Tag Archives: Federal Reserve

Inflation and Time Value of Money

Posted on by

As time passes, the value of money declines.

Consumer-price inflation rose to 8.6% in May, its highest in forty years. This tax on households and businesses threatens the overall health of the U.S. economy. Deficit fiscal spending and supply shocks and Russian invasion are the primary causes of the current historic inflation.

Inflation is defined as the decline of purchasing power of the U.S. Dollar over a certain period of time. Inflation is usually expressed as the change in prices over a one-year period.

Purchasing power means how much your money can buy—its “buying power.” You lose purchasing power when prices go up (inflation) and gain purchasing power when prices go down (deflation). Inflation changes the value of a currency over time.

Inflation, risk and opportunity cost together reduce the value of the dollar as time passes. And, when inflation increases, the purchasing power of the U.S. Dollar decreases.

Inflation is rampant, the Federal Reserve seems poised to raise interest rates even higher than previously expected, financial markets are free falling, and there are fears of recession in the air. All this signals economic pain ahead for Americans.

A recession is my no means certain, with a strong jobs market and consumers still flush from pandemic fiscal government handouts. But inflation is sapping consumer and business confidence.

A tax increase would reduce investment and further restrict supply, which would arguably increase inflation.

Inflation is a cost spread over every American. Unemployment, a byproduct of a recession, lands especially hard on specific Americans and American families. Thus, it natural for economists to accept a little more inflation to protect employment and strive for a soft landing.

Blossoming federal role in directly supporting the consumption of a vast number of Americans is a primary driver of fiscal deficits and persistent inflation.

  • 75 million receive a combination of Medicare, Medicaid and Social Security
  • 98 million receive veteran and retired federal government benefits, college aid, rental assistance, Obamacare, food stamps, etc.

These transfers are financed by chronic fiscal deficits. To remedy the problem, politicians would face the career ending choice of benefit cuts, tax hikes or increase borrowing regardless of the worsening effect in inflation.

If prompt and effective actions are not pursued by the Federal Reserve and Administration, the nation may revisit the Stagflation of the 1970s which persisted more than a decade with great consequences to society and the economy.

References:

  1. https://debtinflation.com/how-does-inflation-impact-purchasing-power/
  2. https://www.acorns.com/money-basics/the-economy/what-is-purchasing-power-and-how-does-inflation-affect-it-/

Recession Causes

Posted on by

Recessions occur typically when the demand for goods and services starts declining rapidly and steadily.

A recession is a significant decline in economic activity that lasts for months or even years. Experts declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.

The National Bureau of Economic Research (NBER) is generally defines the starting and ending dates of U.S. recessions. NBER’s definition of a recession is when “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Unemployment rate. NBER-dated recessions in gray. (Cart below)

Source: Bureau of Labor Statistics via the Federal Reserve Bank of St. Louis.

There is more than one cause for a recession to get started, from a sudden economic shock to fallout from uncontrolled inflation. According to Forbes Advisors, some of the main drivers of a recession are:

  • A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. In the 1970s, OPEC cut off the supply of oil to the U.S. without warning, causing a recession. The coronavirus outbreak, which shut down economies worldwide, is a more recent example of a sudden economic shock.
  • Excessive debt: When individuals or businesses take on too much debt, the cost of servicing the debt can grow to the point where they can’t pay their bills. Growing debt defaults and bankruptcies then capsize the economy. The housing bubble in 2007-8 that led to the Great Recession is a prime example of excessive debt causing a recession.
  • Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes aren’t far behind. Investors can become too optimistic during a strong economy. Former Fed Chair Alan Greenspan famously referred to this tendency as “irrational exuberance”. Irrational exuberance inflates stock market or real estate bubbles—and when the bubbles pop, panic selling can crash the market, causing a recession.
  • Too much inflation: Inflation is the steady, upward trend in prices over time. Inflation isn’t a bad thing per se, but excessive inflation is a dangerous phenomenon. Central banks, such as the Federal Reserve, control inflation by raising interest rates, and higher interest rates depress economic activity. Out-of-control inflation was an ongoing problem in the U.S. in the 1970s. To break the cycle, the Federal Reserve rapidly raised interest rates, which caused a recession.
  • Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. When a deflationary feedback loop gets out of hand, people and business stop spending, which undermines the economy. Central banks and economists have few tools to fix the underlying problems that cause deflation.
  • Technological change: New inventions increase productivity and help the economy over the long term, but there can be short-term periods of adjustment to technological breakthroughs. In the 19th century, there were waves of labor-saving technological improvements. The Industrial Revolution made entire professions obsolete, sparking recessions and hard times.

