Inflation’s Long Game

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Long-Term Inflation Trends

Lessons Drawn from the Inflation of the 16th & early 17th Centuries

A. Inflation comes in multiple waves.

B. Current global population trends (8.0B in 2023 vs. 7.2B in 2013 vs. 6.4B in 2003) vs. the commodity capex deficit trend is VERY inflationary.

C. Perceived demand shocks in the energy sector are a buy.

D. The Fed has far less control over inflation than meets the eye.

E. Inflation fuels real income inequality and that fuels the Power of Labor, and that fuels sustained inflation.

F.  Shrikflation is as old as time itself.

G. Hard asset, bull market trends surge in inflation’s second leg higher.

H. Inflation will trigger a colossal political shift, response.

Lessons Learned, is Anyone Listening?

In the last quarter of the 16th century, prices began to increase slowly in Germany and Italy. In Florence, during the 1490s, prices surged. Masses of starving poor crushed themselves trying to get at the granaries. As is usually the case, an epidemic followed the famine. Soon, Venice lost wars in the East to the Turks and in the West to the French. In 1527 Rome was sacked by the French. Such were the events that ended the Renaissance price equilibrium. Inflation didn’t peak until the mid-17th century.

There are priceless lessons behind us, we MUST take note.

While the price of grain started to rise in Florence starting in 1472, there were areas in Europe where grain prices didn’t increase until about 1500. The last significant price increases in Europe ended altogether in 1650, making for the longest sustained inflation period in the history of the continent. Now, here is the key first lesson. We today think it would be a fine and healthy thing to reach a 2% inflation. False. The sustained price inflation from 1470 to 1650 averaged only 1% a year. However, the length of it, and the compounding of it, wreaked havoc for decades. So, while we debate whether inflation has or will be “over” i.e. if it will ever get to 2%, what we are missing is the fact that even 1% inflation, if it lasts long enough, is extremely deleterious to the polity, as you shall see below. The reader may recall our recap of medieval inflation and how destructive that was. Well, it was only about half of one percent a year on average for its duration, and it was a disaster.

Another lesson, our second, from studying this longest of price rise periods comes from noticing the extreme price variations around the primary trend. There were periods where prices rose well above trend and there were other periods where prices fell well below trend. This is a second lesson from the period we are focusing on in this paper: inflation comes in multiple waves. In other words, the current bout of inflation we have just experienced would be unique in history if it were not followed by yet another. Furthermore, it is a myth that Volcker cured inflation. He greatly reduced it, but he didn’t get rid of it altogether. How so? Well, in the wake of Volcker’s success, the Fed and the rest of the government developed a propagandistic lie: that the only way to avoid the perils of deflation was “modest” inflation. That is a lie because there is a third paradigm: no inflation and no deflation i.e. price stability. The cure against deflation is the same cure as against inflation: zero inflation. 2% inflation is a disease. 1% inflation is a disease. It is utterly false to say our only choice is between high inflation and moderate inflation. If we look at the modern period in toto, we see bouts of inflation followed by bouts of moderation which overall destroy the average person’s standard of living. This is what happened during the period we are considering as well.

What caused the inflation that saw its first sparks in the late 15th century? Population growth. The increase in population strained Europe’s material resources. This is a third lesson that comes from a study of the period. We think about globalization all the time. Yet, for some baffling reason, we think of the present-day inflation as a US phenomenon or a US and EU phenomenon, or as the latter with pushes from OPEC+ and China. Each of these views has something to recommend, but the simple truth is that inflation is a global phenomenon, and if one refuses to look at the total global economy, one will fail to understand the inflationary forces at work in our own day. The fact is, while the US population is growing slightly, because of immigration, the world’s population growth is quite strong. Within a handful of decades, it will crest at over 9 billion souls, more than one billion extra mouths to feed than today. The planet’s basic material resources are not growing at a concomitant rate. Therefore global inflation is inevitable for the next couple of decades at least. And global inflation means the US will suffer inflationary pressures for the next couple of decades at least. Certainly, there will be years when inflation will be less. Just as certainly, there will be years during which inflation will be above trend. The key point is that because the world’s population is growing, long-run inflation is here to stay.

Most countries in Europe showed a catastrophic decline in population in the mid-fourteenth century, which decline continued at a less precipitous rate until the end of the fourteenth century. In the early 15th century, population growth returned, but at a moderate rate. After about 1460 or so, population growth accelerated at a rapid clip. Take England as an example, which, in 1430 to 1470 had a population of around 1 million people. By 1541 the population was 2.8 million. Why did the population stabilize and increase? Well, because real wages had been increasing which increased social optimism which increased family size. Real growth – sustained real growth – is a wonderful tonic if one is planning to have a family. From 1460 to 1510, people married earlier had children earlier, and had more of them.

What were the effects of population growth? The first impact came in the form of increased prices for food. Next came wages and industrial products. “Throughout the first three-quarters of the sixteenth century, agricultural prices rose faster than non-agricultural (in Spain),” writes Earl Hamilton. This was true across Europe. After food prices rose, energy prices rose. In the early years of the period under consideration, energy prices rose slowly. After this initial period of relative quietude, energy prices spiked. Why? Europe was losing its forest and its forest provided fuel: wood. Eventually, around 1530 or so, the prices for wood and charcoal went up faster than the prices for meat and grains. It should be added: not only did energy pricing increase rapidly, but so too did the volatility of those prices.

Energy – the Ultimate Inflation Hedge
Look carefully, oil is very often a CPI leader.  An oil reversal higher points to higher – follow on – CPI.

This is the fourth key lesson to remember as we trade energy today: BUY THE DIPS. Each time energy prices calmed down, another wave of energy price increases followed, for the simple reason that, whatever the peculiar circumstances of a particular season, overall there was simply not enough energy for the populace long-term. So too today: because of a dearth of investment in oil fields there is simply not enough energy for everyone at cheap prices. So, yes, there will be quarters where energy prices are soft, sure enough, but expect new highs down the road.

Intriguingly, industrial prices were slower in their rate rises. During the period, in England, energy prices rose six-fold while prices for industrial goods rose three-fold. This, therefore, is the fifth lesson our study provides: Core inflation is a false measure of inflation. By reducing the number of things that the Fed targets in its war against inflation, it solves its problem by avoiding measuring it. Effectively, the Fed isn’t fighting inflation because it can’t. The Fed has no influence over global population trends. The Fed has no influence over energy investment. Sadly, that means the Fed has no influence over long-term global inflation trends. Everyone is looking for the Fed to cure inflation. It can only have moments of relative success. A true long-term cure for inflation is simply beyond any Central Bank’s grasp. Thus, the market focus on Fed policy is a focus on an illusion.

Around the middle of the 16th century, a new element was added to the inflationary mix: a recognition that inflation existed, that inflation was not transitory, and that inflation was sticky. Once it became widely recognized that inflation existed, the first impulse was to blame someone. However, in essence, everyone was to blame. Inflation caused consumers to spend more money, which exacerbated inflation. People hoarded goods. This in turn caused speculation in goods. This in turn caused panic buying of goods. This in turn caused the degradation of goods: shrinkflation. Just like today as soda cans are smaller and Dorito bags have less chips in them, bakers in the 16th century started selling smaller loaves of bread at higher prices. Hence our sixth lesson: shrinkflation is an inflationary reaction to an already existing inflationary environment.  Shrinkflation is symptomatic of a conscious awareness that inflation is not going away.

A consequence of inflation and of its conscious awareness in the population was that some members of society were able to adapt to the changed circumstances better than others. Of course, there were social imbalances before inflation had set in, but these social imbalances were greatly enhanced because of inflation. While wages at one point increased along with food and energy, eventually they lagged significantly. By 1570 the average wage had been cut in half, or more, compared to the early stage of inflation. Who were most at risk? Those with no capital and few skills: the underclass. Landlords fared much better, so too those with capital. Rates of interest increased in keeping or exceeding the rate of inflation. The Hapsburgs ended up paying interest rates as high as 52%, exceptionally high, but indicative. Feudal lords raised rents. There were times when rents rose faster than energy and food prices.

Wages, Gasoline LEAD CPI
Wages and gasoline are FAR above where the Fed wants them to be. No one seems to care, for now.

