The FED signaled it will take the problem of inflation seriously this coming year. Chairman Powell, seeking confirmation of a second term, voiced concerns with inflation and stated there are multiple tools to use in this fight. The question might be why now rather than can they do it. It is the type of inflation that is key in this current approach.
The current inflation situation reminds many of the ‘70s stagflation era. That is not entirely fair to either era due to the different circumstances. The ‘70s experienced oil shocks and Nixon’s closing of the gold window. That was truly new ground. We are experiencing cost-push inflation due to supply chain issues and the covid shock. There is also a nascent price-wage spiral going on in the American marketplace. Americans quitting jobs are often lower wage workers jumping ship to other companies offering better wages. We keep hearing that employers cannot find enough workers while also hearing that employers have to offer higher wages to recruit. Covid threw a wrench into the immigration pipeline.
This is bad inflation for capital. This eats into margins. The problem our consumer economy has is fewer firms feel confident they can raise prices and maintain marketshare. The FED did not care when asset inflation occurred in housing, stocks, etc. It did not care about medical and education inflation as those are wealth transfers and the recipients were good guys in the system.
This is why the FED is talking tough now. They really want to get back to the old system with a never-ending supply of cheap labor and credit. Raising the Fed Funds Rate, quantitative tightening and reduction of the FED’s balance sheet are all on the table per Powell. The FED wants to deploy the tools Chairman Volcker used forty years ago to tame ‘70s inflation. Volcker sent the economy into recession twice to kill a wage/price spiral.
That is impossible now. To borrow a poker term, Chairman Powell is drawing to an inside straight. He wants to raise rates and curtail inflation but also not cause a financial crisis with higher rates. Zero Hedge brings up the Taylor Rule for a reason, and that policy guide shows rates must be much higher. Our finance economy cannot handle a 5% or higher FED Funds Rate. Borrowing costs would skyrocket for everyone and the entire market would suffer a dislocation. Many firms would go bankrupt and be reorganized even if they survived.
The other problem Powell finds himself in is the problem that increasing rates will not end inflation immediately. If one reviewed the late ‘90s and then mid ‘00s tightening cycles, one could also see massive run ups in core commodity prices and asset markets. The major commodities bull of the ‘00s happened during and after the FED raised rates, which choked out the housing bubble that it created four years earlier in response to the tech bubble popping. If rates rise, we could see another commodities rush that then causes more cost-push inflation until the real economy says “no mas”.
The current bubble is called the Everything Bubble. When this bubble pops, everything will be on sale to those holding any liquidity on the cheap. When was the last market correction? Covid. When was the last bear market? Over a decade ago. Chairman Powell might talk a good game, but it stretches credibility to assume a true bubble popping will happen in an election year with the favored party already in a tight spot. Watch for real actions beyond the public words and remember that only when workers started seeing wage increases did anyone in power worry about inflation.