First, a good article from Think
Advisor (10/24/22) concerning the annual meeting of the Securities Industry and
Financial Markets Association (SIFMA), an organization I subscribe to and is
very much an industry standard. The meeting is attended by many big wigs from
finance and government. Janet Yellen, secretary of the Treasury, spoke at the
meeting (more on that later). One of the panel discussions included several
business economists discussing inflation and recession among other things.
Several are now predicting that there will be a recession in 2023. The
participants listed several factors supporting their conclusion. The factors
are the same as have been discussed before, inflation being the 800 lbs.
gorilla in the room. The article gives some good comments and supports for
their conclusions. Much of the current discussion involves estimating and
second guessing the Fed and its inflation response. Since the 1970s and Alan
Greenspan’s solution to inflation the Fed has been terrified of any type of uncontrolled
inflation. The solution in the 1970s just about destroyed the US economy before
it corrected itself. Corrected itself is also correct, Alan Greenspan and the
Fed did not fix the 1970s economy but they made it possible for it (the
economy) to rebalance itself – governments and individuals don’t control
economies in spite of what they say, economies control governments and people. The
Greenspan solution was one that worked or at least that was what governmental
and financial think tank gurus came up with that worked, and it did work.
Governmental officials and politicians ever since then will do just about
anything to avoid that situation again. The problem is that much of the fiscal
and governmental policies of the past 20 years have been such that it supports
inflationary growth. Then the loose money supply accompanied with artificially
low interest rates (yes, dear reader, rates have been artificially low for 20
years, held down by direct intervention from the Fed which allowed government
to pursue its various expansionary agendas) got away from the governmental
people as it had to do. The low interest rates and expanding money supply
couldn’t go on forever but for 20 years governmental types have been kicking
that can down the road until now. That is why the current administration is
howling that the current inflation isn’t their fault but they are willing to
add to the problem by increasing governmental spending by unprecedented amounts
which is very inflationary. Hence, trying to kick the can down the road again
but the financial system has reached its limit. Goods and services are not able
to absorb the excess funds without adjusting and that means prices have to go
up, in this case way up, way fast (the basic definition of inflation) as we
have seen in the last 8 months. That is why the big concern. This looks a lot like
the inflation rates of the 1970s. The cure is of course, recession, the rapid
deceleration of spending and the removal of the excess money from the system. It
would really help shorten the recession and cause it to be less severe if government
curtailed spending, reduced governmental needs and did not fund new programs
without also including revenue sources (net funding). All of which the current administration
refuses to consider but instead is increasing spending and unfunded programs.
We have to wait for price increases to begin to slow or stop (in spite of the
governmental spending headwinds) as supply and demand are brought into closer alignment,
i.e. demand does not outstrip supply and so prices are normalized and we don’t
have too many dollars chasing too few goods. We have to weather inflation as
price and supply try to find some sort of new equilibrium. I am afraid
inflation hits very unevenly in these situations. It is inherently unfair,
unjust and unkind.
Again,
the mechanism to get inflation under control or rather, under more control is
to dry out the excess money from the economy and that is done by making money
more difficult or expensive to acquire and use. It has to cost more. The
interest rates we pay is the control mechanism. Hence, the Fed Funds Rate helps
increase or decrease what it costs to borrow and use money. In the second
article by Reuters (10-24-22), Yellen is trying to make the point that the
Treasury is aware of the problems of drying out the economy and at least in the
area she has some control over is attempting to assure the financial system
that the government is willing and able to keep one of the major secondary problems
caused by inflation at bay. The problem is that as the cheap money (low
borrowing costs, relatively speaking, caused by very low interest rates) dries
up, investors become unwilling to speculate and began to draw their funds out
of banks and financial institutions and put it in safer places such as Treasury
instruments or cash (again safer is relative). Banks and financial institutions
use leverage to earn additional profits by using borrowed money to invest. You
take your money, they have to go find money somewhere on a short basis to cover
your withdrawals. In the great recession of 2008 there wasn’t enough liquid
funds available to meet the withdrawal needs and the government bailed out many
financial institutions by printing more money among other things and almost
wasn’t fast enough in responding (TARP if anyone remembers). Several big
financial firms didn’t survive or were absorbed. Yellen is trying to tell the
markets she is aware of the situation and it is under control which may or may
not be accurate but we can hope.
The
Bloomberg article of 10-21-22 is a discussion of what Fed Funds Rates may be
and why or why not. There is some speculation that Fed Funds rates may need to
be as high as 4.75% - 5.0%. The Fed is trying to give the impression of
controlling inflation and the financial institutions are trying to act like the
Fed has some control. Both are incorrect. The Fed can’t “control” inflation and
financial institutions are not really supporting the Fed but trying to find any
place to hide away from the train wreck that is coming. As an aside, the financial
economists are having a heyday because they can predict just about anything and
there is a pretty good chance they will be correct at some point, for a change.
Watch to see who claims they got the forecast right and what part of the
forecast in the next 18 months or so. I need to flog a dead horse again. The
Fed can not control inflation with any kind of fine tuning. Watch and see, at
the very most they can nudge the inflation rate around. The Fed will get this
whole process wrong (as measured by various financial institutions, markets and
money gurus). But they may be able to influence inflation to some extent. According
to the people in the know (don’t trust the people in the know), the Fed started
raising the Fed Funds Rate to late or too early, they will not raise it fast
enough or they will raise it too fast, and they will overshoot how high and for
how long rates need to stay up and they will either not decrease rates fast
enough or too fast on the back side of things. They will not be able to stop
the inflation rate from gyrating all over the place, both up and down and they
will likely completely miss their target inflation rate of 2.0% by a wide
margin. The final solution to the last point will be that the Fed will change
the target inflation rate to something other than 2.0%. In two years the Fed
will declare that they beat inflation and it is now tame again at whatever rate
they decide on. Again, not accurate (notice I didn’t say not true) as the Fed
never has really been able to control inflation but rather sets a rate (for the
last several years, 2.0%) that somewhat matches the ongoing economic activities.
There will be more articles about the Fed and its “fine tuning” the Fed Funds
Rate in the coming months. Don’t be fooled by the noise.
The
final article is a bit of fluff about the resignation of Prime Minster Liz
Truss (Britain) after just 44 days in office. She has the distinction of being
the shortest serving prime minster in history. Many of her problems were caused
by very aggressive economic policies that were considered too radical for the
times. Just a reminder why governments tend to be slow and ponderous in their
decisions and a good example of why we have had 20+ years of expansion in this
country. It is too politically difficult to change things and who wants to rock
the boat, even if it needs it until there is some kind of popular uprising that
is consistent with the political leaders thinking. A good example is the case of
Ronald Regan and the then new thinking of supply side economics which was a
good thing.
Articles referenced;
https://www.thinkadvisor.com/2022/10/24/bofa-economist-i-dont-see-how-we-avoid-a-recession/
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