The greatest power and wealth transfer in history

The mark

The most feared, most powerful person on the planet is feared by politicians and central bankers alike. She’s not a billionaire, she’s not a celebrity. She’s a retiree. Baby boomer. And also part of the (still) richest generation and the (still) most powerful voting block. And you know what she REALLY doesn’t like? Nominal losses. Everything else is more or less bearable, but nominal losses on income and assets are unacceptable to her. She is the reason why central bankers are engaging in unbelievable gymnastics to conjure up inflation instead of letting bad public and private debts go into default and bad investments go bankrupt. It’s the only way to avoid nominal losses on pension investments and assets.

The job

One of the biggest financial problems of our time is trying to figure out a way to accomplish the greatest wealth transfer of all ages – from baby boomers to millennials. One needs to do it to avoid the Millennials staging a revolt and without the baby boomers noticing. And they would notice the heist if their government bonds were to have a haircut, their deposits subjected to bail-ins, their utility company shares have their dividends cut or their houses significantly depreciate in value.

The tools

In order to keep the mark relatively oblivious while doing the job, nominal losses need to be avoided. Real losses are inevitable, but nominal losses need to be avoided as much as possible. This is why systemically important insurance companies and banks were (and will continue to be) bailed out. Why bad government debt was and will be monetized (via backdoor, because otherwise there would be “moral hazard”). It was never a feasible choice to let the system cleanse itself via deflation and bankruptcy to put the economy on a more sound footing.

Even though central bankers generally despise inflation, the alternative is so bad that they seem to be working overtime to bring about higher than normal inflation for a longer time. They need it to get rid of massive debts (in real terms, both public and private) and in the process transfer significant wealth from lenders (baby boomers) to borrowers (millennials). It’s anyones guess what that “higher for longer” precisely would be, but since hyperinflation is to be avoided at all costs, my guess would be their dream scenario is something like 3.5% average annually for 10 years. Or 6-for-6. Inflation rate in this range would bring about a purchasing power loss of about 40-45%, which would make debt loads manageable again.

The outcome and collateral damage

Nominal interest rates are going to remain non-existent and real interest rates deeply negative for years simply because nobody could service this debt load in “old normal” interest rate environment. It’s harmful to banks, but it’s a tradeoff between banks and baby boomers doing better or the rest of the economy and millennials doing better and banks are already backstopped, doddfranked and mifidded so it’s all good. The DMV is never going to go bankrupt and neither is a systemically important financial institution.

There is scant reason in this process for commercial and retail banks to remain formally private institutions and people dont really have a reason to own bank stocks, since vital parts of their business models are becoming obsolete. Banks used to be about maturity transformation and net interest margin. These days there is no maturity to transform (since money is infinite and forever) and no interest margin to speak of (since it’s free). They’re becoming increasingly a payment processing institution. Like a water utility, only the pipes are filled with money, not water or sewage. With a regulated ROE of 3% in “new normal” environment. Someone just went “hmm, that’s ok if it’s safe” reading this, and that’s one of the big distortions of our time.

Since quite many questionable investments get made under these distorted conditions, in the ever more desperate reach for yield, labor vs capital (again – in aggregate – millennials vs baby boomers) is going to tilt in favor of labor for a while. Because somebody is going to have to try to market the product noone wants and take care of the office building nobody needs. It’s not to say that labor is going to do particularly well in absolute terms (considering emerging market pressure on western living standards), but labor is finite and in this brave new world, apparently capital is not. So labor is automatically more scarce.

Then again, in a world where many of us consider it a good idea to lend to governments for decades at negative rates, very few predictions can be made with reasonable confidence.

Leave a Reply

Your email address will not be published. Required fields are marked *