Peter Schiff
Operating under the mistaken belief that a modest dose of inflation
is either a prerequisite for, or a by-product of, economic growth, the
nation’s top economists have been assuring us for quite some time that
inflation will stay very low until the currently mediocre economy
finally catches fire. As a result, they believe that the low inflation
of the past few months has frustrated Federal Reserve policy makers, who
have been supposedly chomping at the bit to keep hiking rates in order
to restore confidence in the present and to build the ability to cut
rates in the future if the nation were to ever, god forbid, enter
another recession.
In the weeks leading up to the Fed’s December 16 decision to raise
rates by 25 basis points (their first increase in nearly a decade) the
consensus expectations on Wall Street was that the Fed would deliver
three or four additional interest rate hikes in 2016. But with the
global markets now in turmoil, GDP slowing, and the stock market off to
one of its worst starts in memory, a consensus began to emerge that the
Fed is reluctantly out of the rate hiking business for the rest of the
year.
With such thoughts firmly entrenched, many were largely caught off guard by the arrival last Friday (February 19th)
of new inflation data from the Labor Department that showed that the
core consumer price index (CPI) rose in January at a 2.2 % annualized
rate, the highest in more than 4 years, well past the 2.0% benchmark
that the Fed has supposedly been so desperately trying to reach. It was
received as welcome news.
A Reuter’s story that provided immediate reaction to the inflation
data summed up the good feeling with a quote by Chris Rupkey, chief
economist at MUFG Union Bank in New York, "It is a policymaker's dream
come true. They wanted more inflation and they got it." The widely
respected Jim Paulsen of Wells Capital Management said that the stronger
inflation, combined with upticks in consumer spending and jobs data
would force the Fed to get on with more rate hikes.
But higher inflation is not “a dream come true". In reality it is
the Fed’s worst possible nightmare. It will expose the error of their
eight-year stimulus experiment and the Fed’s impotence in restoring
health to an economy that it has turned into a walking zombie addicted
to cheap money.
While most economists still want to believe that the recent slowdown in economic growth (.7% annualized in the 4th quarter
of 2015, which could be revised lower on Friday) was either caused by
the weather, confined to manufacturing, oil related, or just some kind
of statistical fluke that will likely reverse in the current quarter,
and that the stock market declines of 2016 have resulted from distress
imported from abroad, a much more likely trigger for all these
developments can be found in the Fed’s own policy.
The Chinese economic deceleration and market turmoil made little
impact on U.S markets prior to the Fed’s rate hike. And although U.S.
markets rallied slightly in the days around the historic December rate
hike, they began falling hard just a few days later. Stocks remained on
the downward path until a recent rally inspired by dovish comments from
various Fed officials which led many to conclude that future rate hikes
may be fewer and farther between then was originally believed.
In truth, the markets and the economy have been walloped not just
by December’s quarter point increase, but from the hangover from the
withdrawal of QE3, and the anticipation of higher rates in 2016, all of
which contributed to a general tightening of monetary policy.
The correlation between monetary tightening and economic
deceleration is not accidental. As it had been in Japan before us, the
unprecedented stimulus that has been delivered by central banks, in the
form of zero percent interest and trillions of dollars in quantitative
easing bond purchases, failed to create a robust and healthy economy
that could survive in its absence. Our stimulus, which was launched in
the wake of the 2008 crash, may have prevented a deeper contraction in
the short term, but it also prevented the economy from purging the
excesses of artificial boom that preceded the crash. As a result, we are
now carrying far more debt, and the nation is far more levered than it
was prior to the Crisis of 2008. We have been able to muddle through
with all this extra debt only because interest rates remained at zero
and the Fed purchased so much of the longer-term debt.
In the past I argued that even a tiny, symbolic, quarter point
increase would be sufficient to prick the enormous bubble that eight
years of stimulus had inflated. Early results show that I was likely
right on that point. The truth is that the economy may be entering a
period of “stagflation” in which very low (or even negative) growth is
accompanied by rising prices. This creates terrible conditions for
consumers whereby prices rise but incomes don’t. This leads to
diminished living standards.
