Stores in Venezuela Resort to Weighing Stacks of Bolivares on Scale Rather than Counting It

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Venezuela: a tragic reminder of the follies of political corruption, unjustified increases in money supply, and heavy handed actions by central planners to cheat basic economics.

The Venezuela hyperinflation saga continues.

The Chavez/Maduro political legacy is on life support. Most unfortunately, life in Venezuela is becoming increasingly unsafe. Protests have turned violent.

Increasing the money supply to pay the tab for unrealistic political promises is a very dangerous game that usually ends in tears. In that respect, it is never “different this time” and thousands of years of monetary history tells us no nation or empire has a free pass to utilize baseless money creation forever without facing dire consequences.

There are many people alive today who were around when Venezuela was the wealthiest nation in South America. Now the currency is approaching worthless and so is the wealth of most of its citizens.

This is how many Venezuelan Bolivares it takes to buy one US dollar on the black market (the official FX rate fixed by the government is not accepted by the market). You will notice the amount is now “off the chart” as the exchange rate rapidly moves above 19,000 BSF/USD. This, during a time when USD has fared poorly against most trading partner currencies, meaning it has nothing to do with USD strength.

This is clearly hyperinflation.

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Perhaps the most important point to convey in this post pertains to stock market performance during periods of hyperinflation.

While above-target inflation is generally bad for equity prices because it implies the central bank might react with tighter monetary policy in the near future to reign in excess liquidity, at a certain point equity prices can melt higher if investors don’t expect a meaningful tightening in financial conditions.

Take a look at the Caracas Stock Market Index below.

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Higher prices mean higher revenues for businesses. This can be falsely appealing initially, and is also part of the reason corporate managers tend to join in on the fashionable “inflation is good” bandwagon amongst elites. However, it is only an illusion of higher wealth and profits due to the diminished spending power of supposed increases in revenues and profits.

Not even the most devout Keynesian print and ease perma-doves will attempt to proclaim that investing in the Caracas stock market is making people rich in real terms, even as the market melts straight up in nominal terms.

Be careful in assuming every financial asset bubble ends in a 2008-style market crash. When debt outstanding becomes unpayable, asset bubbles become increasingly prone to inflationary outcomes rather than the more common market crash outcomes for which everyone these days seems to be on the lookout. That is one reason Alan Greenspan indicated more caution about the bond market than the stock market.

At the very least, future potential economic shocks in the US may result in a more fragmented bond market reaction than the typical risk-off correlations (gov bonds up, high yield down, USD up, EM currencies down, stocks down) witnessed in the past 15+ years.

US stock indices will most certainly fall initially during future economic shocks or downturns, but what you should really be focused on in terms of macroeconomic risk management in the current era is one or two steps ahead of a potential shock — how will activist central planners respond given the remaining options at their disposal during a period of heavily indebtedness and aging demographics?

Inadequate Historical Valuation Measures and What Comes Next in This Monetary Bubble Investing Frontier

  • Market analysts far and wide continue to pound their fists on the table daily about overstretched equity valuations (and many other assets for that matter) putting risk markets in dangerous territory ripe for an imminent sizable correction, or worse.
  • Indeed, global risk markets are tremendously overvalued by almost any historical measure. It takes a heroic effort of wishful thinking to believe otherwise.
  • If we take a look at the S&P500 as one prime example, 18 out of 20 of the most widely followed valuation measures are flashing “overbought” with red blinking lights. Four of the measures indicate an S&P500 at least 50% overvalued, historically speaking.