Overall, rents in England, for instance, rose nine-fold from 1510 to 1640 during a period in which grain prices went up four-fold and wages merely two-fold. Increases in rent caused ferment in the countryside. Kett’s Rebellion of 1549 in England wanted rents to be rolled back to where they had been 65 years prior.  Real wages, wages adjusted for inflation, declined from the late 15th century into the early 17th century. Since the upper classes were relatively better off than the lower classes, one could even argue that inflation strengthened feudalism.

Here is our seventh lesson: Long-term inflation increases social inequality, reinforces the power of the rich, and increases the hatred of them by the lower classes. This is not irrelevant to the social and political tensions we see in our own time. Dominant elites gain strength. And they don’t give it up willingly. During the period under consideration, returns to capital were much greater than returns to labor, resulting in labor’s widespread discontent with the status quo. One consequence of increased inequality was squalor: in England, the number of vagabonds and homeless increased dramatically. We see this in our own time as well. The homelessness that so many of us decry is a direct consequence of inflation. Such is the lesson of history.

Another familiar consequence to prolonged inflation came in the form of monetary imbalances. The response to inflation was the creation of more money. Silver in circulation vaulted by 10,000 tons mid-sixteenth century to north of 34,000 tons in 1660, by some estimates. Where did this lucre come from? Silver and gold from America flooded Europe. It is key to understand that inflation was well underway for quite sometime before precious metals from the New World hit European markets. Prices in England and Germany had already doubled by the time Mexican silver reached them. Another argument against precious metals causing, as opposed to aggravating, inflation, is that their effects were not evenly distributed with the distribution of the metals. More silver and gold reached Spain than anywhere else in Europe, but its inflation was less intense than in the rest of Europe. Insofar as one looks only at inflation in Spain, it was worse in the half-century before its money increased than once the treasures began unloading at the port. Much of the silver in Europe came from the Potosi mine in Mexico, which opened in 1545. This mine was responsible for almost half the silver that arrived in Europe from the Americas. It was mined by indigenous slaves. It is quite something to go through museums and look at silver plate from 1550 to 1650 and realize that all that silver passed through Indian slaves’ hands.

Gold Silver Cross
Silver has been outperforming gold for months. As the Fed arrives to the end of the hiking cycle, look for silver (SLV) to outshine gold (GLD).

Silver and gold from the New World didn’t cause inflation but exacerbated it. The desire to increase the money supply existed in the Middle Ages as well during its inflationary period. Once people see inflation rise, they want more money. It is noteworthy that there were fluctuations in coinage that made this trend zigzag.

Hence our eighth lesson is: that inflation causes an increase in the money supply and in the volatility thereof. We saw a huge surge in the money supply recently and now that surge is over. It will reappear. The fluctuations in coinage during the sixteenth and early 17th centuries track quite neatly to the fluctuations in the price of wheat, for example. One might think that New World lucre was sufficient to satisfy money demand, but that assumption would be false. Every old and closed mine in Europe was eventually reopened, and new mines were found. Obviously, in our own time, we are not there yet, but that will change. All this was not lost upon thoughtful observers of the age. This is the period in which the monetary theory of inflation was invented. The first monetarist was, unsurprisingly, Spanish. Martin de Azpilcueta wrote: “Money is worth more when and where it is scarce than when it is abundant.” A decade later, the Frenchman Jean Bodin said much the same. Nicolaus Copernicus did as well. It became commonplace across Europe soon enough. Hence, while the primary cause for inflation was population growth, one aggravating cause was the supply of money.

Naturally, and familiarly enough, fiscal imbalances ran rife. In response to ongoing inflation, from the mid-sixteenth century on, fiscal imbalances ballooned as a primary governmental response. In response to increased fiscal deficits, taxes were increased. These taxes fell disproportionately on the lower classes. Some of the nobility remained exempt from taxation, and certainly from the most onerous taxes. Since government revenues still fell behind, government borrowing increased to make up for the difference. Once we reach the early 1540s, we find that a significant portion of the government of Spain’s revenue went to pay interest on debt, and this is from the primary beneficiary of Mexican silver mining. The fiscal imbalances interacted with the rest of the reactions to inflation, of course. The various inflationary responses to inflation that only increased inflation form a complex matrix in which sometimes one, sometimes inflationary force gained temporary dominance. Falling real wages and higher rents increased inequality as the rich gained yet more power which in turn caused the powerful to raise taxes on the weak only to see government coffers still unable to keep pace with inflation, causing those governments to debase their currencies. However, there were many other cross-currents besides that example.

Thus our ninth lesson is: that inflation causes fiscal imbalances which cause more inflation.
Naturally, all this led to social conflict. It is not pure accident that the Protestant Reformation, and the Catholic Counter-Reformation, moreover, occurred in the second half of the 16th century. The Diet of Worms in 1521 may mark the start of the Protestant Reformation, but it took increasing hold by the mid-16th century.

Social Conflict on the Rise
Ultimately, much like today – social unrest became violent. As inflation increased in the latter 16th century, so too did the volatility of prices. Prices catapulted and collapsed only to catapult again. Overall the trend was higher, but the year-to-year price swings were extreme. When four consecutive harvests failed, from 1594 to 1597 inclusive, famine and sickness increased. Medicine of course was not particularly advanced. Thus there were waves of population decline during this period. Epidemics reduced England’s population by 20% during a five-year period in the 1550s and prices softened commensurately. However, once the population grew again, inflation came back with a vengeance.

As high prices put the government in debt, that debt forces the debasement of currency which puts governments under greater fiscal pressure yet again. As this cycle repeated, social instability increased. Social instability was manifested and increased by war. The steepest increases in inflation were in the 1540s and 1550s, a period of increased war expenditure. Thus our tenth lesson is that inflation exacerbates social tension, the most strident manifestation of which is war, and this social tension in turn increases inflation still more. In our own time, it is obvious governments are spending more on the Ukraine conflict and it is easy enough to imagine other conflicts around the world that would lead to still more increased military expenditure. Yet even without that, who can deny the social conflicts within our own society today?

Matters eventually came to a head. The 1590s evolved into a prolonged crisis. The last quarter of the century was a period of stagflation: rising prices and less opportunity. In the last year of Queen Elizabeth’s reign, prices rose although the economy was in depression. Indeed, across Europe, real wages for laborers and artisans fell while capital continued its advance. As the inflationary cycle reached a climax, prices became more volatile with wild swings every few years in the price for wheat, barley, and oats. Starting in 1591, the weather was wet and cold for seven years running. It was a little ice age, with Alpine glaciers growing into inhabited valleys. Starvation increased. Again, the lack of economic material resources only served to increase economic inequality. A crime wave was the result. As the price of food increased, the incidence of crime increased as well. Given the year-over-year volatility in pricing, there were years when the price of food declined and then so too crime declined only to return once food prices increased again. We note that many retailers have been complaining about inventory shrinkage – theft. This is our eleventh lesson: as food prices increase, theft increases.

Food Inflation Trends are Sticky
Transitory inflation died 24 months ago.

With shortages in food, pandemics were rife. For example, half a million people died in the Iberian Peninsula between 1597 to 1602. In fact, the late 1500s into the early 1600s was the worst pandemic period since the Black Plague of the Middle Ages. Given the food shortages, fertility rates declined. Between the mid-16th century to 1617 in Toledo, baptisms declined by 50%. In fact, this period was the only time the population of Europe had declined since the Black Death. The European economy collapsed outright between 1610 and 1620. The number of ships counted in the Baltic Sea peaked in 1600 and declined steadily for half a century thereafter. Ship counting in the Baltic Sea continues to this day and we have upped the game with the Baltic Dry Index, a shipping freight-cost index, used by economists as an economic bellwether. Tonnage in Seville harbor peaked in 1610 then crashed and continued to decline thereafter for several decades. Industrial production in Amsterdam and Rotterdam peaked in 1620 and began an inexorable decline. War continued in various guises from 1590 to 1650 with only one year (1610) being a year without war. The armies of Europe had never been larger since the Roman Empire. The German population declined 40% from 1618 to 1648. That is a worse hit than even the Black Death. Deficit spending increased. Coinage was debased. Taxes on the lower classes increased. The result? Revolution. Catalonia and Portugal suffered a revolutionary conflict in 1640. Charles I in England faced a full-scale civil war and was beheaded. In France, rebellions, dubbed the Frondes, continued from 1648 to 1654. Altogether in France, there were 264 rebellions between 1596 to 1660. Naples and Sicily suffered civil unrest in 1647. The Netherlands did the same in 1650. Sweden did the same in 1650. Switzerland in 1654. Denmark in 1660. Scotland and Ireland faced a sequence of sanguinary revolts from 1638 to 1660.