According to NBER data, from 1945 to 2009, the average recession lasted 11 months. Over the past 22 years, the U.S. has gone through three recessions:

  • The Covid-19 Recession. The most recent recession began in February 2020 and lasted only two months, making it the shortest U.S. recession in history.
  • The Great Recession (December 2007 to June 2009). The Great Recession was caused in part by a bubble in the real estate market. It lasted 18 months, almost double the length of recent U.S. recessions.
  • The Dot Com Recession (March 2001 to November 2001). At the turn of the millennium, the U.S. was facing several major economic problems, including fallout from the tech bubble crash and accounting scandals at companies like Enron, capped off by the 9/11 terrorist attacks. Together these troubles drove a brief recession, from which the economy quickly bounced back.

If there’s a silver lining, it’s that recessions do not last forever.

References:

  1. https://www.forbes.com/advisor/investing/what-is-a-recession/
  2. https://corporatefinanceinstitute.com/resources/knowledge/economics/business-cycle/
  3. https://www.nber.org/research/business-cycle-dating

Federal Reserve Raises Interest Rates

Posted on by

“Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” FOMC Report

The Federal Reserve raised interest rates 50 basis points (1/2 percent) on Wednesday in an effort to tame inflation that’s soaring at a 40-year high. And, the Fed anticipates that ongoing increases in the target range will be appropriate.

The Federal Open Market Committee (FOMC) is highly attentive to inflation risks. The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run.

Short-term borrowing was nudged up a half a point, and consumers are going to feel the increase in their bank accounts.With a 50 basis-point interest rate hike, you can expect higher costs for:

  • Credit Cards – Your credit card’s interest rate will likely increase slightly within a couple of billing cycles. The size of that increase can vary based on your credit score and credit card provider. A 1% interest rate increase will likely only add a few dollars to your monthly interest payments on a few thousand dollars of outstanding debt. Current average interest rates are close to 16%, but they could be as high as 18.5% by the end of the year.
  • Mortgages – Mortgage interest rates are calculated based on multiple factors, like inflation and the housing supply — but they’re also affected indirectly by the federal funds rate, which influences how much banks pay to borrow money. When that rate increases, the interest on adjustable-rate mortgages tends to follow.
  • Other loans – The federal funds rate is used to calculate the lowest interest rate offered for loans, known as the prime rate. Any loan tied to the prime rate, known as adjustable-rate loans, will likely have a slight increase in interest rates.

If you currently have a fixed-rate loan, your payments won’t change. If you have an adjustable-rate loan, you should take some time to look at its terms, says Jacob Channel, a senior economic analyst at LendingTree: “The last thing you want is to think, ‘Oh, I have a few months before my rate goes up,’ and realize that the rate hike will kick in much sooner.”

References

  1. https://www.federalreserve.gov/newsevents/pressreleases/monetary20220504a.htm
  2. https://www.cnbc.com/2022/05/04/3-things-thatll-get-more-expensive-after-the-feds-historic-rate-hike.html

Racial Economic Disparity vs. Economic Inclusion

Posted on by

“The economic downturn has not fallen equally on all Americans, and those least able to shoulder the burden have been hardest hit.” Jerome Powell, Chairman Federal Reserve

Wealth inequality, also known as the wealth gap, is a measure of the distribution of wealth—essentially the difference between the richest of the rich and the poorest of the poor, according to World Population Review. American household wealth—the value of assets subtracted by the liabilities and debts owed—may have increased largely in the form of equity, mutual funds, and similar investments, but not equally among all Americans.

Wealth inequality is closely related to income inequality, which tracks the money people earn. However, wealth inequality includes not just income, but also the value of bank accounts, stocks and investments, homes, and personal possessions such as cars, jewelry, artwork, and other valuables. Wealth inequality is a major cause of unequal living standards in many communities.

The Federal Reserve’s statistics have confirmed the racial inequity gap related to income and wealth disparities. In its 2019 Survey of Consumer Finances, white families were reported to have had a median wealth level of $188,200, substantially larger than the median Black family’s wealth level of $24,100.

