Why aren't markets clearing?
By Justin Pyvis – Delivered on 12 Oct 2021

Good morning! WA Premier Mark McGowan revealed that his government is looking to improve its Australia-low vaccination take-up by making it mandatory in additional sectors, such as the entire public sector workforce (including school teachers).

It'll be interesting to see how that goes down given the recent protests in Victoria, although COVID-19 vaccination is already mandatory in WA – and without controversy – for FIFO, port, transport and freight workers, health and aged care staff, police and other frontline workers.

Moving on, Victoria's Health Minister Martin Foley said his state is "preparing to open in time for summer", although the unvaccinated will miss out: "If you are not vaccinated, these freedoms won't apply to the same way that it will to those Victorians that are vaccinated."

For some reason we think the Victorian government is serious about that, unlike the empty threat that was dished out by the NSW government for months before it announced it would reopen to everyone at the 80% fully vaccinated mark.

Speaking of NSW, Premier Dom Perrottet revealed he's asking ScoMo to bring forward the border opening not so that you can travel overseas but because of "labour shortages", which is the "next step after returning Australians".

No doubt as the former Treasurer Perrottet is well aware of the damage more than 100 days in lockdown will have done to the economy and the government's balance sheet, hence the intense desire to get back to something resembling normalcy.

Fully vaccinated population (aged over 12)


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Note: Brent oil, gold bullion and iron ore prices are the second futures contract.

The US S&P500 fell 0.69% after Goldman Sachs cut its US growth forecast for the third straight month. Bond yields are spiking on fears of persistent inflation along with disappointing growth (stagflation), after Kraft Heinz became the latest food producer to warn that inflation was "across the board" and higher prices are unavoidable.

Locally, the ASX200 dipped -0.28% with just about every sector weaker except for materials (+1.2%) and energy (+1.3%), which increased on the back of strong gains to iron ore and crude oil prices. A notable loser was gambling giant Star Entertainment, which plunged -22.9% after it was accused of "suspected money laundering, organised crime and fraud", potentially jeopardising its Sydney casino licence.


JobWaster: A report by the Commonwealth Treasury showed that "in the two quarters of 2020 impacted by the coronavirus pandemic, $A27 billion was paid to businesses that had not met the scheme's 30% turnover eligibility threshold". Over half of those funds went to businesses that actually reported increases in turnover compared to the prior year.

Persistent inflation: Investment management company Bridgewater Associates said that if the Fed were to tighten monetary policy due to persistent inflation, "it drives financial markets down, which they probably don't want to do", meaning it will probably "choose inflation".

Oil to $US100: According to ANZ, "you can't even rule out prices hitting $US100 a barrel in the short term if markets continue to trade with the volatility we've seen in recent times". The bank lifted its three-month price forecast from $US78 to $US90 a barrel due to recovering demand and "a supply side which is not expanding as easily as many had expected".

Why aren't markets clearing?

Economist Arnold Kling wrote an interesting post asking the simple question of Are the laws of supply and demand broken? It's a fair question given the energy crisis ravaging much of the world, constant supply chain drama and in the US, no surge in hiring despite the end of unemployment benefits and record number of job openings.

Breaking it down: Kling argues that "When you have an adverse supply shock, prices are supposed to rise to clear markets... A shortage, where people have to wait or the quantity is rationed, only takes place when the price is artificially held down."

Correct. So why aren't markets clearing? According to Kling, "firms do not want to raise prices because they are afraid of blame... because most customers have not internalized freshman econ, stores think they will have better customer relations if they run out of stuff than if they raise prices".

That explains lagging consumer price inflation but doesn't explain energy prices, which have more to do with various government policies.

For example, China's power shortage is largely because "prices paid to generators are regulated by the central government, while coal prices are set on the market", leading to a situation where power plants "avoid generating at a loss by claiming they have a technical malfunction or by failing to purchase the coal they need to run".

In Europe, policy makers committed to phasing out reliable baseload generation from coal and nuclear "before renewable energy was available at scale and competitive cost". Natural gas has been used for "plugging gaps in power production from other sources", but this year the gaps have been gaping.

Why this matters: Market strategists are growing concerned about "a return to 1970s-style stagflation". There are a lot of similarities between now and then, such as central bankers citing various "transitory" supply issues as the cause of inflation. The best example in the 1970s was former Fed chair Arthur Burns, who blamed everything from the OPEC oil embargo to El Niño's effect on Peruvian anchovies rather than his expansionary monetary policy.

Looking Forward: Kling thinks "that the price stickiness will not last forever. Over time, firms will gradually raise prices. I believe that what we are seeing right now is a considerable amount of repressed inflation, and it won't stay repressed for much longer. By the end of next year, I predict that 'shortages' will have been replaced by higher prices".

If he's right, certain asset classes whose valuations are predicated on interest rates remaining low could be in for quite a shock when central bankers belatedly remove the punch bowl.

The Wrap Up
    ☢️Japan's new Prime Minister, Fumio Kishida, wants to restart Japan's mothballed nuclear reactors to ease the country's energy crisis.
    🦇Scientists at Osaka University in Japan may have discovered a vaccine that creates "broadly neutralising antibodies" that are effective against "not just Sars-CoV-2, but also Sars-CoV-1, which caused the Sars outbreak of 2002".
    🐞Paul McCartney revealed it was John Lennon who broke up the Beatles in 1970, saying "I didn't instigate the split. That was our Johnny".
    🕵️‍♀️A US Navy nuclear engineer and his "lookout" wife have been accused of stealing "secrets about the country's Virginia-class nuclear-powered attack submarines on a blue, plastic-coated SD memory card — then sandwiched the tiny device between two slabs of bread slathered with peanut butter".
    ⚛️Queensland's government partnered with Fortescue Future Industries (FFI) to develop one of the world's largest hydrogen-equipment manufacturing facilities in Gladstone. FFI will invest an initial $A114 million, with the government's contribution not disclosed.
    🕵️Just under five hours after Victoria's Independent Broad-based Anti-corruption Commission inquiry into allegations of Labor Party branch stacking commenced, Victorian Labor minister Luke Donnellan resigned from Cabinet after he was named by federal Labor MP Anthony Byrne.
    🤔Having clearly never heard of trade-offs, Hong Kong's Chief Executive Carrie Lam said even a single death from COVID-19 would be too much, pledging to maintain a strict "COVID Zero" policy so that it can reopen its border with China.
    🏉The Redcliffe Dolphins will be announced as the NRL's 17th team this week, entering the competition in 2023.
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