Bad grandpa and bad monetary policy.
Originally Posted: June 13, 2021
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short A follow-up to the inflation piece from last night, Inflation in Context: Liquidity Adjusted CPI, which was a bit wonky, and we don’t think we’ve been clear on our points.
Once again, we send all prayers, positive thoughts, energy, miracles, crystals, and manifestations in the entire universe to Carol K. You have contributed to this post and you may or may not agree with all of the content.
Inflation and loose financial conditions
Our central thesis in last night’s article is that inflation is accelerating rapidly, not just because of the “core effect,” and that financial conditions are too loose.
We’ve taken the previous three super-hot core inflation prints – 0.7%, 0.9%. 0.3% – to create an annual core inflation rate for 3 months. It is now 8.21 percent, its highest level since July 1982, when financial conditions were very difficult during Volcker’s war on inflation, and a month it ranks 97 percent in terms of the most restrictive financial conditions measured by the Federal Reserve Bank of Chicago. Status Index (NFCI).
May’s NFCI was still very loose. Within the 14th percentile of tight monetary conditions out of the 604 months of the index’s life.
our point of view
This is our view: rapid, accelerated short-term inflation with extremely loose financial conditions.
The following chart shows our 3-month core CPI in a revised version – the 3-month core CPI minus an expanded version of the NFCI. It gives more context to historical inflation data as to whether financial conditions are tight or easy.
The revised core CPI came in at 8.92 percent in May, the highest level since September 1981.
looks like 1977
We also looked at all monthly inflation prints of our core CPI data in the lowest quintile of the months with easier financial conditions — 20 percent of the 600 plus months where the NFCI was below -66,215. Just aside, monetary authorities, although they have a significant influence on the NFCI, market conditions, such as the stock market, credit spreads, and mortgage rates, also play a large role. Below are the 105 indicators of which the NFCI is configured.
Case in point, during the depths of the Great Financial Crisis (GFC), even when the Fed was in panic relieving mode, November and December 2008 ranked as the 96th most difficult financial condition in NFCI history. This was a rare case but is becoming more and more common as financial markets now have a significant impact on the asset dependent economy.
The table above shows that in the bottom quintile for the months with easier financial conditions as measured by the NFCI, the 3-month core CPI print was the highest in the bottom quintile, which is rather annoying as it joined the unique company that only spanned months . Before the surge in inflation during the Carter administration.
liquefaction of the OPEC supply shock
Monetary policymakers face a similar dilemma as they did during the mid-1970s – although there are many differences as well. In the face of the COVID pandemic supply shock, it also appears, at least to us, that they are repeating the same faulty logic and reasoning as economic policymakers did at the time.
In the middle of 1973, the wholesale prices of industrial goods were already rising at an annual rate of over 10 per cent; Our industrial plant was operating at nearly full capacity; And there was a severe shortage of supply of many major industrial materials” (Burns 1974).
… The intellectual consensus among policy makers at the time was that cost-push inflation (the type of inflation resulting from increased prices of the economy’s inputs, i.e. workers’ wages) was outside the influence of monetary policy (Romer and Romer 2012). In the words of an economist who presented to the Federal Open Market Committee in May of 1971, “The question is whether monetary policy can or should do anything to combat the persistence of the residual rate of inflation…the answer, I believe, is negative… …it seems to me that we should regard persistent cost increases as a structural problem that is not subject to macroeconomic measures” (Romer and Romer 2012). – History of the Federal Reserve
Too little demand is not the problem, too much demand is the problem
We cannot understand why the Fed continues to focus on restoring all the jobs lost during the pandemic by continuing to stimulate demand. Certainly, we want everyone who wants to work to have a job with decent pay. but…
We took this picture last week at a local fast food restaurant,
Of the 7.6 million unrecovered jobs lost due to COVID, 33.3 percent of them are in leisure and hospitality, and the so-called “massive surplus labor pool” appears to be more of a mirage than a reality, as the Fed seems to believe.
