Tuesday 25, April 2023

Who are the winners and losers of inflation?

When inflation spikes, the losers are those who are long bonds. This is because the value of bonds falls when inflation rises. The reason for this is that bonds are essentially loans, and the value of a loan is determined by the interest rate. When inflation rises, the real interest rate (the interest rate minus inflation) falls. This makes bonds less attractive to investors, and the value of bonds falls.

The winners of inflation are those who have assets that rise in value with inflation. This includes assets such as real estate, commodities, and stocks. The reason for this is that the prices of these assets tend to rise with inflation. This is because they are not directly linked to the value of money, and their prices are determined by supply and demand.

The bond market is a shadow of its former self

The bond market is a market where bonds are bought and sold. In the past, the bond market was a powerful force that could influence monetary policy. This is because the bond market is a large market, and it is a market where many different types of investors participate. If the bond market is worried about inflation, it can sell bonds, which drives up interest rates. This can force the central bank to raise interest rates, which can help to cool inflation.

However, the bond market is not as powerful as it used to be. This is because the bond market is now dominated by a few large players, such as central banks and insurance companies. These players are not as sensitive to inflation as they used to be, and they are not as likely to sell bonds when inflation rises. This means that the bond market is less likely to influence monetary policy, and it is less likely to help to cool inflation.

Why inflation will be a hard dragon to slay

There are a number of reasons why inflation will be a hard dragon to slay. First, the bond market is not as powerful as it used to be. This means that the central bank will have less help from the bond market in fighting inflation. Second, the economy is more globalized than it used to be. This means that inflation can spread more easily from one country to another. Third, the cost of living is rising in many countries. This means that people are more likely to accept higher prices, which can make it more difficult to bring inflation under control.

In conclusion, there are a number of reasons why inflation will be a hard dragon to slay. The bond market is not as powerful as it used to be, the economy is more globalized, and the cost of living is rising. This means that the central bank will have a more difficult time fighting inflation.

A meta analysis of the likelihood of future inflation

On the topic of inflation, I always think that in the prediction game it’s always good to think about who will be the winners and who will be the losers. When inflation spikes, the losers are those who are long bonds. But bonds are largely held by foreigners, the central bank, insurance companies and pension funds and commercial banks. Nobody really wants to hold bonds, but thanks to peculiar incentives to hold bonds (e.g. zero risk weighting on banks’ balance sheets), they do faut de mieux. So, the mighty bond market that stiffened Carter’s and then Reagan’s spines to kill the economy to staunch the bleeding of bondholders are a shadow of their former selves. This applies particularly to the USA, but it applies fairly well to the UK and Europe.

So, for both these reasons, I think inflation will prove a harder dragon to slay than central banks believe.

I am not sure that mine is worse, or that Bard really gets what I meant. Oh well.