The recent uptick in inflation does not somehow invalidate all the
other signs that have pointed to a rapidly decelerating economy. Just
because inflation picks up does not mean that things are getting better.
It actually means they are about to get a whole lot worse. Stagflation
is in fact THE nightmare scenario for the Fed. If inflation catches fire
now, the Fed will be completely incapable of controlling it. If a
measly 25 basis point increase could inflict the kind of damage already
experienced, imagine what would happen if the Fed made a real attempt to
raise rates to get out in front of rising inflation? With growth
already close to zero, a monetary shock of 1% or 2% rates could send us
into a recession that could end up putting Donald Trump into the White
House. The Fed would prefer that fantasy never become reality.
But the real nightmare for the Fed is not the extra body blow
higher prices will deliver to already bruised consumer, but the knockout
punch that will be delivered to its own credibility. The markets
believe the Fed has a duel mandate, to promote employment and to
maintain price stability. But it is currently operating like it has just
a single unspoken mandate: to continue to shower markets with easy
money until asset prices and incomes rise high enough to reduce the real
value of our debts to the point where they can actually be serviced
with higher rates, regardless of what happens to employment or consumer
prices along the way.
If you recall back in 2009 and 2010, when unemployment was in the
8% to 10% range, former Fed Chair Ben Bernanke initially indicated that
the fed would raise rates from zero once unemployment fell to 6.5%. At
the time I wrote that it was a bluff, and that if those goalposts were
ever reached, they would be moved. That is exactly what happened. But
when 5% unemployment finally backed the Fed into a credibility corner it
had to do something symbolic. This resulted in the 25 basis points we
got in December. Yet even as official unemployment is now 4.9%, the Fed
can postpone future, more damaging rate hikes, so long as low-inflation
provides the cover.
But can the Fed get away with moving its inflation goal post as
easily as it had for unemployment? In fact, the Fed has already done so,
with little backlash at all. When created by Congress the Federal
Reserve was tasked with maintaining “price stability”. The meaning of
“stability” should be clear to anyone with a rudimentary grasp of the
English language: it means not moving. In economic terms, this should
mean a state where prices neither rise nor fall. Yet the Fed has been
able to redefine price stability to mean prices that rise at a minimum
of 2% per year. Nowhere does such a target appear in the founding
documents of the Federal Reserve. But it seems as if Janet Yellen has
borrowed a page from activist Supreme Court justices (unlike the late
Antonin Scalia) who do not look to the original intent of the framers of
the Constitution, but their own “interpretation” based on the changing
political zeitgeist.
The Fed’s new Orwellian mandate is to prevent price stability by
forcing price to rise 2% per year. What has historically been seen as a
ceiling on price stability, that would have forced tighter policy, is
now generally accepted as being a floor to perpetuate ultra-loose
monetary policy. The Fed has accomplished this self-serving goal with
the help of naïve economists who have convinced most that 2% inflation
is a necessary component of economic growth.
But as officially measured consumer prices surpass the 2% threshold
by an ever-wider margin, (which could occur in earnest once oil prices
find a bottom) how far up will the Fed be able to move that goal post
before the markets question their resolve? Will the Fed allow 3% or 4%
inflation to go unchallenged? President Nixon imposed wage and price
controls when inflation reached 4%. It’s amazing that 2% inflation is
now considered perfection, yet 4% was so horrific that such a draconian
approach was politically acceptable to rein it in.
Once markets figure out that the Fed is all hat and no cattle when
it comes to fighting inflation, the bottom should drop out of the
dollar, consumer price increases could accelerate even faster, and the
biggest bubble of them all, the one in U.S. Treasuries may finally be
pricked. That is when the Fed’s nightmare scenario finally becomes
everyone’s reality.
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