Way Off Target

The Fed has a ways to go to get ahead of inflation... and stocks have a ways to fall before then.

(Source: Getty Images)

Bill Bonner, reckoning today from Poitou, France...

“Restoring price stability will likely mean maintaining a restrictive policy stance for some time. The historical record cautions strongly against loosening monetary policy prematurely.”

~ Jerome Powell

Last week’s big news came on Friday. In short, the Fed did not ‘pivot.’ Not yet. And bringing our conclusion right up front: the pain has only just begun. It’s later – when inflation-adjusted interest rates are higher than the CPI (consumer price index) – that we’ll find out what a twirl the Fed can do.  

In the meantime, from Yahoo Finance comes the report:  

Fed Chair Powell: Rates will rise until 'job is done' bringing down inflation     

Federal Reserve Chairman Jerome Powell on Friday said the central bank’s job on lowering inflation is not done, suggesting that the Fed will continue to aggressively raise interest rates to cool the economy.

“We will keep at it until we are confident the job is done,” Powell said in remarks delivered at the Fed’s annual conference in Jackson Hole, Wyoming.

While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down,” Powell said Friday.

Stock market investors took the news badly. By the close of business on Friday, the Dow was down 1,000 points. They had expected the Fed to ease up. Inflation has peaked out, they believe. The Fed ought to be able to get back to doing what it does best – inflating the economy.

Way Off Target

But the Fed still is inflating. Its balance sheet is going down, but it is still lending at negative (below the level of consumer price increases) rates. The Fed Funds rate is still 600 basis points BELOW the CPI and 400 basis points BELOW the Fed’s preferred inflation measure, the PCE (Personal Consumption Expenditures). By either measure the inflation rate is still way ABOVE the Fed’s 2% target.

At least the Fed is going in the right direction… raising rates, however timidly.  

Stocks are down – but not catastrophically. The last time the Fed had to do battle with inflation the Dow fell to where it was briefly at the same level as gold. Today, that would mean a Dow of 1,800, not 32,000. And, back then, mortgage rates were over 15%. Imagine a $300,000 mortgage at 15%. Payments would be about $4,000 a month. How many homeowners could afford that?

For the moment, all is calm. The Powell Team gives the impression of a stern resolve. It will do ‘whatever it takes’ to bring inflation under control. 

Everyone knows it won’t be fun. And yet, this is no time for the Fed to give up on its ‘tightening’ cycle. The Fed also needs to regain some of its lost credibility. It was very wrong about inflation;  Fed governors looked like fools. Now, they’re going to stay tough on inflation until lending rates are higher than inflation, not lower.  

Here’s why. “Money” is brought into being as it is borrowed. When banks lend, they don’t go into their vaults and take out money. They just create it – as an accounting entry. So, the more people borrow, the more ‘money’ there is in circulation. This new money ‘inflates’ the money supply… which leads to higher prices.  

Then, as prices go up, people have an incentive to borrow even more money.  Because, the money they pay back will be worth less than the money they borrowed. More borrowing = more inflation = higher prices = more borrowing.  

Either Or

It’s “Inflate or Die.” Either inflation continues. Or, it is brought under control – with higher interest rates – and the bubble dies.

People may put off dying for as long as they can. But you can’t put it off forever. And here’s Senator Warren. Like a bitter widow wagging her finger at the corpse of a chain smoker, she’s getting in position to say “I told you so.” CNN:

Democratic Sen. Elizabeth Warren of Massachusetts on Sunday slammed Federal Reserve Chairman Jerome Powell for suggesting interest rates should go up to combat inflation in the US, saying he could "tip this economy into recession."

News for Ms. Warren: the economy is already in recession. That’s what’s s’posed to happen.  

Mr. Powell is right. Getting control of inflation will be painful. Higher interest rates will mean less borrowing, less hiring, less shopping, lower profits, lower asset prices and lower tax receipts for the US government. It’s a recession, in other words. And it’s how the economy corrects the mistakes and excesses of the Bubble Epoch. That’s the whole idea.

But the pain has hardly begun. The Fed has to get ahead of inflation, not trail far behind it. It has to continue raising rates, until something gives – either inflation… or its own backbone.

Regards,

Bill Bonner