Why This Time Is Different (And Not In A Good Way For Powell)

Authored by MN Gordon via EconomiocPrism.com,

They should have known better.  Fed Chair Jay Powell and Treasury Secretary Janet Yellen, that is.

They spent the better part of 2021 saying consumer price inflation was ‘transitory.’  The two of them are most responsible for this inflation mess.  How could they have been so wrong?

Now the scourge of raging consumer price inflation is here to stay.  This, no doubt, will be a persistent theme in 2022.  Moreover, the Fed’s efforts to tame and control it will be a magnificent source of folly.

To begin, central planners, including central bankers, believe they’re masters of the universe.  That they possess the tools to, in Omar Khayyam’s words, “remould it nearer to the heart’s desire.”

The reality is central bankers are always reacting.  And much of what they do is merely an attempt to cleanup messes of their own making.

Ben Bernanke, then Fed Chair, first commenced the great quantitative easing (QE) experiment in late November 2008.  At the time, the Fed’s balance sheet was approximately $800 billion.  Now, just over 13 years later, the Fed’s balance sheet is over $8.7 trillion – more than 10 times higher.

This mad undertaking has shown that once the QE genie’s let out of the bottle it’s impossible to put back without triggering disaster.  The economy and financial markets have adjusted to the abundance of cheap credit.  Businesses, governments – federal state, and local – and individuals depend on it.  Take it away and the whole debt edifice implodes.

This mad undertaking has also shown the impacts of QE are dependent on where the fake money ultimately flows.  This important distinction is why the Fed’s efforts to control consumer price inflation are doomed.  Let’s explore…

Where the Fake Money Flows

When the Fed first began creating credit out of thin air to buy Treasury notes and mortgage backed securities, hard money aficionados were revolted.  Many prophesized that a Weimar Germany type hyperinflation was just around the corner.

And why not?

As night follows day should not price inflation follow money supply inflation?

Well, yes.  Of course.  But what type of price inflation?  That’s the real distinction…

From 2008 to 2015, the Fed’s balance sheet inflated from $800 billion to about $4.5 trillion.  Over this time, college tuition and health insurance costs went through the roof.  But to the delight of Paul Krugman and other statist economists, price increases for most consumer goods and services were moderate.

Perhaps cheap labor out of Asia helped prevent consumer prices from dramatically inflating.  Still, we posit that moderate consumer price inflation between 2008 and 2015, even with QE, was mainly a function of where the fake money flowed.

You see, QE and the TARP bailouts started in late 2008 were a bailout of Wall Street and big businesses like General Motors via AIG.  Working stiffs got squat.  They lost their houses.  They lost their jobs.  Stimmy checks didn’t show up in the mail.

Specifically, the money supply inflation from 2008 to 2015 flowed to financial assets.  Stocks, bonds, and real estate prices boomed.  Speculative fever boomed too, along with financial engineering schemes like companies using low cost debt for corporate share repurchases.

All the while, average consumers were tight on cash.  Those who didn’t lose their house found some relief through refinancing at lower rates.  But this merely afforded them Sunday lunches at Applebee’s.  The abundance of cheap imports at Costco and Walmart were no match for these piddly cash flow increases to family balance sheets.

From 2015 to late 2019, the Fed attempted to draw down its balance sheet.  But after dropping about $700 billion, to roughly $3.8 trillion, all hell broke loose.  In September 2019, overnight money market rates spiked and the Fed had to backstop the repo market.

This breakdown in the repo market was soon overshadowed by the mass money printing instituted to bailout the consequences of government mandated lockdowns.  Upwards of $5 trillion was created out of thin air to buy Treasury notes and mortgage backed securities.  Only this time it was different…

This Time It’s Different

The 2008-09 bailout of Wall Street opened people’s eyes and minds to what’s possible.  Thus as the Fed went into full big business bailout mode in 2020, the plebs started asking…where’s the people’s bailout?  Where’s QE for the people?

What’s more, the people had a moral case to make.  Through no fault of their own, state sponsored destruction, as a mad response to coronavirus, had eradicated their jobs.  So it was only fair for the people to get a bailout too, right?

The CARES Act, which included a $1,200 stimulus check and an additional $600 weekly payment for the unemployed, offered many people their first taste of free money succor.  They liked its sweet taste.  And they wanted more.

A $1,200 stimulus check was nice, and all.  But a $2,000 monthly payment is way better.  So why stop there?

When money’s free, the supply’s infinite…ain’t it?

Thus more stimmy checks were delivered like manna from heaven.  And many working stiffs discovered it was more prosperous not to work.

But if everyone’s home watching Netflix – or getting rich trading cryptos in the metaverse – who’s left to make pizzas or milk cows?  And at what price?

The federal government’s fiscal deficits for fiscal years 2020 and 2021 were $3.13 trillion and $2.77 trillion, respectively.  That’s nearly $6 trillion of fake money – money supplied via Fed purchases of Treasury notes with credit created out of thin air – that was spent directly into the economy over 24 months.

At the start of 2021, consumer prices, as measured by the consumer price index (CPI) were increasing at an annual rate of 1.4 percent.  As of November 2021, the CPI is rising at an annualized rate of 6.8 percent…marking the greatest increase to consumer prices in over 40 years.  And if the CPI was still calculated the way it was in the 1980s, it would be over 15 percent.

What to make of it…

This week, minutes from the Fed’s December meeting were released.  Finally, the minutes show, committee members are concerned about inflation.  The Fed may even begin reducing its balance sheet and raising the federal funds rate this year.  Stocks sold off and Treasury yields spiked upward on this revelation.

Should the Fed go forward with these credit tightening plans you can expect asset prices to deflate.  But what about consumer prices?

Not likely.  And that’s why this time it’s different…

Unlike the QE from 2008 to 2015, the QE from 2019 to the present included massive social spending.  This was more than a Wall Street bailout.

The $6 trillion in deficit spending represents fake money that’s been released directly into the economy.  Raising rates and selling off bonds won’t mop this money up; at least not with the same efficiency it does for financial asset inflation.

So as asset prices deflate in 2022, something unexpected will happen: Consumer prices will continue to inflate.

Moreover, the Fed will be completely flummoxed by this magnificent folly.  But then what?

Will Congress reduce deficit spending?  Will the Fed push rates high enough to trigger a depression?  Will Weimar inflation finally come to America?

We may soon find out.

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