Three takeaways from this week’s pod with Mike Strain:
Blame the Fed. No really
Blame the American Rescue Plan
Bless Joe Manchin
That’s about it. Because what we heard from recidivist guest Mike Strain is that it should have been clear to the powers that be in Washington that in addition to the vast wells of COVID savings, plus the infusion of cash while Trump was still president, PLUS more infusions of cash from our spendthrift Congress, there was too much dough chasing too little stuff. And that, ladies and gentlemen, is how you get inflation. Plug in supply chain woes, China’s insane Covid zero policy, and yes, Russia’s invasion of Ukraine, and you have “a perfect storm.”
The Fed should have raised rates sooner. Joe Biden should stop blaming Putin; we had inflation and skyrocketing oil prices before February 24 (when Putin invaded). And yes, we’re going to have a recession. It seems almost inevitable, as even the ostriches at the Fed now admit. There are indeed things that can be done to reassure investors that the market isn’t going to crash and that the ship will be righted in short order. So far, however, the Fed isn’t doing those things.
Is there a silver lining? Yes, Elizabeth Warren is still wrong. Mike tackles the “greed” trope nicely… there’s a little bite of that in the highlights below.
HIGHLIGHTS
How did we get here?
MS: I think what's going on is kind of a perfect storm, almost. In a very basic sense, there are two reasons why prices go up. Demand goes up relative to supply, which leads to price increases, or supply contracts for a given level of demand, which makes goods and services more scarce and therefore more expensive, and we're getting both. We had, on the demand side, a $900 trillion economic stimulus that was signed into law in December of 2020. We had the American Rescue Plan a few months later at $1.9 trillion. So that's a massive amount of stimulus that went into the economy in 2021 that carried over into 2022.
Unemployment was rising, the number of jobs were growing, the pandemic was fading, people were getting back out and leading more normal lives. In addition, households have been sitting on over $2 trillion of excess savings due to pandemic era stimulus measures that were put in place in the year 2020, and that also led to a big increase in economic demand. So the demand side of the economy was very strong due to fiscal policy. The demand side of the economy was also strong due to monetary policy.
What did the Fed do to make the problem worse?
MS: The Fed, for example, was still purchasing mortgage-backed securities with the goal of making it cheaper to get a mortgage to buy a house. The Fed was still doing that into 2022 at a time when home prices were growing at a 20% annual rate. So the Fed was kind of pouring gasoline onto an economy that was already on fire
[Back in the 1970s] Paul Volcker came in as Chairman of the Fed and Paul Volcker caused a deep recession, Paul Volcker took the unemployment rate up to 10%, and Paul Volcker made it extremely clear to businesses, to consumers, to the US Congress, and to financial markets that the Fed was going to keep its foot on the back of the economy until it convinced everybody that it was going to get inflation under control. And that inaugurated a period of four decades where inflation was under control,
So this is “path dependence”?
MS: There had been predictions following the financial crisis when the Fed engaged in some extraordinary measures to support the economy like quantitative easing. There had been a lot of concern that those measures would lead to inflation. Those concerns didn't materialize. The Fed knew that. In a technical sense, the Fed's models all told them that there wasn't going to be inflation. Why did the models tell them that? Because the models were built around what's happened over the past four decades. So if you haven't had any inflation over the past four decades, your models are going to tell you that you're not going to have any inflation in the future. The Fed didn't really understand that and continued to rely on the models.
So there, I think, are a number of reasons why the Fed got it wrong. Having said that, I think the Fed should have gotten it right. Certainly, by the summer of 2021, it was clear that we were headed into some choppy waters. And certainly, at that point, the Fed had not caught up nearly as quickly as it should have. The fact that the Fed was continuing to purchase longer-term securities, including mortgage-backed securities, into 2022 is completely indefensible
Why do you blame the ARP?
MS: I listed a whole bunch of factors, but I do think it's worth singling out the American Rescue Plan. Inflation in 2021, would've been... So we had about 7% inflation in 2021. I think about three percentage points of that came from the American Rescue Plan. Maybe that estimate is too high, let's take it down to two percentage points. The difference between 7% and 5% is significant
Is the Fed now getting it right?