However, leaving Germany to one side, the demographic disaster in Europe overall was less than the Black Plague, in part because the economy itself was more advanced. True, the inflation rate overall was higher, but the volatility, while high, wasn’t as high as experienced in the late Middle Ages. While the average price decline in the 16th and first half of the 17th century was double that of the inflationary period of the late Medieval era, the average volatility was about half as much as in the late Middle Ages. Productivity had obviously improved, and this helped to some degree. Markets were more integrated, and this helped as well. The 14th century saw the civilization of the High Middle Ages crumble away. The period we are now examining suffered no such fate. While the first half of the seventeenth century shocked civilization, it didn’t destroy it. Therein lies our twelfth (and optimistic) lesson: given our era’s advances in integrated markets and productivity, it seems unlikely that however bad the inflationary climax will be, in and of itself it is unlikely to destroy life as we know it, barring, of course, thermonuclear conflict.

Crises do end, and by the second half of the 17th century normalcy finally returned. Grain prices fell then leveled out. Energy prices and manufactured goods traded in a price range. Rents and interest rates fell while wages rose. Inequality lessened. The population grew slowly. Productivity improved some as did production overall. Real wages in England for laborers and builders almost doubled from 1650 to 1740 as the power of labor returned. Labor was more valuable than capital. A hectare of farmland that rented for around 12.8 francs in 1670 rented for only 7.5 francs by 1701. Interest rates in England fell from 10% at the beginning of the 17th century to 6% by its end. Overall prices fluctuated in a sideways pattern from 1650 to 1735. The price stability is remarkable. Meteorological shocks still affected food prices, but these prices soon recovered their former level and stability. All of this was bad news for the wealthy, who saw returns on capital decline, rents decline and labor costs increase while prices overall were flat. During this period, gold and silver still flooded Europe. Money supply increased but not inflation.

For instance, in France, from 1683 to 1730, silver livres in circulation increased from 500 million to 1.2 billion. Yet the cost of living remained constant. Not only that, but French coinage went through a series of debasements during those years. Price stability in France and Europe occurred despite monetary expansion, not because of monetary decline. How could this happen? The answer is that population growth stalled.

Population Trends
High levels of dependency and the relative scarcity of labor may induce a shift in the methods of production from labor-based R&D back to a reliance on natural resources. The global economy is going to pass through a severe population problem over the coming century, resulting from the simultaneous peak in global population levels with near-zero population growth (Roser et al. 2013, Giovanni and Tena Junguito 2023). This conflation of world firsts is seen above, which shows that global population is projected to reach a peak of approximately 11 billion individuals in the year 2100, at the same time that population growth is forecast to be moving asymptotically to zero. With Pedro Naso and Timothy Swanson.

Population growth did not accelerate until after 1730. When we look at Japan in the modern era, it has had low inflation and low to negative population growth. The population of the world overall, however, continues to grow in our age, and inflation has only briefly, if ever, run back to zero, where it should be. From 1650 to 1730, commerce was healthy, violent crime fell, and political structures stabilized. This period of low inflation and economic prosperity corresponds with the Enlightenment. This period developed two contrasting economic theories: mercantilism and laissez-faire. Just as the High Middle Ages went through an inflationary crisis and gave way to the glories of the Renaissance, the inflationary crisis of the late Renaissance gave way to the glories of the Enlightenment.

(The above is in part an encapsulation of work complied by David Fischer. We urge a read of his tome “The Great Wave.” Our twelve lessons inferred from the encapsulation we have done are made by the Bear Traps staff and we do not purport them to be explicitly spelled out in the referenced text as we have done in this paper.)




Pick Your Poison — Default or Financial Repression?

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

The Mind-Blowing Hole

After dinner drinks, a friend said these blood-curdling words;
“The US government has already spent $5.3 TRILLION this year. We are on track for the 4th consecutive year with $6 trillion or more in government spending. Since 2020, the US government has spent a jaw-dropping $25 TRILLION. To put this in perspective, the market cap of the S&P 500 is $37 trillion. Spending since 2020 is equivalent to 68% of the entire S&P 500 market cap.”

Walking away from ultra-low rates and Quantitative Easing isn’t so easy given the massive public debts from the governments Central Banks work for. It is universally agreed that debt levels are too high. The question is: How can those debt levels be reduced?

This problem has become particularly acute after the pandemic lockdowns. At 2020-year end, the US had a debt to GDP of 127% which looks conservative next to Japan’s 256% but certainly more aggressive than the EU’s 100%. Given various fiscal measures, these ratios don’t look to be improving any time soon. In this environment, higher interest rates threaten financial stability. High government debt limits Fed options. Volcker was aggressive in part because debt levels were relatively muted compared to today. Debt to GDP in 1979 was a mere 34%.  Volcker raised rates sharply and increased reserve requirements for banks, causing a recession stabilizing the dollar, and reducing inflation. It should be noted that deregulation led the way out of recession. Since then, various crises have been met with aggressive lowering of rates, as we all know. The consensus view among Central Banks has been that they cannot identify bubbles, but they can fix markets once those bubbles pop.


One way to reduce debt is through austerity. As an example, after WWI Italy was burdened with a debt to GDP ratio of 180%. In response, government spending was severely cut back and consumption on expenditures increased. As a result of continuous surpluses, the Italian lira stabilized as debt to GDP declined to 76%. Another example was Germany after unification. Public spending fell, future social benefits were cut. Growth declined but the current account balance went into surplus. It took nearly 20 years, but growth came back. As the economy finally grew, so did tax revenues. There followed investment in Southern and Eastern Europe. Another example was the EU after the Great Financial Crisis. Since EU membership precluded countries from individually depreciating their currencies, government expenditures were reduced. Nominal wages declined in many countries. However, debt to GDP levels didn’t improve, so the ECB loosened credit conditions. For Germany, this caused a real estate and export boom. As a result, debt to GDP levels declined.


Another way to improve debt to GDP ratios is through hidden debt reduction i.e. inflation. It is an old truism that inflation is a tax, and that raising taxes outright is considered an unpalatable risk politically. Higher inflation does reduce the real value of tax revenues. Financial repression means to keep the return to savers below the inflation rate. This is what the US and the UK did after WWII. The UK public debt to GDP was 250% after WWII. In the US, it was 120%. Not only were low interest rates pursued but interest on savings were capped. Various regulations were put in place the effect of which was to direct credit to government. The forced low-interest rate on government bonds reduced debt in two ways. With low-interest rates, compounding was held at least somewhat in check. Additionally, low to negative interest rates devalued the debt that already existed. However, when these techniques were used in emerging economies to protect non-competitive industries, debt to GDP ratios did not improve. Recent history in the US, UK and EU suggests that financial repression has been used with increasing similarity to emerging economies.


Another example of hidden debt reduction is hyperinflation as in Germany after WWI. While a slow-but-steady financial repression gradually transfers wealth from creditors to debtors, hyperinflation does the same thing but very quickly. Workers respond by demanding higher wages, and the increase in money demand is met with an increase in money supply. Germany’s hyperinflation of 1923 was caused by excessive money growth to fund the prior war’s expenses. The transfer of gold from Germany to its enemies didn’t help matters. To offset the negative economic and monetary consequences of the Treaty of Versailles, the Reichsbank extended credit to the German government. Eventually, the German government stopped paying reparations in 1923 causing France and Belgium to occupy Germany’s industrial heartland. That didn’t help matters. The German economy collapsed. The government asked workers to go on strike and compensated them with their normal wages by printing money. Hyperinflation ensued.


