It’s Been Inflation All Along

It’s been inflation all along.  First in asset prices, now in consumer prices.  It’s not possible to indefinitely have the first without the second … after all assets can only be ultimately worth what you can buy with them.

So there are only two possibilities.  Inflated asset prices must come down or consumer prices rise to meet them.  Or some messy combination of both.  

The S&P 500 stock index has risen seven fold since bottoming in March 2009.  The economy has not grown seven times as productive.  There is only one possible explanation tor the difference … inflation.  Yet after months of breakneck consumer price inflation, consumer prices have risen a mere fraction of that.

Economists and investors who fancy that the Fed can prevail over inflation without a serious bear market are due for a reality check.  Consumer prices have a long way up to go if you’re not willing to tolerate a major bear market.  Either way, those assets are going to lose purchasing power.

But when?  This is the year of the reckoning.  Consumer price inflation has finally gotten the attention of politicians and economic policymakers.  The printing presses are slowing and interest rates are rising.  I think it’s no mere coincidence that Synthetic Systems pegs a major trend change in the second half.  If anything, the charts most likely understate its magnitude.  

Alas, it wasn’t necessary.  Had policymakers not engaged in the fantasy that rising asset prices somehow exist outside of the sphere of inflation, they would have begun to allow interest rates to rise as early as 2013, when the financial crisis was fully in the rear view mirror.  Instead they continued to inflate, convincing themselves that tame consumer prices gave them the all clear and that the ballooning stock market bubble was merely indicative of prosperity.  

It wasn’t.  It’s been inflation all along.

16 thoughts on “It’s Been Inflation All Along

  1. jk says:

    as i know you know, for the fed, asset inflation was not a bug, it was a feature. it was supposed to create a “wealth effect” which would stimulate spending and growth. without the ability on their own to spend what they printed, and without more fiscal deficits to monetize, they had no other way to try to stimulate. that this exacerbated inequality wasn’t on their radar, it wasn’t their problem. also their lax bank regulation created the conditions which allowed for a housing bubble, and thus provided the basis of the gfc.

    if the fed had regulated the banking industry more tightly we might have avoided the gfc. if the executive authorities had sent angelo mozillo and his ilk to jail we would now likely have a far more congenial political environment.

    both of those actions required activist governmental authorities. instead the reagan revolution reached its apotheosis in the laxity of regulatory and executive authorities.

    1. Bill Terrell says:

      Sure. I think we agree this has its roots in the early Greenspan days when he stepped in to assure “liquidity” in the wake of the 1987 stock market crash. Over the course of a few too many Greenspan years, this grew into increasingly activist support for asset prices. Bernanke basically codified it with his explicit adoption of a “wealth effect” as a putative transmission mechanism for monetary ease to the real economy.

      That’s about as far as the “Reagan” connection can be stretched, though (Reagan appointed Greenspan Fed Chair.). The regulatory watershed came during the Clinton years with the repeal of Glass-Steagall. Not that it was Clinton’s fault, but it wasn’t Reagan’s either.

      No, the buck has to stop with Greenspan. In my opinion, he probably did the right thing in 1987. But it snowballed from there. Wall Street began to look to him for salvation, and he became its “Maestro”. He played the role of God on CNBC. It went to his head; the adulation fed his ego. Greenspan was a brilliant economist, but also a poster child for “power corrupts”.

      Greenspan underwrote the stock market bubble in the second half of the 1990s. When it, as bubbles are wont to do, collapsed, and he searched for absolution, he cast about for a way to inject massive amounts of money into the system. As you know, money is created by being lent into existence. The US housing market presented itself as a massive body of ready collateral. With the help of the giant housing GSE’s, Greenspan inflated a mortgage bubble.

      When that bubble imploded, Bernanke parried back to stocks. And to and fro we go. While blaming these problems on free market or “wild west” capitalism is popular with fans of big government, it’s a clear case of the pot calling the kettle black. The financial elite support government activism because they control the levers of power. They’ve used it to their immense self-enrichment. The Fed, Fannie, Freddie … are some of their favorite playthings.

      But we digress. Our focus here is the intellectual rationalization … all the way through it has been that “inflation” is a consumer price phenomenon. Assets live in a different universe. They can go to the moon and beyond and there is no inflation problem until it affects consumer prices. This bears emphasis because this is the very excuse Greenspan used to justify inflating an asset bubble. It was the denial crutch for his inflationary program.

