Credit Inflation: Building An Investment Strategy


On August 10, I posted an article titled “Credit Inflation Reaching A Climax.”

I have defined a government policy of credit inflation as one in which the federal government continuously strives to achieve rates of unemployment below full employment by conducting its policy to stimulate unending inflation. Essentially, credit inflation creates fiscal deficits and supporting monetary policy to keep prices rising above expectations so as to gain a little less unemployment in trade for a little higher rate of inflation.

In the article mentioned above, I summarized the history of the government’s policy of credit inflation, which began in the 1960s, and discussed how this policy effort has become ingrained in business and financial decisions in the United States and helps account for the current economic situation we find ourselves in.

A crucial outcome from this policy effort was that knowledgeable and sophisticated investors began to build their investment strategies based on the government’s efforts and, by the early 1970s, had pretty well created a way to take advantage of what the government was doing.

What pretty much “sealed the deal” was when President Richard Nixon bought onto the credit inflation approach, and since his administration, we find that credit inflation is a part of both Republican Party and Democratic Party approaches to the focus of the government’s economic policy.

I concluded the August 10 post in this way:

credit inflation is peaking because investors expect that the government will keep on keeping on. That is, investors see no end to the government support.”

Credit Inflation – The Policy Of Both Parties

The “convention” of the Democratic Party just confirmed that the Democratic Party will continue on with its support of credit inflation if Joe Biden becomes the next president of the US. The Republican Party, under the leadership of Donald Trump, will reconfirm this week at its “convention” its commitment to continue on with the policy of credit inflation.

We move ahead knowing that in the following years, the United States will be facing a continuation of the same basic economic policy the government has been pursuing since the early 1960s. So, the investment policy of individuals must take into consideration what the government is doing and how this impacts different parts of the economy.

And what kind of investment policy should this be?

The Financial Circuit Of The Economy Versus The “Real” Circuit

Macroeconomic policymaking aims to impact the “real” outcome of an economy. That is, the government aims at achieving a high level of “real” economic output so as to ensure that employment is kept at high levels. By altering its plans to tax people and businesses and its plans to spend, the government attempts to influence the investment efforts of businesses and the consumption expenditures of people so as to achieve a high enough demand for “real” goods and services to achieve the employment levels it is aiming for.

The monetary policy of the government is aimed at supporting this effort by making sure that consumers and businesses have a sufficient supply of money to support their spending plans.

Up until the 1960s, government policies did not try and push the economy too hard. As a consequence, most of the funds created by the government went to the “real” circuit of the economy, and consumer price inflation, related to the flow of goods and services being produced, was the primary concern of “too much demand.”

But something changed in the 1960s. With the government now supporting a continuous effort to create money and debt in order to generate higher levels of economic output – levels that would generate more employment – some of the funds being generated began to seep into the financial circuit of the economy. This flow into the financial circuit was assisted by the wage and price controls President Nixon put on the economy in August 1971.

If the government was putting a constraint on prices related to the “flow” of goods and services, maybe money could flow into assets and we could produce some “inflation” in asset prices. And that is just what happened.

By the middle of the 1970s, we saw asset prices moving up, supported by specific programs of the government, especially in the realm of housing. The flow into the financial circuit of the economy was now taking place, and we saw “unusual” increases in the price of houses, in gold, in art work, in some commodities, and elsewhere.

Credit Inflation Takes Off In The Financial Circuit

As credit inflation continued though the rest of the century, many changes took place in the economy to reflect the fact that more and more money was flowing into the financial circuit. One major area of activity was in financial management and financial innovation.

Particularly in the 1980s, we saw the advent of the field of financial engineering and the massive output of new financial innovation. In the 1990s, we saw the advent of many different kinds of asset price bubbles.

And the response of the economy to fiscal and monetary stimulus changed. Economic growth became less responsive to economic stimulus and consumer price inflation became less of a concern.

Let me jump ahead to the 2010s and the recovery from the Great Recession. During the recovery, we had the Federal Reserve pump large amounts of money into the economy, but through the whole period of economic expansion, real GDP only rose at a 2.2 percent annual rate of growth, the lowest in history, and consumer price inflation came in for much of the time under the Fed’s target of 2.0 percent.

Yet, stock prices rose to one new historical high after another. Commodity prices rose. Housing prices rose. And there were a lot of other areas where asset prices saw substantial gains.

Credit Inflation Dominates

As stated in my article cited above, we are in a new era where credit inflation is the accepted norm of many investors, especially the savviest investors. In my estimation, the explanation for the many increase in wealth/income inequality over the past sixty years is the result of the really savvy investors taking advantage of the continued credit inflation of the government.

Given the stance of the two political parties, it is my estimate that, unless there is a major debt crisis, credit inflation will dominate the future and will serve as the foundation for a successful investment policy. It is my hope to use this blog as a vehicle for discussing the environment of credit inflation, the types of investment strategies that will work within such an environment, and the types of portfolios investors might want to build. We will talk a lot more about these topics in the future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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