“I am like any other man. All I do is supply a demand.” - Al Capone. June, 2016 - Commentary

“I am like any other man. All I do is supply a demand.” - Al Capone.   Throughout the course of the last several years I have tried to explain quantitative easing to my kids using supply and demand. I found the best way was by simply asking them, “If I gave you $10,000 what would you do?”  My 12 year-old, without hesitation, said he would buy something for everyone in our family and save the rest. My 10 year-old would buy a PlayStation, a new I-pad and save the rest. My 7 year-old daughter eyes lit up so big she could barely speak then said, “Wait. You are going to give me $10,000!?!” Suffice it to say she would find a way to buy $10,000 worth of pink and purple clothes and stuffed animals. My point is that given choice and handed money, supply creates a wide range of demand.

I then tell them they can only buy baseball cards with the money.   They all look at me kinda funny (I’m sure my daughter is wondering if they have pink and purple baseball cards) and calmly say, “Ok.” I then ask, “What do you think would happen to the price of baseball cards?” “Hmmm…they would go up?” I answer, “Maybe…but what if we gave $10,000 to everyone in the US and told them they could only buy baseball cards? What would happen to prices?” My 12 year-old blurts out, “They would go up…A LOT!” Yep, you got it.

Central banks don’t understand much but they surely understand supply, demand and cornering markets. Crisis here, crisis there, quest for yield….whatever! It’s all supply and demand kids. Print money and prices go up…period. You can argue it is fear or uncertainty but I will call it the allocation (or misallocation) of unprecedented amounts of new capital. Interestingly though, over eight years the problem for the kids (and bankers) has becomes Capone-like as they have supplied too much demand thereby forcing them to buy something other than baseball cards (or what was initially only concentrated purchases of government debt).

Consider the progression of money printing around our globe as central banks have moved form market to market with the printing presses rolling. Our Fed began in 2009 and now holds approximately 23% of the outstanding US government bonds with a total balance sheet of $4.4 trillion. They started buying US Treasuries and quickly added agency debt and mortgage backed securities. The ECB has moved from sovereign debt to corporate bonds including now certain junk issues (their balance sheet is around $3.5 trillion). As a result, $512 billion of investment-grade European corporate bonds are yielding negative rates or 24% of the market (11x what it was just 6 months ago). The Bank of Japan began buying bonds in earnest in 2011 and now owns 24% of the outstanding domestic government debt yet still buys 90% of all newly issued government bonds every month (balance sheet of $4.1 trillion). In fact, the BOJ has bought so many baseball cards that they have begun to buy stocks. The result; as of last April the BOJ owned 10% of the Nikkei 225 index and is now a top 10 shareholder in 90% of the Nikkei 225 stocks and 55% of Japan’s ETF market! C’mon bankers: supply a demand!!!

This is money printing gone mad as what initially started with limited concentrated buying has now expanded to any asset the central banks can justify purchasing. As a result, we firmly believe the yield curve, P/E ratios and all metrics that were constantly quoted from a relative historical perspective are irrelevant as new market equilibriums surface daily due to the continuous printing of money. In places like Japan where debt-to-GDP levels are absolutely unsustainable we also believe a point of no return has been crossed. Fed Chair Ben Bernanke’s solution for Japan eight years after the crisis: print even more money, keep accumulating all the sovereign debt and eventually convert it all to zero-coupon, perpetual bonds. What the flower?!?!?!?  

Homer Simpson; “A light bulb is either on or off.” Lisa Simpson: “Not if you use a dimmer switch.” Homer Simpson: “That’s what the dimmer switch companies want you to think.” Money printing is money printing and will, regardless of what everyone tells you, result in inflation at some point. Question: “If central banks globally printed another $19 trillion and allocated it to the people instead of the governments and corporations what would happen to prices?” We would get inflation…albeit short-lived and at the expense of a devalued currency; guaranteed.  Last week, at the Republican National Convention, Donald Trump mentioned the US national debt was currently around $19,000,000,000,000. My 12 year-old son then turned to me and asked, “How do they pay that back?” I answered simply, “They don’t. They just print more money.” He looked at me and said, “I’m going to take a shower.” Lesson complete…the light bulb was clearly on.   Stay hedged.