Powell Pummels Prices

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FOMC 2022 0504

Markets appear to be taken by surprise this morning as Federal Reserve Chairman Jerome Powell reiterated that the FOMC will do what it takes to quell inflation, even if it means economic pain. I have been saying this for months … that I believe Powell when he says such things. The recent rally in stocks has been fueled by denial … they’ve been reacting to the Fed like a Rorschach test … seeing what they want to see and hearing what they want to hear. Seizing on the most gossamer thread of evidence the battle is nearly won and that the Fed will soon back off from the fight.

It’s not completely without foundation. After all, Powell and Co. did wave the white flag at the beginning of 2019 and cave after having briefly shown some determination to normalize rates. So indeed the FOMC is paying a price for past waffling. But in 2022 consumer price inflation is far higher, and having watched and listened to Powell talk about the inflation problem, I became convinced he really means what he says. For example he has stated flatly that a stable currency is a necessary condition for all else, including sustainably healthy employment. He has also finally recognized – in vague terms (tighter financial conditions) at least – that asset prices lead consumer prices and that they must come down first. 

He gets it.

Yes of course the Fed will eventually relent. But if Wall Street thinks it will happen while consumer price inflation is still near double digit territory without some kind of major financial “accident”, it’s living in La La Land.

We’re seeing early tentative evidence of a forced reality recognition … a decoupling of stocks and bonds of long duration … what Synthetic Systems has been expecting in late 2022. I’m not looking for immediate gratification … SS sees it as mostly a fourth quarter development and expecting bull’s eye timing wouldn’t be realistic anyway … but we do appear to see the fundamentals gradually falling into place.

9 thoughts on “Powell Pummels Prices

  1. shiny! says:

    Hi, Bill. Thank you for this. It’s certainly a red day for everything that isn’t a dollar! I’m trying to put today’s statement in historical perspective to see how this might play out.

    Under Volcker, US debt-to-GDP was 30%, deficit-to-GDP was under 2%, and the US had a strong manufacturing and export base. Today however, US debt-to-GDP is 125%, deficit-to-GDP is 6%, and dependent on rising stock prices for revenue. Rising rates hurt that revenue.

    A statistic I heard is that over the past 120 years, 98% of countries with debt over 130% of GDP defaulted. 100% of countries with deficits of 11% to GDP defaulted on their sovereign obligations within two years, typically using high inflation to inflate away the debt.

    The US government’s largest current obligations are SS and Medicare, military and interest on the debt. It can’t pay rising interest without defaulting on its other obligations. Unless they print. With Powell’s rising rates there’s no way to avoid default but to print, causing more inflation and rising rates to “fight inflation.” Snake eating its own tail.

    My questions are:

    Do you agree with this assessment? If so, do you think Powell is willing to cause another Great Depression or does he simply not understand the consequences of these ratios?

    What would a “major accident” entail (so I know what to watch for)?

    Where do you put the odds of the gov’t revaluing gold to erase a significant portion of the debt to enable them to raise rates safely?

  2. Bill Terrell says:

    Whew … lots to chew on there, Shiny! Let’s start with the notion that the Fed “can’t” raise interest rates because there’s too much debt.

    There are two ways of looking at this. One is that it’s false. The Fed can do whatever it pleases with rates. The real question is whether it will like the consequences. The answer is no, it won’t, but it no longer has the luxury of choosing consequences it will like. It comes down to trying to aim for the consequences that are the least bad.

    The other way is to assume that it’s true. In which case it is also true that the Fed must raise rates. In short, it is both true that the Fed can’t raise rates and that it must raise rates. This however still leads to the same conclusion: which path leads to the least bad outcome?

    Let’s peel back a couple more layers of the onion skin. Okay, so the problem is it can’t raise rates because there is too much debt. But that’s a superficial view, because it fails to consider why there is too much debt in the first place. It’s colossal chicken-or-the-egg dilemma, because the reason there is too much debt is because interest rates have been too low. Thus the real choice is between accommodating the too-much-debt circumstance by keeping rates low and failing to address the underlying problem – and worsening the too-much-debt circumstance that is supposedly handcuffing the Fed in the first place, or to stop kicking the can and finally address the underlying problem.

    So the “can’t raise rates” problem is incurable. The only logical conclusion is complete systemic failure. The dollar goes the way of the dodo, and the means for inflation-financing federal debt along with it … in other words the debt expansion ends one way or the other.

    This leaves the “must raise rates” side to be considered. It must raise rates to discourage the accumulation of still more debt. The consequences aren’t fun, especially for the financial and political establishment. Wall Street will have to learn to live with lower stock prices. The government will have to tighten its belt. But complete systemic collapse is avoided.

    Were I in Powell’s shoes, I would opt for Door #2.

    And it appears Powell is at least going to give it the old college try. See? The real contest boils down to Wall Street and Washington versus the rest of America. Oh … we need to give a dishonorable mention to Silicon Valley as well. The likes of Gates, Bezos, Zuckerberg et al will have to tighten their belts too.

    The pressure on the Fed to buckle in the face of this inflation is intense, and it may fold. But it appears it’s going to at least try to do the right thing first.