“These disparities still stand from a racism that’s systemic. It can be traced from employment to small businesses and wealth and still exist today in ways that still damage our country’s health,” Cleveland-based artist Chris Webb said.

The central bank is studying racial inequities in the U.S. economy. The Federal Reserve says it can only do so much to address earnings and wealth disparities, but feels an obligation to at least research the economic implications of uneven economic outcomes in the U.S.

While the assets of white households are equally split between real estate, equity and mutual fund shares, pensions, and other assets, the assets of other racial groups are less diversified. Almost two-thirds of Black wealth is composed of real estate and pensions, with 38% coming from pension assets alone. Similarly, 61% of Hispanic wealth and 56% of wealth from other races is composed of just these two asset types.

Additionally, according to data from the Census Bureau, 35% of white Americans are 55 and older, whereas only 24% of Black Americans are and only 16% of Hispanic Americans are. Hence, a part of the reason why wealth ownership is much lower among Black and Hispanic Americans may be due to the fact that they are relatively younger on average than white Americans. Black and Hispanic populations may be younger for a variety of reasons, including differences in life expectancy—Black Americans’ life expectancy is 3.5 years less than that of white Americans—as well as immigration trends.

The white population is more likely to be older, has earned more income over their lifetime and hold more wealth than Black and Hispanic populations.

In summary, the causes of wealth inequality in America remains deeply rooted and are systemic. And, the results of wealth inequality in America persists even today.

References:

  1. https://worldpopulationreview.com/country-rankings/wealth-inequality-by-countryhttps://worldpopulationreview.com/country-rankings/wealth-inequality-by-country
  2. https://finance.yahoo.com/news/economic-and-racial-inequalities-are-long-haul-issues-for-the-federal-reserve-220405947.html
  3. https://usafacts.org/articles/white-people-own-86-wealth-despite-making-60-population/

Inflation – The Elephant Affecting the Economy

Posted on by

Historic inflation and interest rates hike fears are sinking many high growth technology stock prices. Inflation in 2021 was the consequences of rapidly rebounding demand in a supply-constrained world.

The fear of inflation and the the fear of subsequent Federal Reserve interest rate hikes are creating concern and panic among some investors. Rising interest rate and skyrocketing inflation worries are pressuring stocks. And by the Fed signaling raising rates in the future, it unsettles and sends both Wall Street and Main Street into a panic.

But, what is inflation?

Inflation is when consumer prices rise, goods and services become more expensive, and money loses value. Inflation reduces your purchasing power, eats away at your investment returns, and chips away at your wealth. Currently, Americans are experiencing the pernicious effects of inflation, especially in the areas of escalating food and energy prices.

2021 was one of the worst years for inflation that Americans have seen recently, with a 7% increase, the highest since 1982. For consumers, this means $1 at the beginning of the year was roughly worth only $0.93 at the end. While the impact might seem small when examining it on a dollar level, it represents a change in the purchasing power of retirement savings from January 2021 to December 2021. The Wall Street Journal’s Gwynn Guilford writes: “U.S. inflation hit its fastest pace in nearly four decades last year as pandemic related supply and demand imbalances, along with stimulus intended to shore up the economy, pushed price up at a 7% annual rate.”

American economist and Nobel prize laureate Milton Friedman opined that: “Inflation is always and everywhere a monetary phenomenon.”  In other words, inflation is invariably a case of too much cheap money and capital chasing too few goods, services and assets.

In the last twenty years, the United States witnessed a large accumulation of federal public debt under Presidents Bush, Obama, Trump, and Biden administrations. Federal debt climbed from 55% of GDP in 2002 to 105% in 2019. Additionally, the U.S. has also endured a decade plus of loose monetary policy overseen by the Fed which has pumped up asset prices.

As a result of the escalating public debt and loose monetary policy, the Federal Reserve most important immediate task, of its dual mandates, must be to get inflation under control and reduced. Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”—what is now commonly referred to as the Fed’s “dual mandate.”

The Labor Department stated that the consumer-price index — which measures what consumers pay for goods and services — rose 7% in December from the same month a year earlier, up from 6.8% in November. That was the fastest growth in inflation since 1982 and marked the third straight month in which inflation exceeded 6%.”

Three sectors–energy/materials, financials and technology–may be viewed as inflation beneficiaries or, at the very least, inflation-agnostic assets:

  • Energy and materials are commodity-based, and oil, gas, and most commodities rebounded from prices that had fallen to a fraction of their pre-pandemic levels.
  • Financials, especially banks, are often viewed as inflation hedges since interest rates historically climb when inflation heats up. This reflects the eroding effect of higher prices on a currency’s value in the future, which is remedied by rate hikes on debt.
  • Technology is a more nuanced winner in the inflation game. The large tech players and most software companies have tremendous economies of scale. As their revenues scale, their costs, particularly labor, do not grow at nearly the same degree, cushioning profit compression from wage escalation.

In a book called “The Great Inflation”, the authors wrote, “Inflation is not an Act of God…inflation is man-made and can be started, prevented, regulated and stopped by human action.”

“To think that a stimulus of this magnitude wouldn’t cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible”, says Jason Furman, former chair of President Obama’s Council of Economic Advisers.

Thus, slowing down in aggregate federal debt growth per capita, tightening monetary policy, and raising interest rates could be effective tools in stemming runaway inflation.

“If I was Darth Vader and I wanted to destroy the US economy, I would do aggressive spending in the middle of an already hot economy… What are you going to get out of this? You’re going to get a sugar high, the higher inflation, then an economic bust.” — Billionaire investor Stanley Druckenmiller, July 23, 2021

References:

  1. https://www.cnbc.com/2021/12/13/op-ed-these-3-market-sectors-shone-even-as-investors-grew-weary-of-hearing-about-inflation.html
  2. https://www.americanthinker.com/blog/2021/12/is_joe_manchin_right_about_inflation.html
  3. https://seekingalpha.com/article/4479557-how-to-better-understand-inflation-and-predict-its-direction
  4. https://www.marketwatch.com/story/why-did-almost-no-one-see-inflation-coming-11642519667

Inflation…Highest Level in 40 years

Posted on by

Inflation is at its highest level in 40 years as December prices rose 7 percent, compared to a year earlier

As a reaction to the COVID-19 pandemic and subsequent shutting down of the economy, Congress and the Federal Reserve responded with a wave of fiscal and monetary stimulus which was and remains without historical precedent.

Thus, we are in the midst of a fiscal and monetary experiment which has no direct antecedents. This renders all economic theories and financial forecasting hugely speculative.

As the second year of the pandemic fades away, Americans are experiencing the ravages of inflation. Prices, as depicted by the Consumer Price Index (CPI*), rose at the fastest pace in 40 years in December, increasing 7 percent over the same period a year ago, reported by the U.S. Bureau of Labor Statistics. The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services.

Correspondingly, calendar year 2021 will go down as the worst year for inflation since 1981, as broken supply chains and higher energy prices collided with high consumer demand for used cars and construction materials, according to the Washington Post.

The energy index rose 29.3 percent over the last year, and the food index increased 6.3 percent, according to U.S. Bureau of Labor.

Higher prices have permeated into just about everything American households and businesses buy, raising alarms for policymakers at the Federal Reserve and White House that inflation has spread throughout the greater economy, the Washington Post reported. Additionally, officials within the Federal Reserve and President Biden administration expect high inflation will persist through much of calendar year 2022.

Federal Reserve Chairmen Jerome Powell said it was essential to get prices down to more sustainable and stable levels to ensure a lasting recovery. “If inflation does become too persistent, if these high levels of inflation become too entrenched in the economy or people’s thinking, that will lead to much tighter monetary policy from us, and that could lead to a recession and that would be bad for workers,” Powell told Congressional lawmakers.

References:

  1. https://www.bls.gov/news.release/cpi.nr0.htm
  2. https://www.washingtonpost.com/business/2022/01/12/december-cpi-inflation/
  3. https://www.bls.gov/cpi/
  4. https://www.bls.gov/charts/consumer-price-index/consumer-price-index-by-category-line-chart.htm

* The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Inflation: Biggest Threat to Investors and Market

Posted on by

“Inflation is not going to be transitory.” Paul Tudor Jones, Tudor Investment Founder

Recently on CNBC, Paul Tudor Jones, founder and chief investment officer of Tudor Investment Corporation, was extremely critical of current Federal Reserve policy. He opined that current Fed monetary policy and Administration fiscal policy are creating persistent inflation, instead of fighting existing inflation.

In his opinion, inflation could be worse than feared and is not transitory. “I think to me the number one issue facing Main Street investors is inflation, and it’s pretty clear to me that inflation is not transitory,” Jones said on CNBC’s “Squawk Box”. “It’s probably the single biggest threat to certainly financial markets and I think to society just in general.”