      This sells well enough with the public … inflation is fun so long as it’s confined to asset prices. But it’s not possible for it to stay that way. Sooner or later the owners of assets will try to put their purchasing power to use. At that point the books have to balance. There can be no more purchasing power stored in asset values than there are goods and services available to purchase.

      The point is that it’s pointless. Over the full cycle assets don’t wind up returning any more than they would if the Fed recognized their price increases as inflation and stopped trying to juice them higher. It just winds up being a more volatile road to nowhere. It’s not all bad intent … some of it is just plain economic ignorance.

  2. jk says:

    you’re right to point back to the repeal of glass-steagall, and that’s on clinton and his svengali, robert rubin, along with sandy weill. we can trace the deregulatory impulse even further back, to carter. but his deregulation of the airline industry genuinely benefitted the american citizenry. repealing glass-steagall, however, was an act of great hubris which planted a time-bomb at the center of the banking system.

    and you’re right, it was greenspan who created the fed’s “3rd mandate,” propping up the financial markets. we’re still playing out that decision.

    here’s a question that raises: how far do you think the fed will be able to go in attempting to control what they call “inflation”? that is, how far until the financial markets- equities, the yield curve, the repo market – create enough turmoil that the fed cries “uncle,” and starts to loosen again? what’s the strike price on the fed put?

    1. Bill Terrell says:

      Yes, not only did we have the Glass Steagal repeal, but even post 2008 its regulatory doppelgänger, the Volcker Rule, was watered down to impotence. Remember that? It was supposed to bar banks from speculating with federally insured funds. That got twisted into technical pretzels.

      The fundamental issue there wasn’t so much what the investment banks were allowed to do per se, but that it was being subsidized by the federal government. What happened with Fannie and Freddie was analogous … remember all that talk about the implied Treasury backing of their paper? There was never any actual committment to back Fannie and Freddie debt with the full faith and credit of the United States.

      But guess what? When it cracked, the government rushed in to retroactively provide one. It made GSE debt whole. Not 80 cents on the dollar, not 90, but 100. This was nothing but a massive after-the-fact gift from taxpayers to GSE investors. They had benefitted from higher yields than Treasury paper on the lack of a Treasury guarantee, but then were handed the guarantee anyway.

      A similar issue plagued the uneven deregulation that ultimately led to the savings and loan crisis. Savings and loan investment activities were deregulated, but the federal backstop was left in place. The problem wasn’t deregulation per se, but a deregulation that subsidized risk.

      The original regulations were a quid pro quo. The government was saying we’ll insure your deposits, but if you accept this backstop, you must also accept certain restrictions on what you can do with the funds. True and balanced deregulation would have withdrawn the backstop along with the restrictions.

      The pattern repeats. It’s the same logic underlying the Volcker Rule. If you’re going to get the government out of the business of restricting activities, you also need to get the it out of the business of subsidizing the losses. The government’s involvement has been far too much of a one way street benefiting the financial elite.

      It’s the same old story over and again. The government puts some safety mechanism in place to ‘protect the public and ensure stability’. But the elite control the regulators and the whole mess winds up working to its benefit at the expense of the public.

      Re how far the Fed can go, check out my post Inflation Is Slowing where I touch on that. May be good fodder for further discussion there.

      Bottom line though is there’s no way to get consumer prices under control without hitting asset prices. The former have to rise to meet the latter or the latter fall to meet the former, or some messy combination of both. I don’t know exactly how much tolerance the Fed will have for asset price declines, but now that the public is getting upset about consumer prices, it will be substantially more than in the past. And there’s no assurance whatsoever that even when the Fed does step in, declines will stop. They continued downward in 2008 long after the Fed began to ease.

      Unfortunately the markets have risen so high there’s almost zero chance of getting out without crisis. This is why it’s so important for policymakers to abandon the pretense that asset prices are unconnected to inflation. The Fed simply does not have the luxury of waiting until consumer prices are raising alarms to reduce monetary stimulus. At this point I fear we’re looking at something on the scale of 2008.

  3. jk says:

    there’s a managerial class [including politicians and regulators] running the gov’t.
    there’s a managerial class running the means of production [both operating and financial].

    in communism the former control the latter.
    in capitalism the latter control the former.

    1. Bill Terrell says:

      I would call the latter “dirty capitalism” at best. There’s nothing free market about the government handing out favors to the well connected.