Argentina, a country people like lending to at par in order to lose money in the most predictable way possible, followed a not dissimilar path in the 1970s. The twist was that much of the capital used to finance its inflation came from overseas and was denominated in a foreign currency: the US dollar. Local debt is not indexed to inflation, and so is devalued through inflation. The central bank would accumulated government bonds, financed by monetary expansion, which fuels inflation. As inflation rose, so too did nominal GDP thereby reducing the debt to GDP ratio. However, when most of your debt is in USD and the dollar appreciates against the peso, default ensues. Eventually, by 2020 over three-quarters of Argentina’s debt was in foreign denominations, roughly $250 billion of it. Argentina has defaulted five times since the 1980s. The government usually expands the money supply in order to buy bonds: financial repression. This causes inflation and lowers the value of public debt. Furthermore, by lowering the currency exchange rate, prices for imported goods increase. Eventually, the market demanded bonds indexed to inflation if they were in local currency. Another Argentinian government tactic was to exchange its foreign reserve holdings with non-transferable dollar-denominated Argentinian Government obligations. However, instead of paying them off at maturity, the government just rolled it over into new debt. In other words, one method of financial repression was theft. The stolen lucre was spent and that exacerbated inflation. Interest rates were held artificially low, and defaults were delayed a year or two. Capital controls and monetary sterilization techniques are employed as well, with inflationary consequences. Ultimately, however, the easiest way to lower debt to GDP is to default, restructure/exchange liabilities for lower nominal amounts, and thus lower debt. Argentina defaults on a regular basis because it is basic to its debt management practice. Ultimately, then, hidden debt reduction becomes unveiled debt reduction.


Besides austerity and severe inflation, there is a third route to improving debt to GDP ratios: extreme economic and currency reform. The classic example was Germany after WWII. No one worked for money, it was worthless. Barter was common. Since debt to GDP was almost 250% of GDP, the fork in the road to lower debt to GDP and thus to bring value to money and a return of money exchange purchase transactions couldn’t be the hyperinflation of the Weimar Republic, which, after all, was an experience that all Germans remembered. Hence currency reform was implemented. Excess liquidity was drained by a reduction in the money supply. Because Germany was occupied militarily, that perforce led to a change in the country’s economic structure. A currency reform combined with a reduction in money is effectively at least a partial default. Once a new currency is introduced at some ratio vs the old currency, the entire economy is changed. To make the velocity of money return to normal, the supply of money had to be reduced by 90%. The architects of reform had all liabilities to the former government and the Nazi party annulled for political reasons. Deutsche Mark debts were reduced by 90%. Those who benefited from the currency and debt reform were taxed at 100%, payable in installments. The remaining assets were taxed at 50%, paid in installments. This redistributed wealth. A liberal market economy was introduced, replacing the planned economy. The path forward resulted in Germany becoming a major global economic powerhouse.


Going forward, one may imagine a fourth way of reducing debt to GDP via inflation would be a digital currency, which might be particularly appealing for the ECB since there is no common fisc backing the currency. Euro money supply would be increased by the ECB purchasing ECB bonds. The money supply would be nominally guided by the expected growth of the Euro area. Money supply would be increased by government purchases of debt, not by loan origination from the banks. The banks themselves would be reduced to interest rate arbitrageurs, effectively. The system would take bond out of the system since they would be owned by the ECB. The ECB could double its inventory of bonds, to EUR 6 trillion and could even suspend payments to its own inventory and/or coupons could be changed to zero. Any kind of large-scale reform, where the more conservative northern countries would take a hit for the benefit for the heavily indebted southern countries in exchange for promises that the southern countries would behave going forward. In other words: digitization of the Euro currency could be accompanied by increased influence of the ECB, decreased influence of the traditional banking system, and realignment of debt levels punishing the well-behaved in exchange for a verbal promise from the perpetually profligate. It would fail ultimately, of course, but not immediately. Bottom line: a EUR digital currency will be more camouflage than substance.


From the above one may easily conclude that the long period of super low rates in developed economies have created excesses and fragilities that cannot rebalance debt to GDP without measures that would be felt as catastrophic to its citizens in its immediate effects. Central banks are driven by events. Central banks don’t pre-empt events. Therefore, we find it hard to believe that financial repression will be avoided until a crisis leaves them no choice. Between now and then there is one clear path: inflation.


“The Federal Reserve may not be that bright, but they are not so stupid as to replicate the Weimar Republic’s hyperinflationary monetary policy. They want to slow-walk financial repression, keeping government interest expense below the rate of inflation by a modest yet significant degree which means keeping what savers can earn lending to the US government below the rate of inflation. This isn’t being done as in some emerging economies as part of a plan to protect inefficient industries. It is being done by the largest economy and greatest military power the world has ever seen, by the country that has the dominant and deepest financial markets, that can be chipped away a bit but not rejected out of hand. You can’t pretend the USA doesn’t exist. What the US does ends up being copied by the rest of the planet. The US government’s financial repression is a back door way of lowering government debt thereby improving the debt-to-GDP ratio to a sustainable level. Politicians are loath to outright raise taxes on the middle class, so they tax everybody via inflation. The Fed doesn’t want inflation to go away. It wants inflation to stay above the US government’s average interest rate expense. The secondary, but vital concern, is to do that without causing hyperinflation. Hence the slow walk. It’s a 15-year program, not a 15-month program. It is no accident the Fed pauses with Fed Funds matching the inflation rate. The Fed spends more time looking at Treasury’s blended average interest rate vs the inflation rate than at the inflation rate itself in isolation.”





Inflation, looking back for forward insights

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Lessons Looking Back and Forward

We have all heard the phrase — “Those Who Do Not Learn History Are Doomed To Repeat It.” As we place our lens on modern inflation, let us take a look back for clues that may help us look down the road ahead.

Global Population Trends
There is a price to pay for all that cheap underwear at Walmart. Think of the last 40 years, we have decimated the U.S. Rustbelt. The good news is millions of people have been pulled out of poverty globally. From 1998 to 2021, the U.S. lost more than 5 million manufacturing jobs thanks to the growing trade deficit in manufactured goods with China, Japan, Mexico, the European Union, and other countries. – EPI Data. The bad news? The per capita consumption of commodities is exploding globally. There are 1 billion human beings in India that do NOT have air conditioning. Another 1 billion in China do NOT own an automobile.  We are suppressing the supply (hello ESG) of many key commodities all around the planet, while at the same time roiding up future demand.  There is a price to pay for exporting higher-paying jobs out of the United States, and the consequences are fast approaching. 

Economic cycles were much slower in the Middle Ages, given the transmission mechanisms of the time. However, broadly, many of the factors that affected prices in Medieval times will be familiar to those who have studied the most recent inflationary bout. Generically, prices increased on average by no more than half of one percent from 1225 to 1345. The main and initial cause of this price increase was an increasing population: a medieval baby boom. Price increases were not uniform, however. Inflation was especially strong in four areas: energy, food, shelter, and raw materials. Of the four, initially, the most striking was the cost of energy.

From 1261 to 1320, English charcoal and firewood rose quite rapidly. Why? Because England, like the rest of Europe, cut down its forests, not just for fuel, but to build cathedrals, while using much stone, and use much lumber as well. Timber and charcoal began to be traded internationally. It was at this time that the coal mines of England, Belgium, and France were developed. Air pollution in London in the 13th century was awful. Nor were forests replanted. Thus, inflation was caused by an increase in demand. The population increased causing trade to increase. The increase in commerce caused an increase in industrial development. Expanding markets increased the velocity of money. As monetary inflation was added to demand inflation, prices rose inexorably.

Eventually, consumers got used to the idea that prices always went up. This led to governments expanding the money supply. In the thirteenth century, that meant expanding the silver supply. England created 200,000 silver coins from 1210 to 1218. In the 1240s, this increased to 500,000 silver coins for the decade. For the decade of the 1280s, silver coin production totaled 1,000,000. The Italian city-states began to mint gold coins for the first time since the fall of Rome. In southern Europe, peppercorns began to be used as a form of currency. The Florentines and then the Genovese invented credit instruments: contracts of exchange and bank transfers.

With the notable exception of Florence (currency = florins) and the Serene Republic of Venice (currency = ducats), currencies were systematically debased. The result was that Venetian and Florentine money was the most sought-after in Europe for international trade.

As a result of the above drivers, inflation became self-reinforcing, “sticky.” Higher prices created a demand for more money. The demand for money was met with an increase in its supply, but as international trade continued to expand, so too did the velocity of money, fueling inflation still more.

Wages are NOT Coming Down
U.S. government spending is UP 10% year over year. We are looking at a near $2T deficit. There are 70,000,000 Americans receiving an 8% COLA (cost of living adjustment). What many people fail to understand, are the colossal social and political drivers of inflation.  Once inflation gets above 6%, the follow-on effects linger on for years.  It´s like spilling a can of Coca-Cola in the backseat of the car. It gets under the seat cushions, it´s in the seams and is extremely hard to kill. Especially with government spending ripping higher which after all was a reaction to higher inflation in the first place!

