Sorry, Fed, Inflation Is Already Embedded

Authored by Charles Hugh Smith via OfTwoMinds blog,

The Fed and its minions are about to get what they so richly deserve: the full blame for the coming catastrophe.

The key justification for the Federal Reserve’s zero-interest rate policy is that inflation is transitory. Sorry, Fed, inflation is already embedded, i.e. inflation is now a self-reinforcing feedback loop: price leaps trigger wage increase demands, supply constraint expectations are now built into wholesale cost increases, and all these increases in wholesale, retail and wage costs drive each other higher as participants now understand that higher wholesale costs drive higher retail prices which feed higher wages which feed higher costs.

The conventional consensus holds that globalization and technology are deflationary. But globalization is no longer deflationary as fragile supply chains logjam and break and prices on the margin soar as demand skyrockets due to hoarding and attempts to restock depleted inventories.

As for technology, the move to remote work is only selectively deflationary, for example, demand for commercial office space has cratered, driving lease rates off a cliff. But in the larger scheme of things, the major “advances” in tech have been concentrated in social media, which is arguably reducing productivity rather than increasing productivity.

Digitizing everything under the sun has made everything dependent on components which are now scarce, scarcities driven by multiple factors: planned obsolescence (so profitable when supply chains are functioning smoothly, not so profitable when supply chains are constrained), agonizingly long lead times to build out semiconductor fabs and exploit new sources of minerals, energy, etc., trillions of dollars in stimulus driving demand higher, which then feeds hoarding and inventory building, further pressuring supplies, and disruptions triggered by everything from the pandemic to shortages of energy.

American workers have been stripmined and abused for 40 years in classic boiling-the-frog fashion, and now they’ve finally had enough. The Great Resignation, like other drivers of inflation, is complex and cannot be reduced to a single cause. Like the other systemic drivers of inflation, labor refusing to work for low pay and being treated like pack animals has been a long time coming, and there are no quick fixes of the sort pundits promote.

Now that inflation expectations are embedded, there’s no going back. Touting bogus inflation statistics (“we took out everything that went up in cost and look, inflation is low!”) is not going to reverse the understanding that inflation is here to stay.

Now that participants understand their income will buy less in the future, they have a powerful motivation to buy something tangible now while the price is lower than it will be next year–a motivation that increases demand and pushes costs higher, which then reinforces the incentives to convert earnings into something real before the Fed destroys even more of the purchasing power. Wage earners have no choice but to demand much higher wages to partly offset soaring costs, and employers who refuse find employees are leaving en masse. Those who increase wages must raise prices to offset their higher costs.

Meanwhile, taxes, junk fees, user fees, etc. only ratchet higher–they never decline, ever. Participants understand the ratchet effect and this also drives demands for higher wages.

Corporate America has pushed the shrinkflation gimmick for years to mask the loss of purchasing power, but that gimmick is wearing thin. People are waking up and noticing there is 10% less in every package while the price jumps 10%–a real-world inflation rate of 20%.

Simply put, the Fed blew it. The inflationary drivers outlined above were all painfully obvious a year ago, and the Fed did nothing but enrich the already super-wealthy to the tune of tens of trillions of dollars while ripping the heart out of the bottom 90% who depend on pensions, disability, Social Security or wages, none of which keep pace with real-world inflation.