Additionally, Jones opined that inflation will be the death to 60 percent stocks / 40 percent bond portfolios favored by retirees. In his opinion, the Federal Reserve policy is creating inflation instead of fighting it. Instead, the Fed should be aggressively fighting inflation.

Currently, the Fed is slow and late fighting inflation.

Jason Furman, the former chair of the White House Council of Economic Advisers and now a professor at Harvard University’s John F. Kennedy School of Government, contends that both economists, and the market, got inflation wrong in 2021. Furman explained that normal multipliers showed that the fiscal and monetary stimulus was well in excess of the economy’s potential to absorb. He expects inflation to remain “very elevated” because demand will be above trend, and the lag from Federal Reserve policy will mean any tightening won’t make an impact until next year anyway.

Consumer inflation expectations

A Sept. 2021 Federal Reserve Bank of New York survey shows Americans’ inflation rate expectations rising to their highest levels since the survey’s inception.

Consumer expectations for inflation rose to 5.3% over the next year and 4.2% over the next three years, according to the New York Fed. Both are the highest in the history of a data series that goes back eight years.

Powell has long held that inflation is being held in check by forces that the Fed has no control over – aging populations, lower productivity and advances in technology.

Powell’s five-point inflation checklist include:

  • Lack of broad-based pressures;
  • Lower moves in high-inflation items;
  • Low wage pressures;
  • Tepid inflation expectations, and
  • Long-lasting forces that have kept inflation low globally.

High technology companies stocks have underperformed the broader markets amid an increasing possibility of Federal Reserve rate hikes this year. Rising U.S. treasury yields have also recently put pressure on high growth tech names.

The valuations of many tech companies rely on the prospect of profits years in the future, and higher long-term Treasury yields typically discount the present value of future cash.

References:

  1. https://www.msn.com/en-us/money/savingandinvesting/here-s-the-market-move-cathie-wood-says-is-ridiculous-as-her-flagship-fund-sputters/ar-AASCrQL
  2. https://www.aeaweb.org/conference/2022/livecasts/inflation
  3. https://www.cnbc.com/2021/10/20/paul-tudor-jones-says-inflation-could-be-worse-than-feared-biggest-threat-to-markets-and-society.html

Looming Threat of Inflation

Posted on by

“Inflation destroys savings, impedes planning, and discourages investment. That means less productivity and a lower standard of living.” Kevin Brady

Brian Wesbury, Chief Economist at First Trust Advisors, is concerned about inflation increasing faster than the Federal Reserve anticipates. Wesbury said that he is focused on the rapid increase in the M2 measure of the money supply. This measure has soared since COVID-19 hit the US, up about 25% from a year ago, the fastest growth on record.

From his viewpoint, the rapid increase in M2 is the key difference between the current situation and the situation in the aftermath of the Financial Crisis of 2008-09. During that first round of Quantitative Easing and big spending bills (like TARP), the M2 measure remained subdued because the Fed kept banks from lending, in part by raising capital standards. As a result, inflation remained subdued as well.

The late great economist Milton Friedman stress that policy makers watch M2: Nominal economic growth and inflation will tend to track M2 broadly over time, adjusted for any fluctuations in the velocity of money, the speed with which money circulates through the economy.

The US economy is healing faster than expected, while the US Congress and President Biden are intent on pouring at least one more massive government spending stimulus into the system, according to Wesbury. They are doing this even though the pandemic is waning, and a double-dip recession seems highly unlikely.

The big risk for the next couple of years is an upward surge in inflation that’s larger than anything we’ve experienced in the past couple of decades.

“I think the inflation prospects for the U.S. over the next five or six, seven years, are quite serious. You cannot have a bumper crop in apples without the value or the price of each apple falling. The Fed has had the largest increase in the monetary base in the history of the U.S., from colonial times to the present, times ten.” Arthur Laffer, an Economist known for his tax revenue theory called the Laffer Curve

He still project 2.5% CPI inflation for 2021, as the government’s measure of housing rents holds the top-line inflation number down. But commodity prices are likely to continue rising and overall inflation will as well in in 2022 and beyond. There is an old saying: When the Fed is not worried about inflation, Wesbury states, “the market should be worried.”

References:

  1.  https://www.ftportfolios.com/Commentary/EconomicResearch/2021/3/1/powell-disses-uncle-milty