  3. Bill Terrell says:

    Next let’s deal with some of the subordinate points. It is a fallacy – promoted by the financial and political elite – that the government can’t cut its expenses. Even if entitlements aren’t cut, it’s certainly possible to stop creating new ones. Medicare Part D isn’t that old. And for land’s sake, did we really need to just socialize billions in student loan debt? And it’s a canard that Social Security can’t be reigned in. The age of eligibility for full benefits was already increased in the 1980s … continuing that process – for those not already near or in retirement – would be utterly painless in comparison to the consequences of failing to do so. Raise the cap on the SS taxable income. And raise taxes on ultra-wealthy corporations. If a progressive rate structure is acceptable for individuals, why not corporations?

    As explained before, if Powell et al continue to raise rates, it’s not because they don’t understand the consequences of doing so, it’s because they understand the consequences of failing to do so.

    It’s not practical to predict the first domino to fall in a financial “accident”. To paraphrase Warren Buffett, you only see who’s been swimming naked when the tide goes out.

    I don’t see the benefit to playing games with gold. It wouldn’t address the problem of out-of-control debt accumulation. Unless you stop incentivizing it, the core problem persists. And how would you “revalue” gold anyway, short of a federal takeover of yet another market? Yet I do think there are ways of minimizing the pain. Sell 50 and 100 year bonds. This has been repeatedly passed over due to lack of support from Wall Street. To hell with Wall Street; what’s more important? I’ve also repeatedly said normalizing interest rates is more important than cutting the Fed’s balance sheet. Let the balance sheet sit for a while. We may not cure the problem overnight, but we can at least stop making it worse.

  4. jk says:

    eorge noble hosting a discussion -heavy hitters discuss markets, economy, fed, energy, dollar, prime broker data, etc, etc
    this is long but the room is full of really smart, really experienced people. jim bianco, jim chanos, nancy davis, noble, michael belkin, michael gayed, tommy thornton, doomberg, john roque, anas alhajji [oil expert], hedge fund people, big money investment consultants and many others.

    starts with technical analysis, then positioning of hedge funds at prime brokers, market so far went down just on re-rating on interest rates vs coming earnings disappointments, how the bond market got it right while the stock market’s been getting it wrong, all macro indicators [e.g. pmi’s] all point down, european manufacturing headed for a world of hurt, etc

    https://twitter.com/i/spaces/1LyxBoXaoAzKN?s=20

  5. jk says:

    luke gromen frequently refers to the large amount of tax income the gov’t gets from rising asset prices, stock compensation being sold, capital gains, and so on. with declining financial markets, not to mention the rise in unemployment that powell is ready to tolerate, and federal automatic stabilizers, this means the deficit rises even more than it would otherwise. meanwhile with qt the fed is not rolling over some of its maturing bonds, meaning bond supply is that much higher as well.

    if the fed really stays with qt and we have financial markets down, and let’s add that pmi’s, for example, are among the leading indicators that the economy is or will be contracting at a significantly higher rate than the de minimus drops of q1 and q2, an enormous load of treasury paper will require still higher rates to clear, unless the fed buys a lot. but the fed, of course, says it will not buy more, net, just roll over its paper less $60b in treasuries every month. [let’s leave mortgages aside for now]. so private buyers and foreign entities will have to absorb all that paper.

    sounds like the dollar will be going up in this scenario because rates will get so high. it also sounds like a vicious circle of rising dollar, lower markets, a collapse of the housing market, rising unemployment, leading to still lower tax revenues, still higher spending on automatic stabilizers, deeper deficits and still more paper to sell.

    1. Bill Terrell says:

      Gromen’s analysis overlooks the big picture. There are two ways to fund government expenditures: taxes and inflation. One conduit for the latter is rising asset prices, which is really just currency depreciation. That’s not sustainable because it eventually spills over into rising consumer prices. And because it’s indirect it deprives the public of the opportunity to see the cost of the programs they’re voting for and make a rational cost benefit analysis.

      The only honest and democratic way to pay for government spending is through direct taxes. As long experience has shown, inflation is a highly regressive tax … one reason it’s so popular with the elite. There is no free lunch … everything is paid for one way or another.

      It’s already acknowledged that the Fed will yield at some point … the only question is when. And there’s no urgency to slash the Fed’s Treasury holdings. But in order to provide any relief it will have to go far enough to spur behavior modification … there is no gain without some pain.

  6. Bill Terrell says:

    The estimable Wolf Richter of Wolf Street just posted an excellent article on this subject. Wolf is a philosophical brother to Finster but much more adept at decorating his articles with data and quotes as well as eloquent literacy:

    https://wolfstreet.com/2022/08/26/markets-tank-while-im-waiting-for-the-powell-was-dovish-tightening-deniers-to-fan-out-and-clean-up-this-mess/

    One such quote is a standout:

    “Powell said that the Fed’s current crackdown on inflation will create “softer labor market conditions,” and “will also bring some pain to households and businesses.”

    “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” he said.”

    It’s a weird feeling for a long time Fed critic to say this, but Powell is right. It’s regrettable that the Fed took so long after the GFC and Corona Crash to remove emergency measures and normalize rates, but late is better than never.

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