MS: The Fed's official forecasts suggest that inflation will come down, but unemployment will not come up. That is not going to happen. The Fed is signaling that it thinks that the level of the interest rate that won't continue to stimulate the economy is around 2.4 or 2.5%. That level is much too low. And when financial investors say, "Wow, the Fed thinks that it can get to 2.5% and that's going to do the trick," or, "Wow, the Fed thinks that the unemployment rate is not going to go up and somehow inflation is just going to kind of miraculously drop without the labor market being hit," this is not credible
And I think if the Fed embraced the reality of the situation, because the reality is the reality, whether or not they embraced it or not, if the Fed embraced the reality of the situation, I think that would give investors some confidence that yes, we're in a tough spot right now, but the Fed understands the situation, they understand what they need to do, and they're willing to do it. And I think that would give some additional confidence to investors that I think would have an impact on stock prices in a positive way. So we'll see. We'll see if the Fed comes around to that.
Is it really all Vladimir Putin’s fault?
MS: It's certainly the case that the war in Ukraine was not the only factor and is the case that gas prices were going up before. I mean, I think you started to see a Ukraine effect on the global price of oil in December of '21. So when you go back to October, which is the statistic you cited, you're not seeing Ukraine in that. That's just these other factors. So more domestic production would certainly be good and is something that we should be doing.
Why are gas prices so damn high?
MS: I think we have gone too far in the direction of prioritizing alternative sources of energy, discouraging oil and gas and mining. It's not a good situation if people can't have the air conditioning on, or they can't turn on the lights, and that's not the kind of thing that should happen in the United States. And if our energy policy is resulting in those kinds of outcomes, then our energy policy needs to change. It's not to say that we shouldn't be encouraging basic research, and it's not to say that somebody might build a better battery and we no longer need to do coal mining, but if we're not there yet, we're not there yet.
Is Elizabeth Warren right? Is it all about corporate greed?
MS: I have trouble with the concept of greed in general in these sorts of situations. I mean, I think companies are trying to make profit and I don't think companies were... I mean, if you want to take this theory seriously, I think you have to ask, "Okay. So we didn't have a lot of inflation in 2019. We had a lot of inflation in 2021 and 2022. If we think that greed is the explanation, then something must have changed. Did companies become greedier?" So if greed drives inflation, then it must be the case that companies became greedier in 2021 than they were in 2019. That seems very hard to believe. Maybe you could argue that companies didn't become greedier, but there was something about the economy that interacted with corporate greed that led to high prices. It's very hard to come up with an explanation for what that would be.
Full transcript here.
SHOWNOTES
Fed won’t change tightening course in short-run, Michael Strain, Squawk Box CNBC, June 2nd, 2022
Four experts react to May CPI, CNBC, June 10th, 2022
The Average US Household is Now Paying $450 More per Month in ‘Unexpected Expenses’ Due to Inflation, Matt Weidinger, AEI, June, 13, 2022
In 2019 Harris said it was clear that almost half of American families were “a $00 unexpected expense away from complete upheaval” – Michael Strain, in 2019, persuasively broke down why that stat wasn’t true
“Americans’ ability to withstand a $400 unexpected expense improved overall in 2021, including due to “the additional COVID-19 relief measures enacted in 2021.” But with generous pandemic unemployment benefits and expanded monthly child tax credit payments expiring at the end of last year, and inflation soaring above wage gains, those figures are likely worse today.”
Will US Inflation Lead to Recession? Michael Strain, Project Syndicate, May 18, 2022
The Fed may have to do something it hasn’t done since 1994 to tame inflation, Paul Monica, CNN Business, June 13, 2022
How the Fed and the Biden Administration Got Inflation Wrong, Timiraos and Hilsenrath, Wall Street Journal, June 13, 2022
Inflation is Here to Stay, National Review, June 13, 2022