The $64 Trillion Question

Does the Fed still pack enough of a punch to K.O. inflation?

Bill Bonner, reckoning today from Youghal, Ireland...

The heart is devious above all else;
It is perverse…
Who can understand it?
I the Lord test the mind 
And search the heart
To give to all according to their ways,
According to the fruit of their doings.

~ Jeremiah, 17:9

“Science advances one funeral at a time,” said Max Planck, who meant that a heart had to come to a dead stop before new data could be properly appreciated and new paradigms accepted. It is the mind that moves science ahead. But it is the heart that rules scientists and everybody else.

‘Over my dead body,’ says the scientist, his heels dug deep into ‘the science’ he helped to discover. ‘Okay,’ sayeth the Lord, ‘that’ll work.’

At least in science and technology death leads to an accumulation of knowledge. In the rest of life, knowledge comes and goes, as if we’re all reincarnated, doomed to repeat the failed experiments of the past. All lovers rehearse scenes of Antony and Cleopatra. All politicians relive the challenges of Abraham Lincoln and Pontius Pilate. And all central bankers eventually channel William McChesney Martin or Gideon Gono.  

Lessons are learned… forgotten... and then re-learned again.

A Brand New Spanking

And so today’s inflation readings must be coming as a shock to the 1,000 or so Ph.D. economists at the Fed. ‘How about that,’ they must be saying to each other.  ‘Printing money really does cause inflation.’  

They’ve added $8 trillion in brand, spanking new money over the last 20 years. And their absurdly low interest rates created an unprecedented debt bubble, with $64 trillion added since 1999.  

So, what do you know? Inflation!

And now, practically every news item covering the inflation numbers leads with the same idea – that the Fed made an old error and now is under pressure to make a new one. The Hill:

“Why the Fed overstimulated the economy.”

CNBC asked Mohammed El-Erian what he thought:

“…they didn't take the foot off the accelerator early enough.”

And here’s the Financial Times: 

The US consumer price index rose 7.5 per cent last month compared with January last year, its fastest annual pace since 1982, heaping pressure on the Federal Reserve to act more aggressively to tame inflation.

And yes… the Fed is bound to act. Its credibility is at stake.

And yes… it will act boldly.  Here’s MarketWatch:

A firestorm of hawkish Fed speculation erupts following strong US inflation reading.

Fed watchers are talking seriously about an “emergency” interest rate hike before the Fed’s next formal meeting on March 16.

Markets Insider:

After the inflation reading, St. Louis Fed President James Bullard, a voting member of the Fed's rate-setting committee, said he's become "dramatically" more hawkish. He now wants a rate increase of 100 basis points — a full percentage point — by July.

Wow… a whole percentage point! Let’s see, that will leave the Fed Funds at MINUS 6.4%. Wow.

Paragons of Prudence

Our bet is that Fed economists are about to relearn another lesson – last rehearsed 50 years ago. In the early ‘70s, inflation rates were rising. Then falling. And then rising again.

In 1970, prices were already going up at a 6% rate. Then, inflation dropped to just 3% in 1973. Back up to over 11% in 1976, the rate then again fell – but only to about 5% – before heading up again. Prices were rising at a 13% clip by 1980.

Arthur Burns is frequently criticized for letting the ‘70s inflation get out of hand.  But compared to his present-day successors, he was a paragon of central bank prudence. His timing might have been off, but the idea was right. When inflation was 6%, his Fed Funds rate rose to 10%... then, the Fed’s key rate went over 12%.  Overall, the bank lent to its members at a rate that was generally positive – by about 3%.  

Paul Volcker took over in 1978. He dilly-dallied for a couple years, and then got serious. Trading punches with inflation didn’t work. He needed to deliver a knockout blow. He put the key rate at nearly 20% – 7 full percentage points over rising prices… and the monster was soon flat on its back.  

A 1,000-Point Uppercut?

Today, the Fed is already on the ropes. First, it told the world that it wouldn’t have to raise rates until 2024. Here it is, the beginning of 2022 and it is already conceding that it will have to do something now.  

Then, when inflation began to make the headlines, the Fed reassured the nation that it was only ‘transitory.’ There would be no reason to react to the higher prices, it said, because they were simply a little blowback from the COVID shutdowns and stimmie checks. Wrong again.  

And now the Fed is concerned about protecting its ‘credibility,’ perhaps with a full 100 basis point (1 percentage point) increase. And yet, the lesson of the Volcker era was that a 100-basis point jab would do nothing; from today’s ultra-low rate, below 1%, it will take an increase of at least 1,000-basis points. Does the Fed still pack that kind of punch?

The most amazing thing to us is that it still has any credibility to protect. It plainly doesn’t know what it is doing.  

But is the Fed really as incompetent as it appears? Tune in tomorrow; we’ll take a look. 

Regards,

Bill Bonner

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