Rates, The Dollar, & The Fed’s Dis-Inflationary Dilemma

Zubu Brothers ^ | Lance Roberts

[blam]

As we move into the second half of 2021, interest rates and the dollar continue to shape the outlook.

Of course, much of the debate focuses on whether rates and the dollar continue to miss the bigger picture. For example, just recently, Jim Bianco tweeted a critical point.

However, while I very much respect his opinion, I am not sure I entirely agree. