‘Reflation trade’ and inflation, consequences and meaning
Reflationary trades tend to involve assets exposed to faster economic growth, price pressures and higher yields.
It is a common misinterpretation to confuse different economic terms that occur in time . It is not so much a matter of financial ignorance but of understanding what each of them really means. In recent weeks, the reflation trade has been spoken of strongly as if it were a rebound in inflation , without taking into account that the global economy has been submerged in an intense phase of reflation for more than a decade.
We should start by explaining what is meant by reflation. It is a scenario in which a government seeks to avoid or overcome a recession based on an active fiscal policy that, in addition, can be accompanied by an expansionary monetary policy.
In other words, the reflation of an economy is neither more nor less than an overstimulation of it. And for this, governments decide to make use of the tools available to them and which can be conventional, such as lowering taxes, raising public spending or lowering interest rates , or unconventional, such as quantitative monetary policies, which basically They consist of an injection of money expanding the money supply.
Reflation rhymes with inflation and perhaps that is why they tend to associate, and although it is true in most cases, it does not necessarily mean that one is a consequence of the other. If the recession is mild, fiscal policy measures may suffice without the need to bring interest rates to zero . In this state, consumption, until then depressed, regenerates autonomously without a risk of inflation that leads to a return to high interest rates.
On the contrary, if the recession is deep and threatens to turn into depression, the possibility of a deflationary scenario emerges. Consumers and companies focus on correcting their balance sheet, that is, on reducing their indebtedness, and consequently private consumption falls rapidly, opening a period of low inflation and growth (Japan).
This leads to the need to implement very aggressive monetary policies such as taking rates negative and circulating monetary helicopters when public spending is insufficient to contain the fall in private consumption.
What is undeniable is that the last two recessions have required unusually long fiscal and monetary policies. Nor is it the case that we are facing a risk scenario of higher inflation, mainly caused by the rise that has been observed in the evolution of real interest rates.
And is that one of the main risks of unconventional policy, the famous QE ( Quantitative Easing ), in addition to ending up being inflationary have the problem that it is very difficult to get out of them. And it is because, as it is being shown, they generate a vicious circle whereby the growing public deficit ends up being monetized by central banks through the printing of money.
The US knows this well, since it has had four quantitative stages in just 12 years in which the average deficit has been 7.5% of GDP with a debt that has gone from 10 trillion dollars to the current 27.8 trillion. And it is that only last year have been applied stimuli equivalent to 25% of GDP, a relationship that is equivalent to a wartime economy .
The US Congressional Budget Office projects a debt-to-GDP ratio above 100% with an average deficit of $ 1.2 trillion. A figure that is equivalent to the GDP of Spain … until 2031 !!!
Framed in this inflation discourse, the American debt has been rebounding for a long time and this positivization of the slope of the curve is a reflection of the implicit inflation expectations. The second derivative is that the interest that the Treasury has to offer to finance its colossal deficit moves upwards .
Under normal conditions, no investor would perpetually finance a deficit economy like the American one. Therefore, it is the Fed that finally acquires that debt in the absence of demand , which makes everything even worse. Add to this the looming commodity super-cycle or the overvaluation of the dollar. Perfect inflation cocktail.
The rise in prices will take more or less, but the logic of the equation is overwhelming. If there is more and more liquidity in the economy, the agents generate a false association between money and gratuity, so prices end up reflecting this upward scenario.
It is very simple. Consider a government that sends a check home as part of its public assistance program . As it is repeated over time, and each time the payments are higher, in the end such contradictory events are generated as there are few incentives to seek employment in an economy with very high unemployment.
That is precisely what is happening in the US . The situation is so grotesque that with twice the number of unemployed than a year ago, hourly earnings increase. And that happens because it is increasingly difficult for companies to attract workers who are not looking for work or wanting to work . Another inflationary sign.
I have been warning in this column for a long time that inflation is an undervalued element of risk. We have become accustomed to “good” deflation due to technology and economic progress, but we are clearly heading for a very high inflation scenario for which we are not prepared. And central banks know it .
Opinion of the Spanish economist Alberto Roldan