How on earth would the ongoing monthly purchase of $40 billion in mortgage-backed securities by the Federal Reserve help the aforementioned restaurant hire, retain, and bring in its workers? So far we’ve been having trouble securing Uber rides because there’s a shortage of drivers on the road in our county.
It is clear that unemployment benefits distorted labor markets. This is a positive statement absent from any political judgment. We are all for more jobs and workers are rising fact But it must be practical, efficient, and non-inflationary. We will take a different approach.
The role of politics, in our book, should be to: 1) create an environment in which business thrives within the rules, 2) protect workers and give them a boost, if necessary, to help them become more productive 3) provide an efficient and effective safety net for those of us yesterday need it. The private sector creates wealth, often in partnership with the government – markets first, then government when markets fail. Markets fail.
Whipsawed retail sales and the ratchet effect
Take a look at how retail sales during the panic, which wreaked havoc on global supply chains – yes, excess demand is the main problem – were affected by the “whip effect”.
Consider that the retailer sells an average of 10 ice creams per day in the summer season. After the heat wave, the retail sales increased to 30 units per day, in order to meet this new demand, the retailer increases its demand forecast and places increasing demand for the wholesaler to 40 units per day in order to meet the new customer demand levels and to prevent any increase Another potential in demand, this creates the first wave of excessive demand that is being pushed down the supply chain.
A wholesaler who notices this increase in demand from the retailer may also build a gradual increase in his expectations, thus creating greater demand for the ice cream manufacturer, instead of ordering 40 units to manufacture it, the wholesaler may order 60 units from the manufacturer, this will lead to Demand inflates further down the supply chain and thus creates a second wave of increased demand.
The manufacturer also feels that the increase in demand from wholesalers may also react to the increase by increasing the manufacturing range to 80 units, and this creates a third wave of over-demand.
A retailer may run out of stock during a heat wave while a manufacturer is producing new stock and may make the choice to switch to an alternative brand to meet customer demand, this will then create a false order situation as sales appear to plummet to nearly nothing so they may not The retailer then places more demand on the original brand of ice cream even though the manufacturer has ramped up production. Alternatively, if the weather changes and end consumers slow down to buy ice cream, it could lead to overcrowding across the supply chain as each layer of the supply chain reacted to heatwave sales and increased their demand. This is an example of waves and bottoms in a whip effect. – CIPs
Supply chain problems are now beginning to reduce production and constrain economic growth. Of course, it’s more complicated than our little story, but using monetary policy to fine-tune the economy is like trying to thread a needle into a boxing glove.
However, excess demand is a much better problem than no demand, but the incentive should have been more directed to those who need it most, which is a financial issue.
Hindsight and criticism who are not in the arena?
Guilty of charge but let’s learn from our mistakes.
Even if the problems in the supply chain are resolved relatively quickly, we still think inflation is heading higher for a longer period, provided that financial markets do not collapse. The following chart makes us confident – if not sure – of our point.
Global central banks have increased their balance sheets by $10 trillion, 50% in the past year, and now banks seem eager to lend this coming summer of love.
Corner of the solution: inflation or deflation
Finally, we believe that there is very little middle ground in the inflation/deflation debate – just a side solution, either high inflation or deflation.
Asset markets are now detached from economic reality and highly exaggerated. They have such a huge impact on the economy that any major correction or disruption would severely tighten financial conditions.
Central bank digital presses will then be run more and more potentially endgame, in our view, hyperinflation for an extended period.
There is no longer any political will to allow real price discovery in the markets. With every 20 point drop in the S&P, Wall Street clowns scream for a rescue.
We think the US economy is in precarious equilibrium – if there is such a thing – and we imagine the following graph because it summarizes our overall view in one simple illustration.
We are now eagerly waiting to be lectured by dog currency traders for 14 years to tell us how wrong we are.
However, we are surrounded, because we always reserve the right to be wrong, and it often does.
Call the markets? Not in your wildest dreams. It’s hard to predict what kind of pizza Elon might eat on any given day and how that might affect what he tweets.
I had never, in my wildest imagination, thought that the financial markets would become a farce for them.
Stay connected, folks. And please continue to pray/think positively for CK’s recover.