Canada's Largest Pension Sees Risks of Inflation?

Paula Sambo of Bloomberg News reports that Canada's largest pension says inflation could rise in a rebound:

Canada’s largest pension fund says policy measures across the globe to address the Covid-19 pandemic could fuel inflation after years of under-inflation while also spurring a rebound in employment and business investment.

“We’re keeping an eye on this because central banks have adjusted frameworks,” Mark Machin, chief executive officer of Canada Pension Plan Investment Board, said in an interview Tuesday. “There is also the risk of a wall of money in savings accounts -- $13 trillion in U.S. banks alone -- moving, and that transfer can cause inflation.”

Machin also sees the synchronized global economic upswing potentially creating further upward price pressure on commodities.

“Emerging markets are where you’re going to see a massive pickup in demand. And we’re very familiar with the infrastructure bottlenecks that exists and some economies’, especially in the Asian emerging markets, dependence on imports and commodities,” Machin said.

Another factor that could generate inflation is an uptick in infrastructure spending as a form of economic stimulus, he said.

“These things are happening because people are building the right things in the right way and there’s lots of investment happening, but you could flow through into some elements of fueling inflation, which will create challenges for some emerging markets and central banks over the time,” Machin said.

The global economic slump caused by the Covid pandemic has had a disinflationary effect, capping a decade in which the central banks of most advanced economies had already fallen short of their inflation targets. Now, the pension fund will be watching to see whether adjustments made by the central banks will spur more robust inflation as economies recover, CPPIB said in its Thinking Ahead report published Monday.

Inflation could still be held down below target levels if governments scale back plans for fiscal and monetary stimulus or if the recovery is unexpectedly weak, the board said. That would raise the risk that real interest rates remain near zero and business investment stays weak.

Widening Inequality

The overall pace of the recovery is the wild card. Machin says he doesn’t see the global economy rebounding to pre-pandemic levels before the second half of 2022.

Covid-19 will continue to be the biggest factor in the global economy in 2021, worsening the rich-poor divide, changing the pattern of trade and driving up public debt around the world, according to CPPIB.

“The pandemic has affected virtually everyone, but not equally,” it said in the report. “The economic crisis caused by the pandemic has exacerbated global inequalities, with social distancing and lockdown policies disproportionately hurting those who are more economically disadvantaged.”

For example, new immigration restrictions and an overall inability to travel for work have led to a significant loss of income for the working poor in developing countries, the pension fund said.

Machin said widening inequality could generate “a permanent scarring in the economy.”

Beyond the question of more economic stimulus, the pace of recovery will depend on how aggressively the disease continues to spread and how quickly vaccines are rolled out, the pension fund said.

Governments’ increased spending through the slowdown will probably push the global public debt-to-GDP ratio above 100%, which should be manageable for countries with control of their own monetary policies. For those without control or those that issue sovereign debt in foreign currency, “fiscal contraction over the medium term may be unavoidable as sluggish growth and high debt levels raise questions about fiscal sustainability,” the report said.

The nations that focused on testing and contact tracing and also managed to slow the spread of the virus through quarantines are in a better position to return to their pre-Covid trajectory, CPPIB says.

China Watch

The pension giant will be closely watching China’s pandemic exit strategy, it said, which could “serve as a helpful case study for policy makers in other countries.”

CPPIB expects global trade to rebound significantly next year. The pace of trade has accelerated regionally, particularly in Asia, it said, while in North America, the regional value chain linkage between the U.S. and Canada has continued to strengthen.

“Beyond 2021, more emphasis on resilience as compared to efficiency in production could reinforce tendencies towards intra-regional linkages, with both contributing to increased balkanization of international trade,” CPPIB said.

Before I give you my thoughts, take the time to head over to CPP Investments' Thinking Ahead website and scroll around. 

There are a lot of great insights there including how COVID-19 has disproportionately impacted women (and I might add, exacerbated pension poverty among women).

By the way, since CPP Investments has been very vocal arguing for more diversity and inclusion at the board level at Canadian companies, let me bring this item to your attention:

Now, if only Canada can emulate our neighbor down south!! (we're nowhere close)

What else? On the Thinking Ahead site, you can also read CPP Investments' 2021 Economic and Financial Outlook. The entire white paper is available here

Most of the things Mark Machin discusses in the article above come from insights from this white paper so take the time to read it as it's very well written and not long (16 pages in all).

Below, the four themes that underscore CPP Investments' outlook for next year:

I want to draw your attention to this page:

The pandemic has exacerbated inequalities around the world and it will likely lead to major transformations of global supply chains.

