"I'm not gonna try it, you try it!"
"I'm not gonna try it!"
"Let's get Mike-e to try it!"
"Yeah, he won't eat it, he hates everything!"
"He likes it... ."

An ad from the mid 80's where a couple of boys are refusing to eat a new cereal called "Life" that their younger and much choosier sibling finds appealing. The memory popped into my head as I heard the news reports that the futures contracts for delivery of 1000 barrels of West Texas crude in May went negative for the first time in history mid-April. Futures traders normally have no desire to take delivery of the underlying commodity for which the contract they are trading represents. Typically, traders sell the contracts a month before they come due. In this case traders holding futures contracts for oil delivered in May found there were no buyers in April. These traders had to pay someone to take the oil off their hands creating an implied negative value for a barrel of oil. While this was technical in nature, and not an actual reflection of the true spot price of oil at the spigot it is instructive in divining the meaning of price discovery in the financial markets.

Consider the purchase of a 6-month U.S. Treasury bill, currently paying the princely sum of 0.05% over a six-month period. A 6-month bill is a contract for the delivery of 1000 US dollars in six months. The bill can be purchased from the Federal Reserve at a discount to its face value for $999.50, the additional $0.50 that is collected in six months is the interest you earn. If you do not wish to take delivery of the $1000.00 in six-months' time, you request that it be rolled over into a new six-month bill when it comes due. As a thought experiment, consider what would happen if there was a shortage of bills five months hence. Folks might start bidding up the "future" price until that bid topped $1000.00. Say the bid went as high as $1000.50, that would be the same as a negative interest rate. This highlights how the demand for money, despite some belief to the contrary, can drive interest rates higher and an over-supply can drive them lower. The caveat being the currency under consideration is a reserve currency, not some decoratively printed paper issued in cartloads by some tiny despotic government. Also the currency, U.S. dollars, is held inside the walls of the reserve system just like oil being held in storage tanks. If you can't take delivery of the oil your futures contract entitles you to, you pay someone to take it from you. If you can't find a place to safely store your 1000 Georgies, 200 Lincolns, 50 Jacksons, 20 Grants, 10 Franklins, 2 McKinleys, or 1 Grover Cleveland you pay the bank to hold them for you (negative interest). Otherwise you take delivery: stuffing the 1000 Georgies into your mattress, 200 Lincolns into your freezer, 50 Jacksons in a safe, 10 Franklins in your wallet, or a lonely Cleveland in your shirt pocket. If you and everyone else had to take delivery of the cash would your inclination be to get rid of it? If you did notice loads of people with wallets full of Franklins would you be in a hurry to unload yours. Would you use them to bid up the price of gold, land, cans of soup, or 100" screen TV's? What if the dollar bills weren't piling up in your garage, and you were only using a plastic bank card to pay for things, would you be less inclined to dump them? Money has just become numbers on a ledger, bits in a computer. How does this affect what you perceive as a dollar's worth of value relative to the value you perceive for the other things available to you or you might wish to possess?

It is one thing to measure the change over time in the number of dollars a consumer must spend for a basket of goods at the market or to rent a home. It is another thing to try and measure their perceived notion of how much they will need to spend for those things 6 months from now. Out of sight out of mind as the expression goes. Inflation is low because it is perceived to be low, inflation is low because the desire to spend savings now is low and money is piling up inside the bank, like oil filling up oil tanks. When there is an oversupply of something its cost goes down. The cost of money is the interest you pay on it in the future. With dollars readily available their future cost goes down.

Classic economic theory espouses that inflation is caused by too many dollars chasing too few goods and services (G&S), but that is a massive oversimplification. Dollars are exchanged for G&S, but these are consumables that are short lived. Dollars are also exchanged to produce long lived assets, and these are matched against other forms of "currency" (stocks, bonds, mortgages, notes, etc.) inside the banking and financial system. Once an item that was used to back a dollar's creation no longer exists, or in the case of an asset becomes less efficient than it's carrying cost (capital interest cost), that dollar becomes over supply and adds to the true rate of inflation. It is when a central bank allows a significant over supply of currency (more than total purchasable G&S and marketable long-term assets) to slosh into circulation that people perceive inflation.

The COVID-19 outbreak caused state and national governments to impose stay at home orders forcing workers (overwhelmingly affecting the hospitality and travel services sector) to stop work. The value of some of these employment activities are short lived, but many are supported by long lived assets which are backed by debt. To the extent an asset becomes irreparably damaged and is taken out of service the value that is represented in dollars of its future earnings (in the form of stock or debt) on a bank or corporate balance sheet vanishes. Viewed strictly analytically, governmental edicts halting economic activity to slow the spread of COVID-19 hava primarily protected the less productive at the cost of the more productive. The question is: will the government's massive fiscal action (PPP loans, small business loans, tax abatement, unemployment checks, etc.) offset that economic damage. Imagine the dollar as an equity debit on the U.S. balance sheet. Damage to the assets side of the ledger is inflationary (more dollars than assets to back them), damage to the financial side of the ledger is dis-inflationary (more assets then dollars to back them). Productive assets are dis-inflationary and result in higher stock values, less productive assets are inflationary and result in lower stock values. When credit is issued, to temporarily offset a sudden drop in productivity, but protects assets from long term impairment the financial affect is a short term drop in the value of future earnings. Stock values go down suddenly but then back up on a curve, like a "Nike Swoosh", as the credit is repaid. The Federal Reserve and U.S. government have kept credit flowing to help prevent the deflationary affects of the stay at home orders. If the damage is not permanent, inflation should stay low and stock values will recover. There is some evidence to suggest that the forced exercise of keeping workers at home, working through the internet, has made some enterprises more productive. The hunch is the market has sniffed this out and expects productivity to increase, on net, six months out. If true, it will continue to go higher.

Double Your Money.
GUARANTEED!

If I had an investment that is guaranteed to double would you be interested? It is probably one of the best investments for long term savers available today! There are a few conditions. The guarantee only pays off after 20 years, and you are limited to $10,000 per SSI number per year. Still interested? If you are then check out the Federal Reserve website for series EE bonds. While I mentioned 2-year FRNs (floating rate notes) over the last few years as a good place to stash short term reserves as a hedge against higher rates for large denominations, the EE series bonds are an excellent gift for newly born children and grandchildren. You can purchase them in amounts as low as $25 and cash them in after the first year. They do not pay much interest today, currently just 0.1%, but at the twenty-year mark, regardless of rates in between, you are guaranteed to be paid back at least double the purchase price. That's a 3.4% federally guaranteed minimum return over 20 years. Today that works out to a 2.3% yield pick up over the twenty-year U.S. Treasury bond sold at market last week.

Invest Wisely!