FWIW # 15 Inflation May 2021

I thought about writing over and over: I told you so. That would be appropriate, but useless. For some time, the Federal Reserve leadership (Fed) has deliberately chosen to use a measure of inflation that under reports what is going on and wring their hands in worry that inflation would never reach the annual 2% level, deemed by some mystical guru on a mountain as the amount of grease to keep the wheels of commerce growing. Both professed beliefs were and still are falsehoods. Shame on them.

Any high school senior taking an economics class only had to look back at history to know (1) inflation is a monetary phenomenon, caused by the political class taxing the poor and middle class without having to admit to the tax, (2) throughout history, the political class has always misused public money, leading to the need to cheat the population by confiscating the public’s wealth through overt (declared taxes) or covert (inflation) taxation, and (3) as long as the political class pretends to care about the middle and lower classes, giving back a small fraction of what they are taking away, the population will focus their attention elsewhere until the pain becomes unbearable. No one can foresee the point where pain leads to action by the population.

The genuine tragedy of the current situation is the deliberate falsehoods told by the monetary and political authorities. Keep in mind, this is not a Democratic or Republican issue. It has been going on since the John F. Kennedy administration. This problem is a problem encompassing how and who we elect as President and members of the legislative branch. The beauty contests we call elections are a product of the evolution of news and information media. Coupled with the questionable politicians elected is an embedded cadre of professional political employees whose vested interest is to grow their sphere of influence. More than the elected officials, whose egos need stroking regularly, the lobbyists nurture and train the professional governmental staffs, particularly those working in the legislative branch. The rotating elected officials and the ones who stay for a lifetime and assume leadership positions, as well as the professional staffs, do not, I repeat, do not have any concern for the long-term inflationary aspects of what they do. Their purpose in life is to accumulate power. Power has two aspects to it: the money being spent, and the jobs created, particularly government jobs. The political class determines who will be the monetary authorities. In the history of the Fed, there has only been one time when the political class appointed a Fed chair whose mandate was to reestablish integrity in the U.S. Dollar. When President Carter selected Paul Volcker to head the Fed, with the mandate to end the inflationary spiral of the 1970s caused by the collusion between the Fed and the Lyndon Johnson administration in the 1960s, he put in place the steps for arresting the downward economic free-for-all. Even Volcker could not restore the currency to the level it had before Johnson; he could only stop the downward trajectory and slowly restore stability to the currency. It took twenty years before the political class could begin ruining the currency’s value again, still continuing to hide their efforts from the population through changing the inflation measurement metrics.

Last week, the Fed and their political masters could not hide the damage any longer. The Consumer Price Index (CPI), not the favored measurement of the Fed but the more realistic one, jumped to an annualized 4.2%. The Producer Price Index (PPI), usually a sign of what will happen to the CPI in the future, jumped to an annualized 6.2%. These same Fed and political authorities could no longer claim inflation would not result from their activities.

They immediately switched and said not to worry, the numbers were transitory. Another falsehood shrouded in political speech. Here’s what they mean by transitory: An item 12 months ago cost $1. It now costs $1.042 for consumers and $1.062 at the producer level. The Fed preaches that the annualized rate will return to 2% for the next six months. If that’s the case, the actual inflation in the next six months will be 1%. Now the original $1 after the next six months will cost $1.052 ($1.042 x 1.01%) and at the producer level $1.0726 ($1.062 x 1.01%). The political and monetary authorities will continue their falsehoods and the currency will continue losing value to goods and services.

More egregious than the falsehoods coming from the Fed is the outlandish comments from Secretary Yellen. She says that the administration and the Fed can control inflationary pressures. Keep in mind, she was the Fed chair in the past and is now the Treasury Secretary. She is a lifelong economist and should have significant historical knowledge of inflation. For her to say Washington monetary authorities and political class can control inflation defies historical experiences going back to the dawn of time. Inflation is like COVID-19. It spreads rapidly, economically kills many, and once in the economy only drastic measures can stop its spread. There is no vaccine for inflation once it starts. She hinted at what needs to be done two weeks ago. In prepared remarks she alluded to interest rates needing to rise. By that same afternoon, she issued a press release walking back from her comments.

Semantics is crucial to understand. ‘Control’ has a meaning that authorities can turn something on or off, as they see fit, like turning a faucet. Stopping inflation can happen, but as witnessed and experienced in the twentieth century, it takes a generation at least to unwind inflation from an economy. The other experience for ‘controlling’ inflation is the severe recession necessary to break the psychological belief that inflation will persist. How to do that? Reverse the leverage being used in the economy. How? Paul Volcker broke the psychology of inflation between 1979 and 1981 by allowing the marketplace to set interest rates. The safest fixed income security, the 30-year U.S. Treasury bond, yielded just under 15% in 1981. The recession that ended in 1982 was severe. Assets of all types came crashing down as interest rate costs increased. So, perhaps Secretary Yellen’s definition of control means killing inflation with severe changes in monetary policy in a short period time. We don’t know because no one has cared to ask her to explain her comments.

