“The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” ― Thomas Sowell
An Unconventional Inflation Gauge
In the below monthly chart the magenta line is the ratio of silver to the S&P 500 Index. A rising magenta line means that silver is rising relative to the S&P 500 Index.
The black line is the 5-year (or 60 month) moving average of the silver-to-S&P 500 Index ratio.
The orange line is core consumer price inflation in the US.
Ideally the impact of geopolitical events, such as the spike in the oil price following Sadaam Hussain’s invasion of Kuwait, and the sharp swings in inflation in the immediate aftermath of the Global Financial Crisis due to base effects should be ironed out of the core inflation series.
The silver-to-S&P 500 Index ratio has led the disinflation / deflation curve in the US over the course of the last 30+ years. As a general rule, the periods during which the ratio has been below its 60-month moving average, inflation has receded. When the ratio has moved above its 60-month moving average and remains above it for some time, inflation has tended to pick-up on a cyclical basis.
The silver-to-S&P 500 ratio is approaching its 60-month moving average and it just maybe that a breach of the moving average coincides with cyclical inflationary pressures picking up in the US once again. Mathematically, barring very sharp moves in either silver (up) or the S&P 500 (down), the series will take some months yet to crossover, if at all. Therefore, it might well pay to monitor the series and its moving average for any signal for a pick up in core inflation.
Notably, the Atlanta Fed’s Wage Growth Tracker has shown an uptick during the past several months. The 12-month average reached 3.7 per cent in June, up from 3.2 percent last year. If wage inflation continues to remain for 3 per cent, its only a matter of time that we see core inflation pick up.
Trade Wars: What Have We Learnt?
With an additional US dollars 300 billion of Chinese exports to the US to incur tariffs and the proverbial line in the sand of 7 on the USDCNY cross having been breached, what have we learnt?
First, the battle lines have been drawn and Beijing has clearly decided that it is not willing to make a deal on purely US terms. If a ‘beautiful deal’ is to be struck, it will now require some concessions from the Trump Administration ― the tough talking China hawks will need to back off, even if a little. Otherwise, China will tough it out and hope that the 2020 election will deliver an adversary other than Trump.
Second, President Trump has run out of Chinese imports to tariff. He could ratchet up tariffs to 25 per cent from the proposed 10 per cent but such a move risks a severe loss of business confidence; and gives China added impetus to let the renminbi depreciate further and stabilise its own economy, at the expense of everyone else’s.
What is seemingly working in President Trump’s favour is the half-life of the impact of his tariff tweets on the US equity market is declining. This may have more to do with liquidity than investor apathy.
The below chart is the year-over-year increase in commercial bank deposits in the US.
Using commercial deposits as a proxy for US system-wide liquidity, liquidity has been in a cyclical contraction since 2013. Since November last year, system-wide liquidity has been picking up. If US commercial bank deposits can continue expanding, the US economy and equity market are likely to remain resilient for the time being.
Given this resilience, President Trump could continue to ratchet up tariffs and assume economic and market damage can be contained, especially if he can bully the Federal Reserve into loosening the purse string. If the Fed plays hardball, however, and markets and the economy have an almighty wobble, President Trump will have a ready scapegoat.
This might or might not be a successful strategy to get re-elected. It will not, however, bring China back to the negotiating table. Instead, Beijing is likely to let the renminbi depreciate gradually in an effort to shore up its economy. And central banks of nations with close economic ties with China are likely to respond by cutting rates to stabilise their respective currencies to the renminbi, much like what we saw happen in New Zealand this week.
It is worth noting that since the breakdown of the trade talks in early May, the Chinese negotiating position has been quite clear, and unaffected by the pressure tactics applied by the Trump Administration. Statements in May by senior Chinese officials, including chief negotiator and vice-premier Liu He, demanded that any trade deal meet three conditions: the list of US goods to be purchased by China to cut the trade deficit must be reasonable and not subject to capricious change; existing tariffs must be substantially reduced or eliminated; and the text of the agreement must “respect China’s dignity”.
The latest tariff threat by President Trump, despite virtually all his advisors objecting to it, achieved very little except giving China an excuse to let the renminbi depreciate. For now, the US-China negotiations are a stalemate. The choice President Trump makes will determine whether China returns to the negotiating table or not.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.