As inflation continued, by the mid-13th century wages began to lag. Real wages fell slowly at first, then with increased rapidity. By 1320, real wages were 25% to 40% lower than they had been 100 years earlier. Meanwhile, rents and interest had risen. Eventually, rents and land values increased more than energy. Interest rates in the Italian city-states rose from 12% a year in 1230 to 20% towards the end of the century. Thus, the cost of capital and shelter increased as real wages fell. Not everyone was harmed.

Core Inflation is Double the Fed´s Target
The “power of labor” and rents are keeping core inflation high – more than double the Fed´s target. Labor strikes are everywhere, inflation is empowering organized labor. Some 20,000 railway workers will strike on July 20, 22, and 29 as part of the ongoing national rail dispute, the RMT union announced Friday.  A strike from 340,000 UPS workers could cause major disruptions across the U.S., and would be the country’s biggest work stoppage since a steelworkers strike in 1959, CBS News reported.

What happened was merchants would lend money out in debased currency but made sure laws were enacted so that they would only get paid back in Venetian ducats and/or Florentine florins. The arbitrage between debased currencies and currencies that held their worth through a constant metal content made some merchant families enormously wealthy. Thus, there was a growing economic inequality between the merchant class and the working-class peasantry. The key is, the growing gap between returns on capital and the returns on labor stimulated economic inequality.

Another effect of constant inflation was an increased imbalance between governments’ public income and expenditures. Basically, governments borrowed more money the longer inflation lasted. Public deficits increased dramatically. This weakened government power, and, ultimately, Feudalism.

As inflation hummed along, it became more volatile. Price swings higher and lower became more extreme. Production and productivity fell, both for land and for labor, reducing much of the populace to subsistence living. This meant greater sensitivity to poor harvests. In those days, a harvest reduction of only 10% could cause severe problems for the lower 50% of the population. A harvest 20% below normal caused widespread starvation.

Governments would come to the breaking point and face up to inflation via “recoinage” or a new setting of the metal content, and, in fact, such recoinages did last for certain lengths of time. Debasement drove prices up. Recoinage drove prices down. Every single time a recoinage happened, the price of oxen fell, for example.

As one might imagine, exchange rates in the 14th century destabilized. Especially when banking families collapsed. In the late 13th century, the large Italian banks extended too much credit to too few monarchs: extreme leverage plus concentration risk. Of course, such loans (if the payments were on time) made the banking families enormously wealthy. However, a banking panic cropped up in 1298. Siena’s most important bank was the Gran Tavola of the Buonsignori. This bank lent to all the governments, all the great merchant families, and to the pope. Its agents were in every major trading center of Europe. It managed to hold on even as its loan portfolio began to sour, but by 1307, the bank collapsed, taking many businesses downs along with it, and crippling the Sienese economy for many years.

The failure of the Gran Tavola of the Buonsignori was the first bank failure, but not the last. In the early 14th century, various Florentine banks fell: the Mozzi in 1302, the Franzesi in 1307, the Pulci and Rimbertini in 1309, the Frescobaldi in 1312, and the Scali in 1326. Six more banks failed in 1342. Between 1343 and 1346 the three huge banks of the Peruzzi, Acciaiuoli, and Bardi imploded. It would take many years for Tuscany to recover.

Another response to rising inflation was the hoarding of precious metals. Inflation demanded an increase in stocks of inventory of silver and gold. This in turn fueled inflation. This pushed many governments to the brink of bankruptcy. As noted above, the decline in real wages made subsistence razor-thin for the masses as well. Poverty and hunger spread throughout the West. Crime increased, mainly the theft of food but also of anything that could easily be exchanged for food. The worst famine in European history occurred from 1315 to 1317, right in the middle of the rolling bank crisis. The population decreased by 10% because of that famine. After famine came epidemics. That in turn led to more crime.

Wars happen in clusters. After 1294, there was a notable increase in military conflict. This strained government purses when they could least afford it. Domestic riots became more common as well.

Then the Black Death struck. The population of Europe in the early 14th century was approximately 80 million. After the Black Death, it was about 60 million. That makes it the worst population decline in European history. The effects of the Black Death varied over time. When it first appeared, food prices went through the roof. However, as the population collapsed, food prices collapsed as well. However, as the artisan class was all but wiped out, the cost of finished goods went through the roof.  Massacres of Jews and foreigners became commonplace. Eventually, the Black Death spelled the end of Medieval civilization.

The Hundred Years’ War between England and France (which had many multi-year hiatuses) left huge swaths of the countryside in complete anarchy. Mercenaries, released from their duties for a year or more, preyed upon the peasantry of the countryside. No one could stop them. Some gangs were as large as a brigade today. Obviously, this curtailed trade, not only agricultural production. Many farms were simply abandoned. This hurt population growth as well. Even after the Black Death subsided, the low point of the European population wasn’t hit until 1401 to 1402.

During the late 1300s, money in circulation declined. The amount of gold and silver in Europe fell. Much of it was hoarded only to be discovered today. Since Europe couldn’t produce enough food and goods, the balance of trade with Asia gradually depleted the money stock in Europe. The decline in money created further economic depression. Land values fell proportionally to the population decline. Grain prices went down, but a shortage of labor made wages go up. The cost of unskilled labor in some towns increased 50% from 1350 to 1400. In real terms, wages increased dramatically throughout Europe.

The result? A new society. As a result of increased real wages, the serfs were emancipated, and Feudalism ended. The Feudal economy had lasted over 700 years. Many of its social structures remained (class consciousness, what have you) but as an economic system, it was finished. As the power of labor increased, the labor class gained political power and peasant rebellions became more frequent and more intense: the Jacquerie in France (1358), the Ciompi in Florence (1378), the Peasant Rebellion in England (1381). The lower classes rose against the upper classes. By the time we reach the reign of Queen Elizabeth in the mid-sixteenth century, rural serfdom no longer existed in England.

Early in the 15th century, prices still fluctuated but began to be more regular and less intense. Commodity prices declined and then stabilized. Real wage gains were permanent. The result? The Renaissance. The fall of Byzantium created a one-time windfall of cultural knowledge for Europe. And now there was steady, healthy demand for it.

Our take: there are parallels between Medieval inflation and contemporary inflation. Surely, the increase in the global population is one factor in long-range multi-generational inflation. Another parallel is the increased consumption of energy combined with a lack of investment in replacement energy. More similarities may be marked in the long-range increase in the supply of money and an increased tendency to believe in higher long-term inflation. Fiat currencies are in a debasement cycle. The collapse in real wages and the concomitant increase in inequality are also familiar. Increased FX volatility, bank failures, and Central Banks hoarding precious metals also have a familiar ring. The increase in the power of labor after a global pandemic is almost eerie in its parallels.  What is most surprising, perhaps, is how even a low rate of inflation (well below the 2% target of the Federal Reserve) can over a century lead to disaster, how even a low rate of inflation leads to yet higher rates of inflation, fluctuations aside. History repeats.

These days, it is a stretch if people discuss inflation from half a century ago, so we thought it might be helpful to look at Medieval inflation. Above is an encapsulation of work complied with by David Fischer. We urge a read of his tome “The Great Wave.” However, for those who lack the time, here above is a summary.






The Great Hijacking

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

The Mechanical Bid

With prescient flare, in 2012 our long-time friend Josh Brown, better known as the “Reformed Broker”, wrote a piece called the relentless bid. He explained that mammoth asset managers like Merrill Lynch and Morgan Stanley are constantly buying stocks and holding on to them as opposed to trading in and out as fees-based accounts replaced transaction-based accounts. Josh has a good sniffer, this was the early stage of the passive investing torrent.

What was the root cause of the great financial crisis? We would put, poorly understood leverage in the system at the top of the list.  Similar problems exist today.

These days there are even larger forces at work that are putting a constant bid under the market. This is the interplay between the $11 Trillion of passive investments and the 0DTE index options, but it has created a ticking time bomb. There are alarming unintended consequences of mechanical buying by passives and the surging options volumes. Both work together in a self-reinforcing feedback loop to artificially distort risk indicators by suppressing volatility. Once again this is causing a massive buildup of one-sided, overcrowded long positions. In the past, this has led to vicious, almost disorderly sell-offs from time to time and it is bound to happen again.