If the Fed was not controlling interest rates, where would the 10 year U.S. Treasury yield be? In all likelihood, the rate would hover between 3.75% and 4.125%, more than double the current 1.65% manipulated rate.

The United States is just now experiencing the point of no return in the inflationary spiral. There is an old saying in the commodity business: The cure for high prices is to produce more. The cure for low prices is to produce less. Any item where there is supply and demand forces at work falls into this category. Lumber prices are up several hundred percent this year. Unless there are artificial political constraints, watch the cutting of lumber increase over the next several months. The extra supply will probably stop any further increases and suppress the current price, but the additional supply will not reduce prices meaningfully if demand stays where it is. Demand will stay high because the population now believes house prices will be higher in the future and interest rates will go up, therefore, the time to buy, build, or renovate is now. That is inflationary psychology raising its ugly head, and the Fed and political class can’t stop it by turning a faucet.

The genuine inflationary point of no return is in wages. Since the 1980s, globalization allowed greedy senior management across the U.S. to boost profits by moving jobs overseas or denying their workers a living wage. The political class deliberately hid the erosion of purchasing power from the wages working families earned. This deception and collusion between these elite classes isn’t new. It went on from 1964 to 2016. It’s back, again. Jobs that were not moved overseas had wages suppressed because of illegal immigration and fewer jobs. Families came to need both spouses working to make ends meet. (I covered this subject in past FWIWs). What is important today, and the future, is the move to catch up the purchasing power of workers’ pay. The federal government is mandating $15 an hour minimum wage for their contractors. Many private employers are paying more than $15 to find workers. To supercharge the issue, the political class is using the COVID-19 pandemic to pay people not to work. Even though the disincentive to work will end soon, once they introduce higher wages into the economic system, it acts like a pebble being thrown into a pond. The ripples eventually cover the entire economy. It’s not possible to treat wages the same as goods and services. Eliminating certain jobs will not change salaries of the remaining workers, which stay at the higher plateau since inflation expectations are still in the economy. Businesses will raise prices to cover the increased costs, families will feel the pinch of the higher costs of living and demand more wages, and the wage-price spiral continues and is dynamic.

Anyone who owns assets, real estate, stocks, and other goods that are bought with currency will have some protection from the inflationary tax. Think of it the correct way: the asset is not going up in value, the currency used to buy the asset is going down in value. Some protection is better than no protection. The danger we all face is what the political class is doing to the poor and middle classes. You have read before in these FWIWs that 45% of Americans do not own any stocks. They may not own any real estate. Their government has deliberately confiscated the rightful earnings on their savings for over 13 years, robbing them of the only way they have for building wealth for the future. At the same time, the inflation tax fostered on them by Republican and Democratic administrations eroded the purchasing power of their savings. When will the poor and middle class say enough is enough? The day will come, we just don’t when, because no one knows how much pain the population will accept.

The United States is an outlier for the psychology and strength of the population. Looking back in our country’s history, the pendulum of conservatism and liberalism swings from one extreme to another, always reversing course just before it appears one side or the other will dominate forever. The tribalism being pushed by politicians today is likely to fail. The efforts to poison the educational system for K to 12 children are already being opposed and eradicated from some school systems. Most immigrants to this country in the last twenty years are hard-working individuals who have made giant inroads into the labor market, pushing out those who don’t want to work. People who endured unimaginable hardships to get to America, no matter where they originated, have always worked hard to share in the bounty of this country. In almost all cases, these new Americans fled the broken promises of socialism or fascism. They know the heartache of totalitarianism cloaked in the promises of the left and the right. It has always been this way since the 1700s.

There are steps to be taken to protect yourself when the inevitable economic reversal happens. Anyone who is comfortable having debt in their financial profile should lock in that debt at a fixed rate for as long a period as possible. Avoid short-term debt. Boost reserve cash to a point where higher interest rates will not force selling assets in economic times that may depress prices. Asset values will go down when the political class tries to slow the rise of inflation. The decline will be temporary. Have liquidity for taking advantage of the opportunities offered. The people hurt the most are those who have thrown caution to the wind and took part in the alternative asset hysterias of the moment. These speculators will have permanent losses of capital.

Investors may have a temporary decline in portfolio value, however, if the portfolio generates the proper amount of income, investors will improve the long-term value of their assets and their future income will rise.

The country will have changed when the next economic correction comes. That’s not bad nor good, just a fact. History tells us change is reality. Those who understand that fact and adjust, looking for the true opportunities rather than yearning for the quick gain, will thrive and grow. Plan to be one of the successful.

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