By David K. Lifschultz

Compliments of the Lifschultz Organization founded in 1899

The Fed’s has laid for itself a trap for when they raise interest rates to stop the inflation that they have created the stock market will crash. If they do not raise rates, the inflation will accelerate. This is discussed below in David P. Goldman’s excellent article.
Actually, it created four centuries worth of credit last year. I created between 1913-1914 and 2008 they created 900 billion plus credit while last year they created four hundred years of credit or four trillion dollars. Not only that, they eliminated reserve requirements giving banks the ability to increase their creation of credit an infinite amount of dollars. This is reminiscent of the actions of Rudolf Havenstein who was President of the Reichbank in the 1920-1923 period.
David Goldman’s excellent article also points out the green movement has caused a contraction in the energy supply which will drive oil and natural gas to astronomical levels. This has caused great interest in Genoil’s ability to develop new oil supplies from idle heavy oil supplies in the ground to great level both for the shipping industry and from Middle Eastern Oil producers. Genoil can convert this heavy oil to light oil at a much lower cost than expensive light oil. In other words, it can take cheap heavy oil and for a nominal amount raise it to light oil making huge profits for the oil companies with such reserves.
Prices for all energy commodities jumped during the past month, some by record margins, as a global energy shortage set off a scramble for gas, coal and oil. Brent crude has doubled in the past year, Newcastle coal has quadrupled, and Netherlands natural has risen seven-fold.
There are many small reasons for the global energy squeeze, and one big one: Investment in hydrocarbons has collapsed under pressure from the Green agenda adopted by international consensus.
Energy investment in the United States has dwindled as large institutional investors boycott fossil fuel investments. China’s critical electricity shortage is the result of draconian regulation of coal mining, exacerbated by Beijing’s punitive ban on Australian coal imports.
The idea is fanciful that the world can re-direct US$100 trillion in capital investment during the next 30 years to reduce carbon emissions to zero by 2050, as the International Energy Agency has proposed.
To put in context what this number implies, I note that the combined free cash flow of the 4,100 companies worldwide with a market capitalization of at least $1 billion was $332 billion in the first quarter of 2021, or $1.33 trillion annualized.
To put this in context: $100 is about 70 times that sum to be spent over 30 years. In other words, the entire free cash flow of the world’s private corporations would barely make up a third of the Global Reset investment budget.
The political pressure of the Green agenda has virtually wiped out investment in the US oil and gas industry. Capital expenditures for US exploration and development companies during 2021 (and projected for 2022) are only a fifth of the 2015 peak of $150 billion.
Meanwhile, oil and gas companies are sitting on mountains of cash. The free cash flow of the oil and gas industry will rise to $50 billion next year, the highest on record. In 2015 the oil and gas industry showed negative free cash flow because it borrowed to expand production.
Now oil and gas companies are paying down debt and returning cash to shareholders rather than take hydrocarbons out of the ground.
There has been an increase in energy demand due to an unseasonably hot summer and the reopening of airline flights and other forms of transportation, but the spectacular increase in energy prices is the result of constraint on demand.
Virtually the whole of the world’s political elite has signed on to the carbon neutrality agenda, including the government of China, which appears to believe that support for carbon neutrality (which China has pledged by 2060) will mitigate hostility to China in the West.
But the energy market suggests that the hard reality of supply constraints will overwhelm the Green agenda before it gets started.
The energy price shock adds to the inflationary pressures that continue to build in Western economies. Supply constraints in the United States have spilled over to the services sector, as the Philadelphia Federal Reserve’s survey of nonmanufacturing companies indicates.
Prices paid by services companies are rising at the fastest rate since the survey began in 2011, with more than 50% of respondents reporting higher input costs.
The cost of shelter, which comprises about two-fifths of the US Consumer Price Index, continues to rise at a record pace in the United States. This hasn’t turned up in the official data, because it takes time for old rental leases to expire and new leases to be written.
But several additional percentage points of inflation are now programmed into US inflation for the next two years.
That makes inflation a perfect storm. The stock market’s September setback, which left the S&P about 5% below its peak, reflected inflation risk and the associated risk that the Federal Reserve will raise interest rates in the future in response to inflation.
But the stock market’s reaction to date has been far more benign than the inflation data might indicate, and more benign than expectations about future interest rates might suggest.
As long as investors have to pay the Federal government to take their money, they will continue to take risk in the equity market. The so-called real yield (the yield of inflation-indexed bonds) at the five-year maturity is now -1.68% a year, which means that investors “expect” to lose 9% of their principal over five years. Of course, inflation-indexed bonds pay investors for inflation, so the effective loss will be less.
During the past 15 years, the yield on inflation-indexed US government bonds has tracked the expected federal funds rate (the Fed’s overnight lending rate to banks) very closely. That relationship broke down during the great monetary expansion of the past two years.
Given the market’s expectation for the federal funds rate 24 months from now, the 5-year TIPS yield should be more than a percentage point higher than it is today. There’s a simple (but disturbing) explanation for the discrepancy: The Fed has been buying most of the TIPS available on the market.
If we take into account the Fed’s purchases of $200 billion in TIPS since the Covid crisis began, this and the expected federal funds rate explain the current level of TIPS yields almost perfectly.
That’s not comforting for equity prices. The “real” interest rate on US government bonds explains virtually all the change in stock prices during the past three years.
As the Fed forced down the “real” interest rate, by reducing its overnight rate to zero and by purchasing hundreds of billions of dollars in TIPS, investors were forced into stocks.
The chart above shows the relationship between the 5-year TIPS yield and the S&P 500 (the linear relationship shifted after the Covid crisis). The link between TIPS yields and tech stocks is even closer.
At some point, the Fed’s game is going to come to an end. The magical thinking of a green agenda financed by endless amounts of printing-press money will be followed by a nasty hangover. Rates will rise and the asset bubble will pop.
Exactly when that will happen is beyond anyone’s capacity to forecast, but the unpleasant September in US equity markets was a foretaste of what we can expect.
David Lifschultz