Blames tangled-up supply chains but not what’s causing supply chains to get tangled up in the first place: The most grotesquely overstimulated economy ever.
By Wolf Richter for WOLF STREET.
Fed Chair Jerome Powell, during a panel discussion hosted by the ECB today, admitted again that inflation pressures would run into 2022 and blamed “bottlenecks and supply chain problems not getting better” and admitted they are “in fact at the margins apparently getting a little bit worse.”
“The current inflation spike is really a consequence of supply constraints meeting very strong demand, and that is all associated with the reopening of the economy, which is a process that will have a beginning, a middle and an end,” he said.
OK, good, he almost gets it: “very strong demand” is causing this. But where the heck does this “very strong demand” come from?
Here’s where: The most grotesquely overstimulated economy ever. The Fed has handed out $4.5 trillion to investors in 18 months, and repressed short-term interest rates to near 0%, and long-term interest rates (via the $120 billion a month in bond purchases) to ridiculously low levels, and this has inflated asset prices, including home prices, and beneficiaries are feeling rich and flush, and they’re going out and borrowing against their assets and buying $70,000 pickup trucks, electronic devices, yachts, second and third homes, and a million other things. That’s where much of the demand comes from.
The other part of the demand comes from the government, which spread $5 trillion in borrowed money around over the past 18 months – stimulus checks, forgivable PPP loans (over $800 billion), extra unemployment benefits, funds sent to states to spend how they see fit, to airlines and other big companies to bail them out, which then used this money to buy out their employees that then spent this money.
“We see those things resolving,” Powell said. “It’s very difficult to say how big those effects will be in the meantime or how long they will last.”
When he was asked if the Fed wasn’t “overdoing” the stimulus, he just brushed it off: “The historical record is thick with examples of underdoing it,” he said. “I think we’ve avoided that this time.”
The Fed’s stimulus through asset price inflation isn’t going to “resolve” unless markets come down hard – bonds, stocks, homes, cryptos, and a million other speculative vehicles. Those markets have been inflated to a mind-boggling extent, and some of this inflated wealth is going to get spent unless it evaporates first.
So when does Powell expect this money from the markets to evaporate? There is so much excess cash chasing assets and so much asset price inflation out there now that it may take years to remove their stimulative effects – unless there’s a massive all-encompassing crash, in which case the Fed would start all over again.
So what exactly is going to stop these inflationary pressures? Divine intervention? Maybe.
And yet, despite the stars being lined up like this in favor of drawn-out heavy-breathing inflation, the Fed doesn’t see the current inflation spike to “lead to a new inflation regime, in which inflation remains high year after year,” he said.
And there’s another thing in this Spandex transitory inflation: Consumers and businesses have changed, all of a sudden. The money vaults were opened, and suddenly, price spikes are no longer demand killers – as they had been in prior decades.
People and businesses now pay whatever. Businesses do so because they know they can pass it on to the next entity in line, and finally to the consumers; and consumers do so because they’re flush with these grotesque amounts of sudden money from the heavens – Fed and government stimulus.
There are many examples of “price spikes don’t matter.” New and used vehicles are among them. Vehicles are the ultimate discretionary goods. Most people can just keep driving what they have. The average age of all vehicles on the road is 12 years. Most 12-year old vehicles are still perfectly good. Leases terminate after two or three years generally, and people can buy the vehicle at a preset price at the end of the lease. Very few people have to buy a new or used vehicle this month or next month or this year. They buy because they want to buy.
Consumers proved this during the Great Recession when they didn’t want to buy, and new and used vehicle sales collapsed, and stayed low for years, until consumers wanted to buy again.
Now, flush with money and newly inflated wealth, they want to buy. Sales were strong in March and April, but then inventories plunged, and got depleted like never before, and there wasn’t hardly anything to buy over the summer and in September, and sales plunged, but prices skyrocketed because enough consumers wanted to buy, and they paid no matter what to get that truck or SUV.
If consumers had refused to buy at those prices, dealers would have drowned in inventory in a few months. And price cuts would have set in.
That’s a mindset: to pay whatever. Suddenly price doesn’t matter. Consumers have accepted that prices will be far higher, ridiculously high: Used vehicle retail prices spiked by over 40% year-over-year this summer, and in August were up 32% from August last year, when prices had already begun to spike.
Auto dealers, including the largest one, Auto Nation, booked fantastical gross profits because consumers suddenly didn’t mind paying out of their nose for vehicles.
This grotesquely overstimulated demand, and the attitude it generated among businesses and consumers that price doesn’t matter, have created a situation where price spikes don’t cause a collapse in demand that would then pull down the price spikes.
While this has happened with some commodities, it hasn’t happened with consumer products. And this is a radically new dynamic that we haven’t seen in decades. And it isn’t going away, unless the whole shebang comes apart all of a sudden – which Powell and the rest of the Fed are certainly not predicting.
Meanwhile, they still have the foot fully on the accelerator, repressing interest rates and printing $120 billion a month.
So OK, that $120 billion a month will likely be tapered out of existence over the next nine months or so. And long-term interest rates have already ticked up in response to the expected end of QE. And yesterday, St. Louis Fed president James Bullard came out and put the beginning of the balance sheet unwind – asset levels actually dropping – on the table for mid 2022.
But short-term interest rates are not on the table yet. And even if long-term interest rates continue to rise, they will remain deeply negative in real terms – below the rate of CPI inflation – which is very stimulative.
So why would this Spandex transitory inflation suddenly end on its own, with all this stimulation still going on, with the whole mindset about pricing having changed, with all this inflated wealth still out there ready to get spent and create more of this “very strong demand?”
There is simply zero reason that this would change on its own. And from what we know, the Fed is certainly not counting on – and is not trying to engineer – a major asset price plunge to fix this inflation situation.
When the Fed acknowledges, way too late, that this Spandex transitory inflation is in fact ingrained, and won’t just go away on its own, the Fed would be prepared to act, Powell assured us. And eventually, it would, because inflation in the US, if it’s big enough and lasts long enough, becomes a political bitch.
And the Fed does have the tools to deal with it: Jacking up interest rates, for example, with 50-basis-point rate hikes 10 meetings in a row, and by reducing the assets on its balance sheet by something like $200 billion a month for two years straight. That should do it, I’d say. The tools are there. The will is not.
But until the Fed gets serious about it, inflation isn’t going away on its own, and any efforts by the Fed to persuade people that inflation will just go away, despite the ongoing stimulus, sound outright silly.
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