      With capitalism itself, the ownership of the means of production is very broad based. When we’re young we labor. We set aside some of the fruits of our labor to acquire capital. Then when we’re old and not as able to labor we can still survive on our accumulated capital. In short, virtually everyone is both labor and capital, with the mix shifting from the former towards the latter as we age.

      In today’s corrupt capitalism, the government subsidizes the concentration of capital. The prime route of administration has been via the Fed. By hammering interest rates down to nothing, there is no competition to induce corporations to pay a yield on their stocks. There is no excuse for multi-trillion-dollar corporations to not pay dividends. This is only possible in a world where the dividends on cash are nothing. The Fed has given corporations a captive investor base by removing traditional savings alternatives.

      So what we have is giant corporations bottling up capital inside the corporate walls. They promote buybacks as a way to “return cash to shareholders”. Excuse me? That doesn’t return a cent. The shareholder must sell to see any return at all. Instead the corporate elite realize the returns via their stock option comp plans. The rich get richer courtesy of the world’s most powerful central planner.

  4. jk says:

    note that now it is managers, even more than owners, of capital accruing great wealth. e.g. jamie dimon: made his billions not as an entrepreneur, not as an investor, but as a manager.

    call it “dirty capitalism” if you want, but it’s the only kind of capitalism we have. personally i do not believe in pure free market economics- the winners will always take control of the gov’t and create and/or control regulators to create and maintain their moats, and thus accrue their monopoly rents.

    1. Bill Terrell says:

      Indeed the managers have found the cookie jar and they’re in elbow deep. There are two developments responsible: 1) The aforementioned ultralow rate policy, and 2) The relaxation of restrictions around corporate stock buybacks. Fix these and the gravy train stops.

      Note that at least the first is a problem of excess government power, not capitalism or freedom. Strip the Fed of its ability to target interest rates. It can do all it needs to run monetary policy by buying and selling Treasuries and gold.

      Even the second is a problem of government. Corporations were not created by nature; they are creations of the state. Government gives them certain privileges and is entitled to set limits on their behavior. It’s not at all inconsistent with free markets or capitalism for it to prohibit corporate managers from helping themselves to shareholder capital.

      In general it just doesn’t make sense to blame free markets for problems caused by government. Look at the big picture. At every turn, the regulatory state winds up working for the benefit of the regulated. The FDA, ostensibly instituted for the protection of the public, is effectively an agency for limiting competition in the medical field, protecting and enriching its real constituency. Copyrights have grown from being granted for the constitutionally provided “limited times” to indefinitely renewable. We could go on. The bottom line is government has become a wealth concentration enabler that free markets could never have dreamed of.

  5. jk says:

    it used to be illegal for a company to buy its own stock. that was changed when corps went to stock-based compensation. companies went to stock based compensation when a law was passed saying they couldn’t deduct the cost of an individual’s compensation for amounts over $1million. that law was passed because the public was affronted by seeing the amounts of money these guys [almost 100% guys] were being paid. there is, indeed, a lot of gov’t policy every step of the way.

    of course, we mustn’t forget that corporations are people, with all their rights and privileges. it’s the law. [someone once said they wouldn’t believe corporations were people until one was given a death sentence in texas. arthur anderson kind of met that criterion, but it was a partnership.]

    btw, has there ever in history, anywhere in the world, been a free market economy? or is “a free market economy” merely a theoretical construct used to simplify analysis.

    1. Bill Terrell says:

      Yeah I think that was done circa 1982. At the time stocks had been burdened by a sixteen year bear market and arguably were too cheap. Cheap stocks to investors means expensive capital to corporations, and it was weighing on the economy, So whatever the practical details, liberalizing the buyback rules may have had some theoretical justification at the time.

      But that pendulum has long since swung to the opposite extreme. Stocks are very expensive to the investor and capital very cheap to the corporations. Partly why we see so much precious capital squandered on frivolous projects while society has so much more pressing unmet needs. There’s every reason to tighten up the rules. There’s nothing to prevent corps from returning capital to investors the old fashioned way. Dividend payments require the actual distribution of cash and reach all shareholders equally, not disproportionately to the benefit of insiders with fancy stock option plans.

      Arguments that dividend payments restrict the company’s ability to grow are misdirected. Investors are left free to choose whether to reinvest them in the same stock or to another more deserving company. And the notion that a trillion dollar mega cap needs to retain all its earnings and grow is just silly.

