"Can the Fed Get Back Home?"
by Bill Bonner
“Go too far. Stay too long. Can’t get back.”
– Words of an old preacher.
YOUGHAL, IRELAND – "The bond market is on the move. It packed up in August of last year, which now appears to have marked the top of the bull market in bonds that began 41 years ago. And last week, Treasury yields (which rise and fall inversely with bond prices) topped 1.75% after Federal Reserve chief Jerome Powell let it be known that he was okay with rising inflation threats. One-point-seventy-five percent doesn’t sound like much. It’s not… still barely zero in real terms. (Consumer prices are rising at a 0.4% rate.) But it’s more than three times what it was last August.
Cash is on the move, too. Last Thursday, $271 billion of it bolted from the feds’ vaults, mostly to fund the stimmy checks. That was more than the entire GDP of Finland. Has the Fed already gone too far and stayed too long? Now, with rising rates in the bond market, and an almost infinite demand for new cash, can it ever get back?
Trillion-Dollar Wonders: Just to remind readers, “inflation” refers to the act of increasing the money supply. And just to be even clearer, while there are many factors that come into play, as the quantity of dollars increases, eventually… sooner or later… before Hell freezes over… ceteris paribus – so should prices.
The money supply – using the Fed’s balance sheet as a convenient, though incomplete, measure – rose from under $700 billion in 1999 to $7 trillion today. That is, in two decades, the Fed inflated the money supply by 10 times as much as all the Treasury secretaries and Fed governors had done in the previous 21 decades. Meanwhile, the goods and services available to buy with this money, measured loosely by GDP, only doubled, from $10 trillion to over $20 trillion.
The idea behind the post-1971 “monetarist” scheme was that the Fed would control money growth, allowing it to rise by about the same measure as the general economy. This was supposed to maintain price stability as well as eliminate sudden credit shortages. But as you can see, so far in the 21st century, the money supply grew nine times faster than GDP. And now it will have to grow even more – to replace the cash that just got away. And more after that… to pay for the $1.9 trillion American Rescue Plan… and more still… to pay for new infrastructure… and all the other wonders that the feds have in store for us.
So, we shouldn’t be too surprised that prices rose, too. Money bids for goods and services. If the quantity of money goes up faster than the supply of available goods and services… logically, prices will rise.
Waste of Money: To this bare skeleton, we add some fat. Included in GDP is government spending. But the services offered by the government are not the kind that you are usually looking for. Few people wake up in the morning and say, “Today, I’m going shopping for an F-35 Joint Strike Fighter.” Instead, they want the things the government doesn’t make.
Government spending is almost completely focused on the consumption of wealth, not the creation of it. In other words, it doesn’t add to the supply side of the supply/demand teeter totter. It subtracts from it. So, when government spending increases as a percentage of GDP, that too should be cause for higher consumer prices.
After WWII, total government spending – state, local, and federal – shrank to a bit more than 25% of GDP. Last year, it was over 40%.
Flood of Liquidity: Economists describe inflation as more and more dollars “chasing” consumer goods. But dollars are not always ready to run. Sometimes, people choose to save, rather than spend. And if the feds create a dollar and it goes nowhere, it has little effect on prices. Where it decides to go matters, too. Most of the additional money generated in the 21st century was dropped off in the capital markets.
The Dow rose from around 11,000 in 2000 to over 30,000 today. Bitcoin was worth nothing (it wasn’t invented until 2008) and now sells for more than $57,000. Non-Fungible Tokens (NFTs) didn’t appear until 2014. Since then, more than half a billion dollars’ worth of NFTs have been traded.
Don’t Fight the Fed: A flood of liquidity lifted most boats… but not all of them. Some 40% of U.S. stocks are still underwater from the washout of ’08-’09. As the feds pumped more and more liquidity (dollars) into the markets, the old timers – with their Graham and Dodd on their desks… and an autographed photo of Warren Buffett on their walls – were unsuited to it. They knew how gold provided protection from inflation, but they weren’t sure about bitcoin. Was it a protection against inflation… or just a measure of it? And NFTs? What the heck were they? Where were they going?
Nobody knew for sure… but they were on the move. But then, just about everything is on the move now – the bond market… the way we work… gender… politics… culture…but to where?
Wall Street legend Marty Zweig’s famous line – “don’t fight the Fed” – turned out to be the best advice of the last 20 years. The Fed was inflating. And like plastic bottles on a sour tide, up popped the lightest – and often the trashiest – assets.
What will happen in the next decade is our subject for tomorrow. Will the old-timers get another chance? Will the Fed keep inflating, even as bonds go down? Or will it be able to get back to a more “normal” monetary policy? We will see. Stay tuned…"
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