The Fed slams on the brakes.
For a decade America experienced low consumer goods inflation, but high and rising asset inflation. The Federal Reserve had a policy of very low interest rates. It had the desired effect of keeping economies humming and the "animal spirits" of entrepreneurs energized.
When businesses and investors are being exuberant, they tend to be indiscriminate about it. With interest rates at zero every investment looked good--or at least better than nothing, the yield on cash. Stock prices were high, house prices were high, startup businesses had high valuations. Speculators had even bid up the prices of assets that are essentially imaginary: Crypto-currencies and Non-Fungible Tokens.
Policymakers didn't worry much about asset inflation. People like getting richer. It was miserable for young people trying to buy a first home, but bonds are an asset, too, and like other assets, their prices were high. (High bond prices is another way of saying low interest rates.) Young people could buy expensive houses with a manageable mortgage cost, when amortized over 30 years at 3% to 4%.
The Fed, encouraged by the whole political and social environment, created too much money and left interest rates too low for too long. How could that happen? I blame everybody for being in on it. Biden. The Fed. Politics. Democrats. Republicans.
After the Financial Crisis of 2008-2009 policymakers realized they had been too cautious. Demand had been destroyed. Banks were shamed by the careless loans they had made, so--now chastened--they were reluctant to loan money to anyone. The GOP blocked spending on infrastructure that might give then-president Obama a "win." It meant there was a recovery, but a painfully slow one.
Trump was elected. Republicans, then controlling all three chambers of government, said, "Now, let's spend." A theory emerged to justify it: MMT, Modern Monetary Theory. It asserted that deficits don't matter. The supposed party of fiscal restraint, Republicans, saw an opportunity to make Trump more popular. It worked. Democrats didn't push back on spending. Democrats are always ready to spend. After all, there are problems to solve.
Then Biden got elected. Republicans rediscovered fiscal discipline, but Democrats were in a narrow majority and had learned the lesson from the Obama and Trump experiences. Stimulate! The problem is that in the supercharged and stimulated COVID world there is no lack of demand. COVID created a lack of supply. In America and around the world, producers and shippers of physical things remain disrupted. War in Ukraine exacerbates matters. Americans have more money and fewer things to buy. The result is inflation.
Inflation of consumer goods is not an American problem. It is a world problem. United States' inflation is squarely in the middle of peer countries.
There is a world price for most tradable products. Biden is paying a political price. He campaigned saying he would stop new oil leases on federal lands, and that creates a compelling target for blame. American oil companies have massive opportunities for new drilling. They aren't doing it because $120 oil, and minimal new drilling costs, is wildly profitable for them. They are doing what companies do in a capitalist economy: Maximize rewards for shareholders.
The supply-demand imbalance means inflation. Americans don't like it when it happens here to consumer goods. The Fed is trying to fix it by raising interest rates. This changes investment opportunities and investment and consumer psychology. Investors who want a safe place to park capital can once again get a return from cash, and not feel forced to place it in risk assets. It means that the future potential income from businesses will be discounted back to the present by a factor bigger than zero. That lowers their present values, which shows up as lower stock prices. Businesspeople are looking ahead and thinking things will be slower, harder, and more expensive. That psychology means people defer investments and projects. Enthusiasm turns into caution.
The cause and effect are complicated and uncertain, but the world tends to work in this order:
The Fed raises interest rates.
The stock market cools.
Consumers and businesses get more cautious.
The economy gets sluggish or falls into recession.
Inflation moderates.
This is a grim outlook for Democrats. There are political consequences. In 2022 Democrats will be blamed for inflation. In 2024, Democrats will be blamed for the recession.
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5 comments:
The question still remains, when economic times get tough, who is most able to, or most responsible for, bearing the burden? Current tax policy ensures that the burden will not be borne by those best able to bear it. The burden will be carried by working people paying $6 a gallon for gas, by young families facing higher mortgage rates, by unsophisticated and impressionable investors who sunk their life savings into cryptocurrencies, by the same people who always get to clean up after the party.
So middle income voters will punish the Democrats for all this, When it is the Republicans who make sure the deck is stacked against them.
Thanks Peter - very helpful explanation of the economics and politics. What do you think about notion proposed by some economists, that while inflation is a global phenomenon, the Fed's Covid stimulus has left the US in much better economic shape than the rest of the world? If that's true, what do you think the Biden administration could do to shift the myopia of Americans who only compare their well-being to some (perhaps) unrealistic benchmark and not globally?
It's not correct to say that Republicans were profligate during the Trump administration. During the COVID recession, we had a realistic concern about deflation. Petroleum prices, for a short time, were negative, if that's the word for it. So the government and the Federal Reserve were right to inject a lot of cash into the economy. Sure, some (or many) businesses didn't need PPP "loans," and not everyone needed rent relief, but on balance measures such as these enabled us to avoid a far worse economic setback than we experienced. But when the Biden administration took over, was additional COVID relief necessary to the tune of $1 trillion? Probably not. Where did we cross the line of spending so that the present inflation became inevitable? And why are we still imposing tariffs on Chinese imports, assuming, as many Democrats would say, that Trump's tariffs were always a bad idea?
I'm inclined to be more simplistic.
COVID in Russia put pressure on Putin who then attacks Ukraine to deflect criticism. Putin can now blame suffering in Russia on externals, and the the people go along with it; another Big Lie foisted on an oppressed population. By all accounts the war is popular in Russia, but the fact is that it doesn't matter if they do or not. Few will openly dispute the State, and those that protested have been imprisoned.
The World economy, already traumatized by the pandemic, stretched financially, freezes.
Even before COVID I was of the opinion that low interest rates masked the effects of income inequality and it appears I was correct. The market sell-off is a return to the mean. Interest rates rises will be absorbed by lower home prices, among other adjustments.
The solution is the repeal of the Republican tax cuts.
During George W. Bush's 2nd term, the economy melted-down due to bad real estate mortgages. We hit a recession from about 2007 through about 2013. Real estate lost lots of its fair market value. George Bush lost the support of huge numbers of conservatives due to his bungling and corruption. Today, the Bushes are unwelcome in the Republican Party. They are outliers.
In light of that, and in light of Joe Biden's horrendous presidential performance thus far, I'm wondering how long it's going to take for Democrats (and Peter Sage) to accept reality, and publicly turn-on Joe Biden.
Curt Ankerberg
Medford, OR
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