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11 Aug 2022 12:10
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  •   Home > News > Business > Features > The Investor

    Watch For Spiralling Inflation

    The CFA Society, an association of investment professionals, invites a guest speaker of international reputation to NZ every year. We had the pleasure this time of hearing from Bud Conrad, chief economist of US based company Casey Research.

    Investment Research Group
    Investment Research Group
    He firmly believes the outlook is for inflation rather than deflation. He notes the US government, along those of most western countries, has run a budget deficit for 30 out of the past 35 years and appears addicted to printing money to solve problems.

    For example, when confronted with the bursting of the dot-com bubble, Federal Chairman Alan Greenspan poured unprecedented amounts of money into the economy rather than letting the markets fully correct.

    The newly created capital created another bubble - this time in housing. As real estate prices moved up, more buyers were attracted to the market, driving prices higher still.

    As tales spread of newly enriched home-owners, coupled with easier borrowing terms from banks awash with cash, prices began to escalate.

    Behind the scenes, something else was going on. Banks began moving away from the traditional practice of studying an individual's personal balance sheet and credit record to decide whether to make a loan and instead adopted the equivalent of a production line.

    New mortgages were viewed as products, to be marked up, folded into packages with other mortgages, and sold off as quickly as possible. The result was poorer lending standards.

    As rates rose on some mortgages - particularly those with temporary low 'teaser' rates - more and more borrowers began to default. In fact, so many borrowers defaulted or got seriously behind on payments that investment performance began falling far outside expectations in the banks' valuation models.

    With confidence in the models ruined, investors that had paid hundreds of billions of dollars for complex packages of loans whose value could be determined by the models discovered they had no idea what these were worth.

    This soon resulted in a vicious cycle. Troubled financial institutions became desperate for capital but concerned lenders were reluctant to lend. One by one, industry leaders all over the world began to fail.

    The Federal Reserve launched a number of programs to provide fresh capital, running into the hundreds of billions of dollars. Conrad believes that this new money sends the clear message that the US government is now willing to risk a US dollar crisis rather than risk a possible deep recession.

    "Government bailouts are inflationary in nature. The Fed's actions, which are being parroted around the world, will create massive amounts of additional liquidity. They are meant to encourage yet more borrowing and credit expansion... when, in fact, exactly the opposite is needed.The result will be currency depreciation."

    The Fed eventually will be forced to raise its interest rates to attract investors, mostly from overseas. Conrad argues that significantly higher interest rates "are a certainty". When interest rates rise, investments likely to suffer include fixed interest, real estate development and some shares. The equities most at risk are companies with debt, rapidly growing businesses and manufacturers. Investors are thus advised to focus on resilient businesses such as utilities and inflation-resistant resources.

    © 2022 David McEwen, NZCity

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