Canso Investment Counsel Ltd. gets to the core of the inflation issue in the December 2022 edition of their Market Observer publication. Read more here: https://www.cansofunds.com/december-2022-market-observer/
Why are bond returns down so significantly this year?
Many investors are wondering why the supposedly safe bond returns are down this year. Now, the reason for this obviously are interest rates. So interest rates in Canada in the five, 10 and 30 year space were up about 2% this year alone, which as we all know, interest rates move inversely to bond prices. So that translates unfortunately, to a bond price drop of about 22%.
What role has monetary policy played in stimulating inflation?
So for the last 10 years, inflation in Canada and the US has averaged somewhere around 2%. Inflation this year is much higher, it’s about 6.9% in Canada for the month of September and just above 8% in the US.
Now, just like in the 1970s, economists are very quick to blame inflation on existing current factors. In the 1970s they blame the price of oil as a major factor behind inflation. This time around economists are very quick to blame what’s happening in Ukraine and all the Covid lockdowns that have happened over the last couple years. We recognize that those factors are very important to inflation and have certainly not helped things. Where we stumble on is the amount of money that has been printed over the last couple years by banks around the world to combat the effects of Covid lockdowns.
Now, that’s certainly something that we have seen in the past, for example, in 2008, 2009. But the difference that we recognized this time around is that back in 2008 and 2009 again, was the Fed was combating credit crisis. So the idea was to print money and to put it into the commercial banks to essentially shore up their balance sheet. This time around obviously, the Fed was not facing credit crisis. The Fed wanted to make sure that consumers out there were out in the economy spending money to support the economy. So this time around the $4 trillion that were printed were actually given out directly to consumers in the form of EI and other measures.
So this new money that was given out to consumers, obviously consumers what they do with money in their hand, they’re going to spend and with a limited amount of goods because of all the effects of Covid lockdowns, we’re not surprised to see inflation the way it is today.
Why is increasing the amount of money in the economy a problem?
Well, that’s one of the basic monetary principles and the best way to explain what’s going on right now is probably to reference the game Monopoly. So if we were to double the amount of money chasing the same amount of goods you can expect, as the law of demand goes, you can expect those places to go up in price.
So that’s exactly what we’re seeing in the economy today and again, to reference, there’s a lot less goods in the economy today than there were two years ago, but you have about twice the amount of money in circulation. So that’s what’s at play right now.
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