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  • Therein lies the problems with historical valuation analysis: first, it is based on backward looking data only. Additionally, valuation alone has proven to be an inadequate timing mechanism.
  • Assist FX does not see the historically overstretched valuations currently witnessed in global equities, real estate, and bonds imminently leading to a near term risk-off crash as the base case, although that is always a possibility. Valuations will likely become even more stretched first. Additionally, the current bubble investing environment might lead to a different ultimate resolution than the traditional risk-off market correction/crash many are accustomed to witnessing. We see a different range of scenarios playing out involving capital eventually being less attracted to paper/fiat based financial assets and more attracted to physical-based assets and decentralized stores of value. Imbalances may very well be resolved via asset depreciation in real terms rather than in nominal terms. An occurrence of this nature is not likely to materialize for some time, but risks are building daily as global debt pressures become less and less reversible.
  • Key question: Is this time really different? Answer: yes and no. There has never been another time in history where global central banks have been this supportive of asset prices all at once. During a time marked by real estate bidding wars and new all time highs in global stock indexes, central banks still feel the need to create more than $200 billion dollars per month from thin air to buy mortgage bonds, stock ETFs, and government bonds. Markets are rigged, but they are actually rigged to rise in order to supposedly create a self fulfilling “wealth effect” of unrealized asset gains fueling greater economic activity and confidence.
  • You can’t skirt the basic laws of market supply and demand forever. Reference Venezuela as one of hundreds/thousands of unfortunate examples involving central planners throwing a grand party on borrowed time that ends in widespread misery as soon as the bill comes due. Today’s advanced economies are not being operated with the same extreme mismanagement as in Venezuela, but less severe policy errors are impossible to ignore when cumulatively compounded over time.
  • Current state of global monetary policy: The Fed, ECB, BOJ, PBOC, BOC, SNB, RBA, RBNZ, and other central banks have enabled massive asset price inflation to grow unchecked across several asset classes, particularly in real estate and equities. They do this in the name of fighting a phantom crisis of consumer price deflation which only seems to exist in heavily adjusted inflation index data conjured up by statisticians who know the entire political and industrial complex desires the lowest official readings possible. The appearance of low inflation makes GDP look higher, wages look stronger, and government transfer payments linked to inflation indexes lower. Understated inflation indexes are to politicians and executives what Photoshop editing is to swimsuit models.
  • What many well-meaning analysts have been getting wrong is just how long this type of central planning charade can go on before supply and demand imbalances are aggressively shocked back to reality in a reversion to the mean event. That is because this is not only a function of economic mathematics but also of mass psychology. Dispassionate valuation modeling alone is not enough for a prudent money manager. One must also have their finger on the pulse of market psychology to know when the music has stopped and isn’t coming back on for a very long time during the metaphorical musical chairs game also known as investing in a bubble environment. Assist FX research indicates the music isn’t quite ready to stop–we aren’t there yet. But don’t pile into expensive asset classes with huge leverage either. Stay vigilant and nimble.

Bottom Line: Assist FX has believed for some time, and continues to believe, that central banks have “doubled down” on a quasi commitment to keep asset prices elevated by doing “whatever it takes” as their primary strategy to minimize the onset and severity of cyclical recessions. This improves the appearance of macro economic activity in the near term while adding to dangerous systemic risks longer term. It is difficult for financial markets continually pumped with newly created money and ultra low interest rates to simultaneously crash and stay down. It tends to materialize with earnings multiple expansions in stocks, cap rate contractions in real estate, and overall suppressed volatility, making nearly all asset classes appear “overvalued” for a much longer period of time than many market observers believe can occur.

Make no mistake. We are in yet another central bank inspired asset bubble that was engineered to “fix” the aftermath of the last two central bank inspired asset bubbles. The imbalances grow more pronounced with each reflated bubble because instead of having moderate, occasional recessions where the most unproductive debt is reset via bankruptcies, you have massive unproductive debt imbalances augmented much further by artificially cheap credit and financial engineering. This dramatically increases systemic risk associated with major financial crises, economic meltdowns, and complete monetary system resets. Yet, bubble environments can exist for very protracted periods of time.

Nearly everyone who thinks about these types of economic topics knows at some level, whether more conscious or subconscious, that the current central bank driven free-lunch asset holders are enjoying today are creating the types of systemic risks that endanger the global monetary system tomorrow. This will push private citizens worldwide to increasingly seek alternative stores of value for their savings. That is why demand for decentralized, alternative stores of value such as block-chain technology-based digital currencies is set to accelerate. The block-chain trend is just getting started. As for traditional financial markets, we see a continuation of the type of slow grind, nearly dead volatility asset price levitation to continue for the time being.