Inflation has fallen from its high of 9% in June 2022 to 3% currently. It was transient, lasting only 3 years. This reduction would have occurred without the Federal Reserve’s actions because the supply chain disruptions caused by COVID were meant to be resolved as transportation the containers were eventually unloaded. This form of inflation is called “Demand-Pull”. It is caused by the demand for goods and services exceeding the supply.
Although it was not necessary to control inflation at this time, it is time for the Fed to take its foot off the interest rate brake in its zero interest rate policy (ZIRP), because the real war on inflation is approaching and will require all weapons in the Fed’s arsenal.
The next wave of inflation – the BIG one
The other form of inflation, called “Cost Pushing,” is not transitory. It is classic inflation also caused by too many dollars chasing too few goods. This happens when a government prints a lot of money, as has happened globally over the past decade.
Argentina and Venezuela are rich countries that still suffer from hyperinflation, defined as inflation above 50%, because their governments made serious monetary mistakes that the US is repeating.
The world is running on unprecedented levels of debt, amounting to $200 thousand per capita. The US enjoys a special status as the “dirtiest shirt in the laundry basket” because the US dollar is the world’s reserve currency, so we enjoy a special privilege that provides some insulation, but we are not immune from inflation. Also, China may be in cooperation with Russia to make the Chinese yuan the world’s reserve currency.
The US has printed more money for COVID than any other country, exposing it to cost-push inflation that will last a long time and push inflation above 3%. It’s the next wave.
Who is paying for COVID? When was the last time you heard the words “balanced budget”? The relief from COVID has a colossal The $5 trillion price tag.
“Modern Monetary Theory” (MMT) is the supposed justification for the money the US has been “printing” for the past 15 years since 2008. The theory states that governments that own the printing press can print whatever they want to solve economic crises, except if it causes inflation, in which case that money must be returned with taxes.
The money supply is currently $3.5 trillion above what is needed to support economic activity. “Excess money” will drive cost-push inflation in the next wave. The “trend” shown in the chart below is the money supply needed to keep the economy running smoothly. “Current” indicates the surplus, also known as “too much money”.
There is little political will to absorb that money from the economy with taxes, so inflation will continue.
MMT seems to have “worked”. A recession in 2008 was short-lived, stock prices soared and inflation remained close to zero — until recently. We are currently experiencing a mix of demand-pull and cost-push inflation that is shifting to predominantly cost-push.
A couple of videosin madness clearly and humorously. DThe EBt limit – a guide to US federal debt made easy uses household debt to explain the federal debt. Fred Thompson on economics explains the wisdom of quantitative easing to save the economy in 2008.
$3.5 trillion in excess money is a lot, but The multiplier effect expands this to $35 trillion, which is 150% of GDP and 100% of our total debt. A trillion dollars is 1000 billion or one million million — that’s a huge amount of money According to CNBC:
If you pay $1 per second, it would take less than 12 days to pay off a $1 million debt. It would take 32 years to pay off $1 billion. Will you pay $1 trillion at a dollar a second? 32,000 years.
A trillion is a 1 followed by 12 zeros, like this: 1,000,000,000,000.
One trillion square miles would cover the surface of 5,000 planet Earth.
A trillion people would be 10 times as many as have ever lived (based on the Population Reference Bureau’s very rough estimate of 108 billion people ever).
A trillion dollars is enough to give $3,195 to every man, woman and child in the United States. (Author’s comment: we actually got the helicopter money in bigger checks)
For the typical American family, earning $50,000 a year, it would take 20 million years to earn enough to pay off $1 trillion in debt.
The chart below shows the magnitude of recent money printing compared to our most expensive wars.
But that’s not the whole story of debt. We (through our government) have made promises about Social Security and Medicare that are unlikely to be kept, and Quantitative Easing has widened the wealth divide beyond comprehension.
The image below shows that total US debt is more than 5 times gross domestic product (GDP) when the total includes off-balance sheet promises for Social Security and Medicare.
Tax bills for Social Security have been insufficient to pay all benefits since 2018. The Government Accountability Office (GAO) reports that Social Security will go bankrupt in 2026, followed by Medicare in 2034. Many say that you have the press means you can’t go bankrupt, but the reality is that the inflationary forces are already out of control.
The MMT has hit the inflationary bear and is angry. Cowboy wisdom instructs “When you find yourself in a hole, stop digging.” This is the current mission of the Fed.
The Federal Reserve is the arsonist tasked with putting out the fires of inflation
It is ironic that the Fed is helping to control inflation when it is complicit in its creation.
“Printing” isn’t really what the presses are about. The US Treasury borrows money as bonds and T-bills. In normal times, there are plenty of buyers for these bonds, but lately they haven’t been, so the Federal Reserve buys them, manipulating bond prices to execute a zero interest rate policy (ZIRP). In this way, money is created out of thin air.
According to the Federal Reserve, its balance sheet has grown from normal levels below $1 trillion to $8 trillion currently, with most of the increase during the pandemic.
Warren Buffett praised the Fed for saving the economy in 2008 with its QE, but warned that unwinding the Fed’s large increase in bond holdings could have disastrous consequences. In other words, downsizing is dangerous, and the greater the accumulation, the greater the risk. The Fed is playing with fire, as shown below.
The Fed does not have a dial that can turn to a desired level of interest rates, but it has been able to suppress interest rates by buying bonds at premium prices. When the Fed takes its foot off the brakes by reducing bond purchases, interest rates rise and bond prices fall because the Treasury must attract more buyers by sweetening the pie.
No special Fed meeting is required to “set” an interest rate — rates revert to a fair market price when they are not being printed. A fair market price in a 3% inflation environment yields 6%. We should expect inflation to rise above the current 3% level, causing interest rates to rise again.
Rising interest rates do a lot of damage, as we learned in 2013.Conic tantrum.“Higher interest means higher payments on our $34 trillion government debt. Interest at 6% would require spending 84% of tax revenue on debt service, leaving little for other spending, so deficits would grow to $5 trillion a year, which is 3 times the $1.8 trillion current dollars. Tax revenues are about $4.5 trillion a year. The debt clock will spiral out of control.
What’s worse is that the stock market will crash, as it almost did in the 2013 Taper Tantrum, because bonds become attractive alternatives and corporate earnings are discounted at a higher rate. At this stage of the cycle, the Fed will be encouraged to stop tapering and resume buying bonds. The market expects this “pivot” to happen again soon.
But this time is not like 2013, when inflation was close to zero. This time the Fed’s bond buying will fuel the very fires of inflation the Fed is trying to put out.
The Federal Reserve cannot simultaneously continue to manipulate interest rates below the ZIRP while lowering inflation. He will have to choose. The best choice is to let bonds return to market-driven prices, raising interest rates and lowering stock prices. Allowing market forces to work is the best solution even if it causes pain in the short term.
As advertised in a chiffon margarine ad, “It’s not nice to fool Mother Nature. Markets are better left to set fair prices.
Market pundits have declared the end of the inflation that has started a stock market rally – the Santa Rally – in anticipation of a Fed roll. But the Fed has historically cut interest rates to spur a bear market — to stimulate investment in stocks. – instead of fueling a rising stock market. The Fed should allow the market to determine fair prices for stocks and bonds. She should abandon ZIRP.
We are ignoring the teachings that should be learned from recent stock and bond market developments. Ignorance is not bliss.
Investors should prepare for the next wave of inflation by moving into inflation hedges like TIPS and other assets that are not stocks or bonds.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.