When it comes to the topic of inflation and hyperinflation one of the most interesting books is an account of what happened in Germany during the 1920’s. It’s titled When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany. It’s interesting, not because I think the United States is headed towards a hyperinflation like what happened then, but because of what caused the inflation of that age and who the Germans blamed for it.
The cause was simple.
The Germany government had accumulated massive government debts thanks to World War I and the allies also put big reparations on to the government that made their debt situation worse and unpayable. As a result the government basically printed away the debts by printing more and more of its currency. It increased the money supply and with more currency in circulation hyperinflation came.
But, the Germans didn’t understand that this caused the inflation. Instead the German people, guided by politicians and various factions, blamed different groups, usually crafted as enemies against them, for what was happening to them. So, some thought international currency speculators making profits, farmers hoarding crops to drive up prices, or Jewish plotters were to blame. Typically, whoever was cast as the culprit was presented as a manipulator working against them. And they believed it all.
In the 1970’s, though, in the United States there was also a period of high inflation caused mostly by growing US debts thanks to the the Vietnam War and deficit spending that culminated with the dollar going off the gold standard. But most Americans blamed hoarders, OPEC, and currency speculators for it all. In fact, when Nixon took the dollar off the gold standard he told everyone on TV that he was doing it to fight international currency speculators. Few it seemed understood that the chief cause was monetary policy having rates too low in the face of growing debt. Here is a clip of the Nixon speech. In it he makes no mention of how the Vietnam war drove up the debt, instead he presented an upside down world in which going off the gold standard “protects the value of the dollar” and talked about international currency speculators as enemies. Anyone who believed what he said in the speech left with a confused view of what was really happening.
The same is the case now when it comes to confusion over inflation. In reality if it wasn’t for zero interest rates and the QE policies created by the Federal Reserve in the response to the market crash of March 2020 and economic shutdowns we wouldn’t be seeing the inflation we are seeing today. The policies helped make the stock market go up, but they are creating the inflation of today too.
If there was one day that was a tipping point it was the day in which the Fed announced these extreme measures on Sunday, March 15, 2020. President Donald Trump held a historic press conference celebrating them.
President Trump had been calling for the Federal Reserve to lower rates to zero for at least a year before this press conference. I guess he thought the low rates would make the stock market go up more and help him get re-elected.
Zero rates and QE does help the market go up.
But now the country is stuck with inflation growing and if the Federal Reserve raises interest to stop it then it will cause a bond bear market that will take the stock market down with it and cause more economic hardships. It doesn’t want to do that so it is sorta trapped, because it also doesn’t want inflation to get more out of control either.
The only possible way out is to raise interest rates slowly in the next couple of years in hopes that they can do it slow enough that it won’t hurt the stock market and that in time the inflation will fade before it gets even bigger.
Unfortunately, the Federal Reserve has tried this before and it failed.
If you can recall in 2006 and 2007, Ben Bernanke said he was raising rates slow enough to bring in a “soft landing” and instead you got the crash of 2008.
In 2000, Alan Greenspan raised rates three times and the stock market went into a bear market for three years as the technology bubble imploded.
So, the odds are more failure again than success for Jerome Powell in stopping this inflation without eventually causing financial and economic turmoil.
But one thing that is required to do it is to make sure that people don’t realize that it is monetary policy and this cycle of zero rates and QE that is the cause of this inflationary cycle, which is turning out to start in a similar manner as that of the 1970’s did. Just check out this recent article in which I compared today’s inflation date with that of the 1970’s.
As a result, the Biden administration is putting zero blame for the Federal Reserve and monetary policy for the inflation and instead putting blame on consumers themselves. That is according to a recent New York Times article in which Biden administration officials put out this message. The article reads:
“Administration officials overestimated how quickly Americans would start spending money in restaurants and theme parks, and they underestimated how many people wanted to order new cars and couches.”
“Mr. Biden’s advisers, along with economists and some scientists, believed that widespread availability of coronavirus vaccinations would speed the return to prepandemic life, one in which people dined out and filled hotel rooms for conferences, weddings and other in-person events.”
“Instead, the emergence of the Delta variant of the virus over the summer and fall slowed that return to normalcy. Americans stayed at home, where they continued to buy goods online, straining global supply chains and sending the price of almost everything in the economy skyward.”
“Because of the strength of our economic recovery, American families have been able to buy more products,” Mr. Biden said this month at the Port of Baltimore. “And — but guess what? They’re not going out to dinner and lunch and going to the local bars because of Covid. So what are they doing? They’re staying home, they’re ordering online, and they’re buying product.”
In other words, the Biden administration is claiming that inflation is being caused by Americans buying too much online and causing the supply chain disruptions. The implication is that in time the supply chain will normalize and the inflation will stop.
If you believe that I got a bridge to sell you.
Of course, interest rates have been too low since the era of Alan Greenspan and US monetary policy has generated wild boom and bust cycles for decades, which have created an economic malaise in this country. Donald Trump won, because of that, but, in the end, he championed, and even celebrated these policies as they went to an even greater extreme. The Biden administration is trapped by this legacy and is providing cover for all of the mistakes that came before it, by not identifying the true cause of today’s inflation. Biden reappointed Powell, because he will give him the slow motion rate hike policies he wants and because as a Republican and a continuation from the Trump administration he can give him some political cover that he wouldn’t have if he put in a new Fed Chairman or a Democrat for that position if things do not work out too well.
Investors who put full confidence in Alan Greenspan and Ben Bernanke ended up being wiped out in those last two bear markets. Investors of today need to remember those lessons and be ready to figure out how to navigate the markets for themselves and not put blind faith in Federal Reserve officials and President Biden or some future Presidential candidate that might run against him either. They must believe and act for themselves instead.
Although I am hopeful that the market can hold up or rally after the decline of the past week, heightened market volatility in the bond market and stock market is a sign that the market environment is starting to change as it has been accompanied with a collapse in the internals of the market that has slowly been taking place since the summer.