Federal Reserve Board Chairman Jay Powell is staking his reputation on the current spike in inflation being transitory.
Powell and his colleagues on the Federal Open Market Committee believe the economy is still reeling from the Covid pandemic and requires continued, unprecedented monetary and fiscal support. Powell is undeterred by first quarter annualized GDP growth of 6.4%, pointing instead to the economy being seven million jobs short of where it was pre-pandemic.
Accordingly, the Fed is keeping the monetary spigots wide open, holding short-term interest rates at zero and ballooning the money supply, buying $120 billion of securities every month. Powell remains committed to holding the short-term fed funds rate at the current emergency level until 2023.
But could Powell be wrong?
Yes, of course, proclaim a growing chorus of economists led by Larry Summers, treasury secretary under Bill Clinton, and a man once considered for the job Powell occupies.
Summers fears the economy is overheating and coming to the boil. Already, consumer prices are up 4.2% year-over-year, the fastest pace in 12 years and two percentage points above the Fed’s target. With the Biden administration spending $4 trillion in stimulus, says Summers, ‘it is pursuing the least responsible fiscal policy in four decades’.
‘Help Wanted’ signs abound
On main street America ‘Help Wanted’ signs abound, whether in Des Moines, Rockville, or Racine.
There’s little doubt the economy is distorted and over-stimulated. Warren Buffett, the 90-year-old sage of Omaha, says ‘85% of the economy is operating at super high gear’.
We’ve resorted to helicopter money – three rounds of government cash floating down from the sky into bank accounts. Combined with expanded unemployment assistance, many workers are being paid at a rate of .$35 000 annually not to work. Covid benefits often exceed pre-pandemic pay. Jamie Dimon, head of JP Morgan Chase, the country’s biggest bank, says over-generous government support is a disincentive to work.
Simultaneously we have labour shortages and 6% unemployment.
The Biden administration says distortions in the labour market are also transitory. Commentator Martin Sandbu agrees. He writes in the Financial Times that because fiscal support will be withdrawn as the pandemic abates, the US is about to experience ‘the mother of all fiscal tightenings’.
What about the undeniable signs of inflation? Commodity prices have soared and not yet fed through into the economy. Lumber is up 400%, ocean shipping rates the same, grocery prices are up, gasoline is at a seven-year high. We may be approaching a new bubble in housing as home prices this year are up 14%. The housing boom results from record low mortgage interest rates.
Most important price
Jim Grant, who writes Grant’s Interest Rate Monitor, has long argued that the interest rate is the most important price in capitalism and that today it’s at its lowest level in a thousand years. Savers, of course, are punished because, adjusted for inflation, interest rates are negative.
Grant worries that the Federal Reserve has distorted economic activity and laid a foundation for high inflation. Bear in mind that we’ve had no significant inflation for two decades, meaning most Americans are unaware of how debilitating it can be.
As we reach the midpoint of 2021 the stock market remains near a record high. The bull market in equities has gone on for 12 years, the longest in US history, and there’s been only one brief ten percent correction in February 2020. Is a bear market coming?
Alarmed at the hugely stimulative monetary policy, bond guru Bill Gross, co-founder of Pimco, wonders if Powell ‘has changed his conservative clothes and unleashed the potential for chaotic future economic and market outcomes’.
Jim Grant tells the tale of Bill Martin, who served as Federal Reserve chairman for a record 19 years. In the mid-60s Martin was summoned to Lyndon Johnson’s Texas ranch to be ignominiously reprimanded for having raised the discount rate by a half percent. It was the middle of the Vietnam War and Johnson was pursuing ‘guns and butter’, spending heavily on war as well as social programmes. To no avail, Martin told the president he couldn’t do both without triggering severe consequences.
Haunted
Sure enough, in 1966 inflation doubled to 3.8%, a precursor to the high-inflation 1970s, when it averaged 6.3%. At a retirement party in 1970 Martin lamented: ‘I’ve failed.’ The remark reveals the extent to which Martin was haunted by the Fed’s failure to act decisively early on to contain inflation.
Will the same be said of Powell? We’re likely to have an answer in 2022.
The views of the writer are not necessarily the views of the Daily Friend or the IRR
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