      But wouldn’t restricting this practice be impeding the free market? No! Corporations are not free market entities. They’re chartered by the state. The state gets to to set the conditions. As it stands the playing field is strongly tilted in favor of that class of labor known as corporate management. The actual capitalists – folks like thee and me – have little input. Ever get a proxy asking for your vote on executive compensation? The ones I’ve seen are “advisory” only. We don’t even have a say in how much we are paying our executive employees.

      Along with more normal interest rates, I would like to see a progressive rate schedule for corporate taxes. Let the biggest richest corporations pay higher rates. Then let the dividends they pay be tax deductible to the corporation, while taxed as ordinary income to their recipients. These changes alone would catalyze a dramatic lessening in wealth and income inequality.

      A truly free market economy is an idealization. Like an “ideal gas”. (Remember that?) It’s doesn’t exist in real life but is nevertheless a highly useful abstraction. Antebellum US was otherwise pretty close, but was marred by the starkly non-free-market institution of slavery. But Lincoln was also an exponent of Henry Clay’s “American System”, a euphemism for the federal government taking an activist role in picking winners among industries. That sowed some bad seed that we’re still harvesting today. Aside from that though, things remained pretty free until 1913 … and as you know yours truly views that number as an especially unlucky one for the US … it led to the 1920s bubble and ensuing depression. The postwar period though was still pretty free and prosperous, though also not without its problems, and the eighties and nineties are generally remembered as an era of peace and prosperity. All of these examples, however, were in my view much more free market than we have now or have had since the turn of the millennium. The growth in the power and aggressiveness of the Fed alone is responsible for a good chunk of that.

  6. jk says:

    if companies are short of capital there’s only 1 way they can buy their own stock: they must lever up and use debt to make the purchases.

    i’m all for collecting more taxes from the corporate sector if we can figure out a way to stop them from using the double-dutch-irish sandwich and other shell games which somehow maneuver all their profits to other jurisdictions. recent international talks about a world-wide minimum tax standard might help, but perhaps some kind of vat might be the solution.

    along with banning buy backs again, i agree wholeheartedly that we should make dividends deductible at the corporate level, encouraging the distribution of excess capital as ordinary income back to investors, who themselves could be taxed progressively.

  7. cb says:

    Excellent article and commentary, but I must protest a couple of lines.

    1. Greenspan, the “maestro”, was not a great economist. He was a pompous ass who proved himself a failure, and charted a path ruinous to working Americans.
    2. Inflation, even if confined to asset prices, is not fun and does not not sell well with the public at large. It does sell well with the large owners of assets, but much of the public owns an insufficient amount of assets to benefit, and find detriment in the inflation of house prices.
    3. I have no clue what you mean by your statement “There can be no more purchasing power stored in asset values than there are goods and services available to purchase.”

    1. Bill Terrell says:

      Not sure what the exact Greenspan quote was you refer to, but if I said he was a “great economist” it certainly was with a heaping helping of caveat. I maintain my position … as a whole, not as an out of context phrase. I have very low opinion of Greenspan’s performance at the Federal Reserve, so if anything such a phrase could only have been in the context of a diss.

      I think there are enough owners of assets – stocks, bonds, real estate – either directly or via via pension plans, IRAs 401(k)’s and other retirement vehicles, that it’s fair to say that inflation is “fun” for the public while it’s confined to asset prices.

      The standard model of retirement is that when we’re young we labor. We set aside some of the fruits of our labor to accumulate capital. Then when we’re older and not so efficient at labor, we don’t have to starve. So the majority of us do own assets and enjoy seeing them rise in apparent value.

      Do a small minority disproportionately own the assets? Of course. But relatively few of the majority seem to mind as long as they think they can tag along for the ride. Middle class living standards may actually be subtly slipping the whole time, but most of that loss comes in big lumps as inflation spills over from the things they own and into the things they want to buy.

      No need to take my word for it. The celebratory tones with which the media greet increases in stock prices is proof enough. Especially in contrast to the dour way in which they report increases in consumer prices.

      I’m puzzled by your comment “I have no clue what you mean by your statement “There can be no more purchasing power stored in asset values than there are goods and services available to purchase.””.

      It’s practically a tautology. Assets – stocks, bonds, realty, etcetera – are the means whereby those aforementioned young laborers accumulate and store value for later use in retirement. At which point they are exchanged for consumer goods and services. I would just say it’s self evident that the aggregate purchasing power stored cannot exceed the aggregate of goods and services available for purchase, except that the economists running the Fed don’t seem to get it at all.