The Ticking Time Bomb
Open interest in index options has soared to all-time highs. As dealers get lifted on calls in size (large banks offering options – marking markets) – they MUST buy stock (Apple, Tesla, Nvidia etc) in size to hedge their upside risk – this helps trigger short covering. As stocks move higher, option market markets then have to buy even more stock. The gamma squeeze is on. Each day that passes by, chat rooms are now filled with MORE and MORE speculators — crowd-sourcing specific targets with the goal of triggering a FAR more intense SQUEEZE.

The Power of Passives

The cornerstone of this story is the growing dominance of passive investors. Today, passive investors are generally responsible for as much as 70% of all daily stock trading volumes. More importantly, they hold about 50% of all the assets in ETFs and mutual funds, equal to about $11 Trillion. Ten years ago, they held only $2.2 Trillion or 24% of assets and at the turn of the century this percentage was in the single digits. Assets at passive investors have exploded higher in recent years and many of these passive funds are not managed by portfolio managers or any human being for that matter. Computers are running these funds and make allocations based on quantitative parameters. One of the big ones is the level of volatility. So-called volatility-targeting and risk parity funds mechanically increase their exposure to stocks when volatility goes down and vice versa. Another group of investors called Commodity Trading Advisors have about half a trillion in assets and do the same thing. Since the start of the year volatility has been going down. Both realized and implied volatility are grinding lower almost every day, which leads these funds to mechanically buy more stocks every day.

The Passive Overdose
Warning – your 401k has been hijacked by SEVEN stocks.  There is nearly $18T inside the Nasdaq 100 – Microsoft, Apple, Google, Nvidia, Tesla, Amazon, and Meta, makeup nearly 54% of the QQQs. Assets under management with passive investors, which are those funds that mirror indices and/or specific quantitative parameters, have grown from $2.5 Trillion in 2012 to more than $11 Trillion by Q1 of 2023.

 But Why is Volatility Going Down?

The land of the ZERO Day Junkies – 0DTE options, better known as dailies, now represent almost 50% of daily volumes in S&P index options.

The Zero Day Take Over

While there are plenty of headwinds left, negative surprises have dissipated somewhat compared to 2022 and the Fed is no longer that aggressive with interest rate hiking. This has brought hordes of option speculators out of the woodwork again. But what is different nowadays is that options markets are dominated by so-called dailies, which were introduced in early 2022. These dailies, officially called zero-day to-expiration options (0DTE), list on the same day as they expire. Bank of America’s legendary volatility research team calculated that dailies are now close to 50% of total S&P options volume.

Last year retail investors were reluctant to get involved, with extreme volatility and negative headlines jolting the tape day in and day out. But since the start of the year, open interest has skyrocketed and has now reached a record of more than $10 Trillion. In a market with declining volatility, gamma balances tend to be positive, whereas the opposite is true for increasingly volatile markets. Gamma is a somewhat mysterious concept but what it basically means for the market is that when gamma is positive, dealers must sell when markets go up and buy when markets go down. And when implied volatility decreases, the gamma of calls and puts increases. With option volumes higher than ever, gamma balances are also very large (positive) and this has a dampening effect on intraday volatility. Every time the markets kneejerk lower, dealers come in and buy, and when the market rips, they sell. These gamma-induced intraday reversals leave the market with little change at the end of the day, and implied and realized volatility is melting away (chart 6).

Gamma Overdosing
This historical chart shows the interplay between gamma and volatility. Gamma is generally positive and increasing when volatility (VIX) is low and negative and declining when volatility is high. This means that in low-volatility markets dealers tend to sell stock and indices when markets rally and buy when markets sell off. This has a dampening effect on volatility and it’s easy to see a positive feedback loop with lower vol creating higher gamma that leads to even lower vol. The opposite is true as well, and in volatile markets, dealers sell when markets go down and buy when they go up so this enhances volatility.

A Perverse Self-enforcing Loop

As we have determined, the explosion in options volumes is now causing large positive gamma imbalances which dampens volatility. This in turn triggers the passive investors algorithms to mechanically increase their exposure to equities as well. With $11 Trillion of assets, such mechanical buying is colossal. Even a 1% increase in exposure leads to $110 Billion of buying. On top of that, the usual suspects also keep buying stocks mechanically. These are the corporate buyback programs ($850 Billion per year) and the dividend reinvestment plans (DRIPS) that buy stocks with the dividends they receive (around $500 Billion per year). What is new now is the massive increase in option volumes, which increases gamma and dampens volatility. This opens the door for all kinds of trend-following passives to allocate more money to equities, further driving down volatility. This wall of money going into the market pushes stocks up and nothing turns people more bullish than higher stock prices. So this lures is an army of individual investors and speculators, who buy on top of all these different passive buyers. The result is a self-reinforcing feedback loop where layers of different investors pile into the S&P and the Nasdaq, who themselves are disproportionately exposed to a dozen mega-cap stocks.

Top Heavy – The Great Hijacking
The 15 largest stocks in the S&P now represent 36% of the entire index while the ten largest stocks in the Nasdaq 100 represent 60% of the index. These largest stocks are of course Microsoft, Apple, Amazon, Google, Nvidia, Meta and Tesla and the like.

Then there is the Fund Squeeze

One more factor driving up stock prices now is the squeeze that is occurring in several large mutual funds and ETFs. JPMorgan’s Hedged Equity Fund (JHEQX) is a $15 Billion fund that invests in the S&P and hedges it with a put spread. This hedge is financed with a short, out of the money call. If the market plunges lower, JHEQX has a put to limit the downside, but if the market rips higher, the short call limits their upside. The fund rolls those positions every quarter and for Q2 the date of the roll is June 30.¹ This is when the fund buys back those 40,000 June calls and sells September 29 calls about 5% above where the S&P is. Given the size of the fund, they sold 40,000 calls with a 4320 strike at the end of March. In one day, the open interest in that particular call rose from $800K to $17bl (chart 6). The open interest remained around that level until last week when it ran up $25 Billion.

All this impacts the market in two ways. Speculators are now clearly front running JP Morgan, who they know must come in and buy back that in the money call. They are bidding it up because they know JP is a forced buyer. But this gets dealers get more short, and they have to hedge with buying futures. Moreover, now that the call is in the money, the delta is rapidly moving towards 1, which means that dealers’ gamma is surging higher. As we now know, dealers will suppress volatility with gamma hedging which artificially eats away at volatility.

This is not the only fund in a pickle. The $7 Billion Global X NASDAQ 100 Covered Call ETF (QYLD) is apparently rushing to buy back out-of-the-money calls they have been selling as part of their strategy. These are just two examples but I’m sure there are plenty of more funds that find themselves getting squeezed by this mechanical bid in the market.

OI Trends – Danger Will Robinson
Open interest in the 4320 call that ex[ires on June 30 rose from $800K to $17 Billion when JP Morgan’s JHEQX came in and sold 40,000 calls in late March.

When the Music Stops – the Bomb Goes Off

All of this has two potentially terrifying consequences: it ends up artificially mispricing underlying market risk and it leads to massive overcrowded long positions. Should something unexpected happen that takes the market by surprise, the reverse action usually occurs in lightning speed. A sudden spike in volatility causes waves of passives selling all at the same time. Remember the 2011 flash crash. That was just an appetizer. The Volmageddon in early 2018 squeezed volatility from 9 to 40 and the S&P down 11% in just a few days and there wasn’t even an obvious catalyst. But the blow-up of a couple of short vol ETF, which was the result of months of crowding into long positions, led to almost uncontrolled selling. Then there was the corona crisis. This was an obvious risk-off event, but the selling was so extreme that the Fed had to intervene with a $ Trillion asset purchase program to support markets. The S&P went down 35% in one month and the VIX surged to 83. Liquidity completely dried up and in less than thirty days we had two black Thursdays and one black Monday. Even during the Lehman crisis, it took the market three months to drop 35%.

Should something unexpected hit the market again, and 2018 proves that it doesn’t even have to be some major negative news, it could trigger a domino effect of selling that quickly cascades into a market plunge. I’m not saying this is imminent but when it happens, individual investors are last in line to sell behind the passives, hedge funds, dealers, and institutions. Individual investors need to be aware of why volatility is so low, where the bid in the market comes from, and that the current tranquility is artificial and can change at the blink of an eye.

