Let’s open with a quick review of the current inflationary cycle, beginning with the deflationary crash of 2008. That crash emerged from a prior inflationary cycle that culminated in an inflation panic with crude oil prices reaching $147 a barrel in the middle of that year, quickly followed by rapid deflation that left it trading in the $20-$30 range only six months later. This background – that deflation was born from inflation – is essential to counter the widespread misconception that deflation results from inflation simply sliding too low … the “slippery slope” theory of deflation.

In this deflation, the American dollar gained purchasing power, first reflected as falling prices in real time capital markets, and soon thereafter in consumer prices.

The issuer of the US dollar, for our purposes identical with the Federal Reserve Note, responded by embarking on an aggressive campaign to reduce its purchasing power, slashing its main policy to zero and issuing trillions over the next several years. It succeeded in countering the increase in the value of the dollar (deflation) with a renewed decrease (inflation). But it did not stop with this success; it continued to aggressively debase the dollar for years after the crisis had passed. It did so on the aforementioned “slippery slope” rationalization, the unsupported hypothesis that inflation was needed to prevent deflation.

Based on an invalid premise, it should have come as no surprise when this inflation led to another deflationary crash. Over the following decade, individuals, institutions and politicians all learned that the Federal Reserve was determined to drive the FRN lower, and took advantage by building up massive short positions, that is, borrowing trillions of dollars against most every available asset, including bonds, stocks, real estate, and future tax receipts. This amounted to a pile of tinder in search of a spark. So the 2020 Covid shutdowns triggered an epic short covering rally, with the dollar soaring in value in early 2020, reflected in plunging asset prices. The deflation was so severe it led to oil prices briefly going negative.

Amidst the wreckage it fomented, the Fed reopened its 2008 playbook, promising to nail its policy rate to zero for the foreseeable future while printing trillions.

It worked. The deflationary crash was arrested. But once again the Fed kept going. The dollar continued to sink against most every other asset, as seen in soaring prices of everything from bonds to stocks to gold to lumber. Even when price effects of dollar depreciation began to noticeably spill over into consumer prices, it hesitated, failing to acknowledge it was already looking at lagging data. As a result, when it finally began to respond, it took aggressive tightening to stem the decline.

It succeeded in producing a mild deflation as dollar appreciation registered first in the real time capital markets. The dollar rose against other currencies, bonds, stocks, and commodities as indicated by falling dollar denominated prices. This persisted for most of 2022 even as consumer prices continued to accelerate through mid year.  But by later that year, as the lagged effects of this deflation began to flow through to consumer prices, the rate of ascent began to moderate. This moderation continued into 2023.

Aided and abetted by ill-considered Fedspeak, however, markets seized on a pivot narrative and the dollar began to fall again, evident in foreign exchange and rising asset prices, even without any actual Fed policy easing. This inflationary surge dominated most of 2023, and as of the beginning of 2024, is now in the pipeline en route to consumer prices.

My congenitally cranky disposition has led me to put the bad news first. From this you may infer that there is good news to follow. Alas, there is.

Since the beginning of 2024, the dollar has found firmer footing. It can be seen in forex markets, but the dollar’s purchasing power in terms of bonds and stocks is at least as telling.

Let’s take a longer view. The high point of the global equity market in terms of dollars was reached on November 8, 2021. VT traded at $109.00 on that date. As of this writing it is at $100.35. There are at least two ways to interpret these data. One is that stocks have lost purchasing power relative to dollars. The other is that dollars have gained purchasing power relative to stocks.

It should be obvious though that these aren’t actually distinct interpretations. They are equivalent.

They both leave open the question of whether the bulk of the change in purchasing power was in the stocks or the dollars.

The question is readily settled by making similar comparisons with other asset classes. Bonds, commodities, realty, other currencies. If they don’t send a consistent message about the dollar, Occam’s Razor dictates we conclude stocks did most of the changing. If you can make the same statement about dollars regardless of what other asset class you compare them with, though, the same principle dictates that you must conclude it was the mostly the dollar whose value changed.

We discussed this more fully in A Day Of Inflation, but in short, people use a whole variety of assets in which to store purchasing power. Securities such as currencies, bonds and stocks are all ultimately claims on goods and services. Their combined total purchasing power fluctuates little compared to their relative shares of that total, especially over short time frames, because total purchasing power is defined by the total body of goods and services available for purchase, a much more stable variable than relative asset values. The result is that a gain in purchasing power of one asset must be offset by a loss in another. If most assets gain relative to the dollar, the dollar must have lost. This loss occurs first in the capital markets, later in the consumer and labor markets.

The weakness in asset prices, in terms of dollars, since the beginning of the year, then, is good news on inflation. It has the potential to offset the inflation already in the pipeline from 2023. So long as (dollar denominated) asset prices don’t turn higher again, last year’s progress on quelling consumer price inflation may be sustained.

A curious corollary: The Fed could well begin to cut rates in 2024, possibly even in the first half. But if markets run up in anticipation, it makes it unlikely. Paradoxically, the Fed will cut, but markets have to cool first.

In the event that asset prices do run higher and the Fed eases nevertheless, the good news is nullified, and we should be prepared for inflation as far as the eye can see.