released this week, US consumers say they expect prices for things like rent, gas, food and medical expenses to increase in the next year.

Usually when inflation increases, central banks start to hike up interest rates to stave off inflation.

This time though the Fed is saying they won’t be raising interest rates for a few years, even if inflation rises.

The Reserve Bank of Australia has said a similar thing. That is, they won’t increase rates from close to zero until we see the unemployment rate go from today’s 6.4% down to 4% or lower and an increase in wages of 3%. Something they don’t expect to hit until 2024.

In my head I think it’s very difficult to raise interest rates because a) there’s a lot of debt in the system and b) most of the wealth is in housing and stocks.

Increasing interest rates would really affect people’s wealth.

That is, unless inflation really gets out of control, which could very well happen at some point.

On one side, you have cashed-up consumers locked in unable to spend, plenty of liquidity, a recovery on the way and a vaccination program…with more stimulus coming in.

On the other hand, you have high debt and central banks promising to keep rates low for years.

It’s an explosive combination.

We could be heading into a 1920s-style post-First World War-type boom with more money flowing into stocks and property as interest rates stay close to zero for a while.

On that note, my colleague Greg Canavan thinks we could be dealing with Life at Zero for a very long time. In a situation like this, what do you invest in and what to avoid? To that end, he’s put together a ‘Surviving Life at Zero’ roadmap. To learn more, click here.

Best,

Selva Freigedo,
For The Rum Rebellion