Volatility Trends

Implied volatility is the market’s forecast of a likely movement in the price of a security or an index. Realized volatility is the measure of price variation for a particular stock or index over the last period such as a month. Both realized and implied volume is going down is due to artificial suppression of volatility by options and passives.




Tesla Tax Loss and Positive Catalysts

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Massive Retail Capitulation
This week, TSLA equity traded 61% below the 200-day moving average, the most in a decade — Tesla reports Q4 unit sales before trading starts Tuesday, January 3rd.

Tesla vs. CAT, the Mad Rush into Industrials
Investors are falling all over themselves to exit tech stocks and increase exposure to industrials. Hard asset plays have dramatically outperformed financial assets – and long-duration “growth” equities. The street is looking for $112B of sales in 2023 vs. a $384B equity market capitalization for TSLA stock.  She used to trade at 80x sales, just wow.

A $1T Loss?

If TSLA touches $98, the market cap loss is near $1 trillion,  she traded at $105 pre-market this week. Close to $25B value of shares traded Tuesday, more than Apple, Amazon, Microsoft, and Google combined. Nearly 700m shares in 3 days this week, that´s 25% of the float. This is an epic retail exit – tax loss selling. Daily RSI was near 17 this week, the lowest of all time for this capitulation measuring stick. Tesla was 5th largest in the S&P, now 18, now less than UNH, Lilly, and Chevron. If you sell TSLA equity in December – the investor can buy the stock in 31 days and still book the loss for tax purposes. In years with LARGE Q4 equity market losses – the “January Effect” can be fairly impressive. Looking back over the last 50 years – when you have a down December, stocks are up 1.2% in January. Since 1991, with stocks off more than -2% in December, they have been up +3.7% on average in January, Bloomberg terminal data. 

**The January Effect is a tendency for increases in stock prices during the beginning of the year, particularly in the month of January. The cause behind the January Effect is attributed to tax-loss harvesting, consumer sentiment, year-end bonuses, raising year-end report performances, and more. – CFI.

“Historic forced by margin calls for Tesla – it´s all retail Larry, ALL retail – rather than sentiment shift, see large scale TRF (Schwab, Ameritrade, etc) volume. The SIZE TSLA margin calls are forcing (triggering) ALOT of cross-selling through the entire long duration – speculative equity campgrounds.” — Equity Portfolio Manager on the West Coast, in our Bear Traps Portfolio 

TSLA normally reports quarterly unit sales in the first weekend after the end of each quarter. Consensus is looking for a total of ~420K cars sold (down from 450K est. a few weeks ago). Given that New Year falls on the weekend, there is some uncertainty as to when exactly TSLA reports Q4 unit sales. We believe either Monday or Tuesday, January 3rd around the market open is most likely.

Previous January Report Date / Time

Sunday 1/2/2022 11am Stock +13.5% the next day
Friday 1/2/2021 9:55am Stock +3.4% the next Monday
Friday 1/3/2020 8:17am Stock +3% that day
Wednesday 1/2/2019 8:34am Stock -1.5% that day

Is Team Biden coming to Tesla’s Rescue?

At the start of the new year, buyers will once again enjoy a tax credit when they purchase a Tesla vehicle. The original 2010 EV tax credit had a quota of 400K units. For Tesla, the tax credits fully disappeared in early 2020 when Tesla reached that unit sales quota. But thanks to the Inflation Reduction Act (IRA) that Congress passed earlier this year and Biden signed yesterday, the tax credits are back in 2023. In the IRA there is a $7,500 tax credit for buyers of EVs, including TSLA and GM, who lost their previous tax credits. However, there are other strict limits on which brands would be eligible for the full credit, based on the selling price and where the cars and components are made. Unless the car is made in North America (NAFTA), the buyer is not eligible for the full tax credit. In addition, at least 50% of the battery parts will need to be made in North America. Lastly, a minimum of 40% of minerals used in the batteries must be sourced from the US or countries with free trade agreements with the US. So even buyers of GM and Tesla cars might only be eligible for half ($3,750) of the tax credit because their batteries and minerals come from a “foreign entity of concern” (China/Russia).

However, the Treasury Department recently said that the final decision on the critical minerals’ requirement won’t be available until March. As a result, all the requirements in the IRA governing EV cars, minerals, and parts will be waived. This means that, until Treasury issues its final set of rules, it will allow the full $7,500 tax incentive on all qualifying models.**

“We don’t expect them to reach 400K (unit sales) in Q4, data comes next week – early January. But, we also don’t think they always tell the truth. So, who knows? The IRA (Inflation Reduction Act) is about the only thing here between TSLA and a complete collapse in demand from what we can see. Also, many other countries have subsidies that are ending on December 31st. So, TSLA is benefitting from demand pull forward in those other countries. That will reverse in the March quarter, and may offset some of the benefits stated by the bulls.” CIO, Large Fund.

So, prospective EV buyers in the US will be extremely motivated to buy their EV before the Treasury issues their final list of requirements in March, as it could potentially save them thousands. We could therefore see demand for Tesla cars and other EVs (2 out of every three EVs sold in the US are Tesla’s) being pulled forward into Q1.

Musk is keenly aware that all this might have led EV car buyers to postpone purchases until Q1 and he increased year-end rebates to $7,500 and 10K miles of free charging in early December. Whether this was enough to meet Tesla’s estimates for 420K unit sales for Q4 remains to be seen. We will know this before trading starts on January 3. But the IRA waiver could still cause a burst in US sales in early 2023.

This is not the only boon for Tesla starting next year. The EPA is proposing to increase the cellulosic ethanol component in the renewable fuel standard will climb to 2.13 billion gallons from 630 million. Refiners will be allowed and by necessity required to comply with these mandates by buying “eRINs” credits from EV manufacturers. Since Tesla has by far the most EV cars on the road, refiners will have to buy most eRINs from Tesla.

In years past Tesla always boosted gross margins from “Zero Emission Credits” that other car makers bought from Tesla to offset carbon emissions. Now the administration is giving Tesla another back door subsidy, although it is yet unclear when these rules go into effect.

** EV and plug-in models were manufactured in North America in the 2022 and 2023 model years that DOE says are eligible: Audi, BMW, Chevrolet, Chrysler, Ford, GMC, Jeep, Lincoln, Lucid, Nissan, Rivian, Tesla, Volvo, Cadillac, Mercedes and Volkswagen. Yet because of price limits or battery-size requirements, not all these vehicle models will qualify for credits. Note that IRS details issued on Dec 29 indicated that only 20% of Model Y would be eligible for full tax credit, unless Tesla lowers their price on certain versions of the Y.




Inside Job

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

At 9 am Friday morning, the WSJ’s Nick Timiraos made a market-moving call from the highest mountain.  The talented financial journalist — a classic pawn of the Fed — startled investors from the beaches on Long Island to the skyscrapers of Japan. After talking up extremely aggressive (rate hikes) action from the U.S. central bank for much of the last five weeks – Nick published a piece that pushed back against excessive rate hike expectations and suggested the Fed is not going to overcook the Porter House.  An hour later, the BoJ (Bank of Japan) comes in and starts a massive forex intervention, pushing the yen up 3% in the span of an hour. Coincidence? It was an “inside job” — let us dig in.

Catastrophic Damage Potential
In our view, Joe LaVorgna is the best economist on Wall Street, he shared this important chart with clients this week. “Interest-rate changes have their peak effect on growth in about one year and on inflation in three to four years. “ IMF Paper recently released. 

Over Cooking the Porter House 

More than 300bps of rate hikes in six months, $50T more debt on earth since 2018 – how does one calculate the damage? The MOST important fact of the day, week, and month?  The Federal Reserve DOES NOT know the extent of the damage they have ALREADY inflicted!

“It always takes 6-12 months to quantify a move in rates impact on the underlying economy – thus central bankers most often over ease and over-tighten” – Milton Friedman.

Yen Move and its Connectivity
The U.S, ten-year bond yield (orange) vs. Japan´s yen (blue)  — Always, always. Always, always connect the dots. There are no coincidences. The Fed, the White House, the Wall Street Journal, and the Bank of Japan – were all working closely together on Friday morning.

