Interesting Noah Smith article Inflation is real; now it’s up to the Fed
I generally agree with Noah that Biden is powerless to reduce inflation, and that it will either require the fed abruptly raising rates a lot (which will not happen), a crisis or recession (also very unlikely, IMHO), or simply inflation returns to the baseline of 2-3% (the most likely outcome).
Had Trump been reelected, inflation would possibly be even higher, due to Trump being better for the economy than Biden (due to less regulation, the expectation of lower taxes [raising taxes is generally considered deflationary, or at least that is how the bond market interprets it, in invoking the EMH]). Except for taxes, Biden’s domestic economic policy is very similar to that of Trump. Both Trump and Biden support abundant stimulus spending and forever-low interest rates. Trump in 2018-2020 was imploring the fed to keep rates low. The notion that Trump cares about inflation, or would sacrifice points of GDP or points of the S&P 500 to stave off inflation, is not only laughable but demonstrates ignorance of Trump’s economic policies and agenda. Had Trump won, Tim Pool and others would be talking about how inflation and shortages are indicative of a strong economy. The politicization of inflation is unavoidable but is why social media is such a terrible source of information.
If this continues, it means people are starting to doubt the Fed’s commitment to restraining inflation. And this is the real danger, because that could cause a price-expectations spiral that would send inflation into double digits — and would eventually force the Fed to pull a Paul Volcker and throw millions of Americans out of work just to put the genie back in the bottle.
According to what or whom? The fed will not be forced to do anything. There is no immutable law of economics that says negative real bond yields cannot be sustainable forever. The evidence suggests risk-averse debt holders will settle for negative real returns indefinitely, just like how negative interest yields have proven sustainable in Germany and other developed countries.
Here is what I think will happen:
Conditional on continued strong GDP growth and the absence bad news, the fed will raise rates, but only very, very slowly. Real interest rates will remain negative, which is bullish for stocks. Except for junk bonds, real bond yields will remain negative (except for perhaps 30-year treasury bonds), which is also good for stocks.
Inflation will not get out of control, but this is not because of expected rate hikes. I predict for 2022 and onward, that CPI will return to growing at 2-3%/year, instead of 5-6%. There will be no stagflation either.
It will take very little to push interest rate expectations lower. Some bad news out of China, a return of Covid, or some weak GDP or job growth can easily delay rate hikes. The ‘flight to safety’ trade means even the smallest hint of uncertainty or bad news will force bond yields and interest rate expectations lower even as the stock market and corporate profits keep surging. The fed will look for any excuse, however small, to delay rate hikes forever.
Because of these factors, everyone will be forced into riskier assets such as stocks or real estate or otherwise lose money due to inflation. Except for junk bonds, there is no way to get a positive real yield from fixed income. In part, this is why I am so optimistic about the stock market going forward and why I am fully invested, such as 3x ETFs, Tesla, as well as having others invest.
But he’s probably just been talking to crypto friends who’ve been telling him this stuff in order to pump up the value of their Bitcoin portfolios. Some Bitcoiners have really run with the whole “digital gold” idea, and are trying to get people to view crypto as an inflation hedge. And if enough people start to think of it that way, then it really will be an inflation hedge. That’s why we’re seeing this talk of hyperinflation from people with lightning bolts in their screen names.
Jack Dorsey, when he’s not banning people for Covid/vaccine ‘misinformation’, is spouting off nonsense about crypto.
Noah continues:
This is a tough one. In theory, deficit spending raises aggregate demand, which tends to be inflationary. We’ve done a lot of deficit spending for Covid relief, and people like Larry Summers and Jason Furman have been predicting that it would lead to inflation. The theory here is pretty simple, too — Covid relief put money in people’s pockets, and they spent that money, so prices went up. Thus, the recent inflation numbers may look like vindication for Summers, Furman, & co. Inflation is global, of course, but most countries did quite a bit of Covid relief spending.
So the real answer here is that we don’t know how much Covid relief spending has contributed to the rise in inflation. Doubtless Republicans and some centrist Dems like Joe Manchin won’t wait for confirmation, and will use inflation as a reason to nix Biden’s spending plans, just as they used the inflation of the 1970s to call on Jimmy Carter to cut social spending. It may even work.
The answer is ‘not much’. Most of the stimulus money was saved or used to pay down personal debts. This is deflationary. The evidence suggests, based on the Obama stimulus [American Recovery and Reinvestment Act of 2009], that stimulus spending does not add much to growth, inflation, or job creation, and any economic gains tend to be temporary. Because stimulus spending is temporary and the economic gains are very modest, and the stock market is a forward-looking indicator, the stock market would not have risen so much as it has since 2020 if only stimulus was to blame, because of the expectation of stimulus being temporary. Indeed, inflation remained low after 2009 despite the Obama stimulus, suggesting it did not contribute much to economic growth in spite of its large cost. It’s evident that strong consumer spending and surging corporate profits are playing a bigger role than stimulus.
As disused earlier, the huge post-Covid v-shaped recovery of the stock market, real estate, consumer spending, and GDP caught a lot of experts and pundits by surprise. The expectation was that, even with stimulus, that things would take years to recover as the US economy clawed its way out from the depths of the pandemic, but then Game Stop stock went up 100x and suddenly a FOMO unlike the likes ever seen took hold. In the span of months, the economy switched from surplus to scarcity, and supply was unable to keep up with such sudden unforeseen demand. Pretty much everything kicked into high gear, including inflation.