The disruption in global supply chains relates to theme 4 in the white paper, deglobalization:

The white paper also discusses the unprecedented monetary and fiscal response to the pandemic all over the world: 

Importantly, the Outlook 2021 clearly states the following:

The fiscal response will likely push the global public debt-to-GDP ratio above 100%. These levels of public debt should be manageable for countries with control of their own monetary policies. We will be watching for fiscal tightening that could slow the pace of the recovery. For countries without control over their own monetary policies, or those that issue sovereign debt in foreign currency, fiscal contraction over the medium term may be unavoidable as sluggish growth and high debt levels raise questions about fiscal sustainability. We will be watching for changes to fiscal frameworks, particularly in Europe where increased fiscal transfers among member states featured prominently in the policy response.

How is all this related to inflation? I'm not sure why Bloomberg jumped on the inflation bandwagon because if you read this white paper carefully, you'd conclude the risks of deflation are just as present as the risks of inflation. 

However, on CPP Investments' Think Ahead site, they link to this tweet from The Economist where there is an interview with Mark Machin in a podcast and one of the topics discussed in the podcast is whether inflation is dead:

You can listen to this podcast here and it's very interesting. It begins with a discussion on inflation in the first ten minutes (great insights) and the interview with Mark Machin begins at minute ten and last ten minutes. Take the time to listen to Mark Machin's comments. 

Mark talks about CPP Investments, its governance and its investments and he refers to the rising risk of inflation longer term.

He discusses their investment in Viking Cruises and the risks of commercial real estate, He mentions that working from home is here to stay but if you pick your spots and tenants correctly, and diversify across geographies and real estate categories, you can mitigate a lot of uncertainty. 

He also talks about the "wall of money" headed into infrastructure and discusses the risks of doing greenfield infrastructure (ie construction risk) and why they prefer investing in brownfield projects.

[See Barbara Shecter's Financial Post article where Machin discusses infrastructure in more detail, including their investment in Highway 407 and why they'd like to see governments privatize more infrastructure assets.]

On the recovery, he says the market is pricing in a "substantial recovery in 2021" but there could be a "significant correction" if there is a setback with vaccine rollout.

The other risk Mark Machin refers to is the huge transfer of capital from governments to companies and individuals and that could bring about inflation longer term.

When asked how to hedge against this risk, Mark Machin says "diversification" across geographies and different programs (emerging markets and all this different strategies across asset classes that will be great beneficiaries if inflation happens).

Alright, does this mean inflation will happen? No, not necessarily. 

Let me briefly give you my thoughts.

Three years ago, I discussed whether deflation is headed to the US, outlining seven structural factors that led me to believe we were headed for a prolonged period of debt deflation:

  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund and private equity titans cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Globalization: Capital is free to move around the world in search of better opportunities but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.

These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and to prepare for global deflation.

Has anything changed during the pandemic?  On many levels, things have gotten worse, the tsunami of liquidity the Fed and other central banks have unleashed has only exacerbated inequality, disproportionately benefiting Wall Street speculators, corporate titans, tech billionaires, and ultra rich families.

Now that central banks are backstopping madness we shouldn't be surprised everyone is making a mad dash for trash and retail speculators are trying to generate income in this nothing matters market:

How will it all end? In tears, and don't take my word for it, listen to Charlie Munger:

Of course, the market frenzy Munger warns of can last for a very long time but when it ends, fortunes will be wiped and devastation will hit Wall Street and Main Street.

And that's not exactly inflationary, central banks are basically sowing the seeds of the next deflationary crisis.

Are you confused? Don't be. Central banks can only create asset inflation and housing inflation, not real inflation which only comes from sustained wage gains. And wages aren't going up anytime soon.

So, call me a deep skeptic but all this talk of inflation is grossly premature and somewhat misplaced.

You can have cyclical inflation because the US dollar was weak this year boosting import prices but that's not to be confused with secular inflation.

The same goes for fiscal stimulus, it can only boost demand for a period of time but it doesn't lead to permanent inflation. 

Will the pandemic disrupt global supply chains? It already has. Will it lead to deglobalization? The verdict is out on this.

Anyway, I love this topic and would love to really go head to head with CPP Investments' Think Ahead team to flush it out appropriately because if you get it wrong, it will cost you billions in returns.

Once again, please take the time to listen to The Economist podcast featuring Mark Machin here (his interview starts at minute 10 after an interesting discussion on inflation).

Also, please take the time to read CPP Investments' 2021 Economic and Financial Outlook. The entire white paper is available here

Below, Real Vision’s Roger Hirst uses Refinitiv’s best-in-class data to look at the potential for reflation in early 2021, or for a rollover in economic activity. Government policy has already been incredibly loose, but so far it has provided little more than life support, even if US equities have rallied. It may even be that we get inflation, rather than reflation if consumers start to spend before supply chains are replenished. Interesting discussion, take the time to watch this.