Yen Move vs. Gold Miners
The prospect of a softer Fed policy path juiced gold miners on Friday.  The probability (interest rate futures) of another 75bps rate hike in December plunged from 65-70% to 25-30% and February´s formerly expected 50bp hikes fell from 50% probability to 25-30%.

“When former Federal Reserve Chair Paul Volcker took office in the summer of 1979 and quickly pushed interest rates to about 20%, it brought an almost immediate recession, but inflation took about three years to fall to manageable levels.” IMF

BOJ and Fed – all Together
Bank of Japan – after their first intervention failed – they brought in the Fed for support in round #2.

No Coincidences

All the drama was no coincidence – since August – many market participants have piled into the same trades, a) Yen weakness – USD strength, b) yields up – bonds down, c) equities lower. This has been the playbook – a classic over-crowded trade. Suddenly the Fed pushes back against excessive hawkish market expectations, opening the door for BoJ to buy up the yen, thus forcing position unwinds.  The BOJ wants and needs Fed support after their last – failed attempt to support the yen a few weeks ago. We believe they put a phone call in to Fed chair Powell seeking important, corroborating support.

Midterm Elections and the Market Bounce
The Nasdaq is close to 9% off the October lows – Why now?

White House Makes the Call
US PredictIt 2022 Senate Party Control Republican — The White House is as nervous as a long-tailed cat in a room full of rocking chairs. After months of kicking ass on the chances of keeping control of the U.S. Senate – there has been a fierce reversal.

More Dots to Connect – Asset Prices and Elections

The Fed was put on notice from the highest levels – White House officials were knocking on Fed chair Powell´s door this week. They couldn’t get OPEC to help oil prices lower, to support the inflation fight. Now politically – the S&P MUST move higher ahead of the BIG DAY on November 8th.  Midterm elections are won and lost in suburbs, where 401Ks are even more important than the price at the pump. If you are inside the Biden White House – you desperately want equities higher, and fast and soon. 

“San Francisco Fed President Mary Daly Says More Rate Hikes Needed, Dismisses ‘Pivot’ Talk” MarketWatch – October 5, 2022

Just after lunch on Friday it was Mary Daly, president of the Federal Reserve Bank of San Francisco. Daly stressed, “We don’t want to be too reactive;  one can easily find yourself overtightening.” — “we don’t just keep going up at 75 bps increments, we will do a step-down, not to pause, but to 50 bps or 25 bps increments.” This is a SHARP reversal from Daly´s comments above from October 5th. 

Quiet Period

“Heading into the quiet period – which started Friday evening – the Fed started to lay out a policy path shift to help support asset prices during the quiet period.” CIO NYC in our live chat.

Later in the afternoon – James Brian Bullard – the chief executive officer and 12th president of the Federal Reserve Bank of St. Louis came barreling in with further evidence of a coordinated policy path shift.  He stressed the Fed should use more caution next year. Bullard is looking for a disinflationary process going into 2023. The slowdown in money growth is a positive factor for inflation. The Fed wanted to calm markets on the eve of their blackout period (which started Friday night, no more Fedspeak) ahead of their Nov. 1-2 policy meeting. This is an extremely dovish sales pitch relative to PREVIOUS – extremely hawkish expectations – “You’ve come off zero. You’ve gone to this much higher level of the policy rate. But once you’re at the right level, then you can just make minor adjustments at that point — maybe to stay where you are, maybe to go a little bit higher, based on incoming data,”

The Fed Just Opened the Door to a Softer Policy Path

“This judgment about where you need to be to put meaningful downward pressure on inflation, I think that’s a key part of the policy debate in the next two meetings.”

Fed governor Mary Daly said that policymakers should start planning for a reduction in the size of rate increases, though it’s not yet time to “step down” from large hikes. This is a SIGNIFICANT shift.

“It should at least be something we’re considering at this point, but the data haven’t been cooperating,” Daly said during a moderated discussion hosted by the University of California Berkeley on Friday. At the November meeting, “we might find ourselves, and the markets have certainly priced this in, with another 75 basis-point increase, but I would really recommend people don’t take that away as it’s 75 forever. A slowdown to more incremental increases of 50 or 25 basis points will be appropriate as the Fed’s benchmark rate gets closer to its terminal level for this hiking cycle, Daly said, per Bloomberg.

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.



Power of Labor vs. EPS

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Economic Signposts

Classic economic bellwether – UNP is close to 9% lower in two days – this is an extremely important leading indicator.

“US railroad workers prepare for a strike as rail companies see record profits – As Biden’s recommendations fall flat, negotiations between management and unions are at an impasse – and workers are prepared to walk.” The Guardian

September 15 Update – File Under NOT Deflationary Freight – Rail Labor “Deal” includes – a 24% wage increase over 5 years, including a 14.1% effective immediately, as well as five annual bonus payments – National Carriers Conference Committee.

*Inflation is juicing labor bargaining power, and demands.

Secular Trends – Headwinds for Equities
A large bear reversal in the classic economic bellwether, UNP – major technical fail. Some would say labor threatened national strike risk is high, which is true and obvious, but the larger picture is the power of labor, back to 1960s era strength. Many equities are NOT priced for a secular change in the power of labor, indeed.  This week, street research is picking up on macro crosswinds, a pending reset in the rails and trucking market, and stubbornly high labor inflation juices the risk of top-line growth and margin expansion into 2023.

What makes inflation sustainable? Inflation has a traditional pattern: an exogenous shock (war, pandemic, an oil embargo, what have you); followed by the rise of the power of labor in the form of wage inflation; followed by the government mucking things up.  An example of the latter, to pick one among many, is that not only are there not enough trucks and truckers but there are not enough parking spaces for the truckers to park their vehicles. Why? Because of restrictions on how close trucks can park to highways (where, naturally, there is plenty of space for them to park!).” Bear Traps Report, January 2022.

Labor Power vs. Profit Margins
Bernstein notes – “labor cost inflation for agreement workers will at best be the worst we have seen since de-regulation.” The Street is still looking for $244 (down from $258) in S&P 500 eps next year. The SPX is at 3950 ish, that´s a PE of 16.2x — a very pollyannish 2023 earnings outlook. Sure nominal earnings are helped by inflation but, real bottom line earnings get hammered in an inflation-enhanced “power of labor” world. 

A Look Back at Labor

While Covid is nowhere near as bad as the Black Death of the mid-14th century, precisely because the latter was more extreme, its ramifications are easier to see and learn from. In 1348 the plague crossed into England and wiped out half the population. With fewer peasants and serfs, labor was in scant supply and the peasants, and those serfs that could escape the manorial estate or had fulfilled their obligations to their lord, charged much more for their labor. Landowners’ profits plummeted. This in turn destroyed commerce in the towns, with dire financial consequences. Chaos ensued. Various laws were enacted in an attempt to hold wages to pre-plague levels. Never before had the royal government allied itself with the landowners against the workers in such an obvious and heavy handed way. This proved extremely unpopular. Nonetheless, wages continued to rise and many peasants were able to join guilds from which they had priorly been barred and learn trades, moving up the socio-economic ladder.

The off-again-on-again Hundred Years War against France heated up again and taxes were raised in 1379 and again in early 1380. The taxes were innovative, extensive, and unpopular because they were poll taxes, levied on every eligible individual regardless of rank or income. A third poll tax was instituted at the end of 1380, the most unpopular of all. Poll tax collectors interefered with life in every town and London seethed in unrest. Furthermore, political partisanship was extreme and the ruling class divided.

Finally, when investigations into failure to pay the poll tax in villages in Essex occurred at the end of May 1381, outright revolt ensued and spread like fire across the country, an uprising historians now call The Peasants’ revolt. Eventually the Tower of London was sacked and many royal officials murdered. The revolt was finally suppressed. 1,500 people were killed in the process. The population had not revovered from the plague and is estimated at 1.8 million at the time. It would be like over 300,000 US citizens being killed today.


In any event, there was a clear relationship between the plague and the ensuing power of labor and wage inflation. Furthermore, while the poll tax was thorough-going, our inflation today is more so. Geopolitical risks abound and if war ensues, inflation will take another leg up. We’ve had revolts in our own history, not to mention civil war. So a risk for civil strife exists now and over the near term. We may see more riots, and more violent ones, in the coming years.




Investment Newsletter

Show Buttons
Hide Buttons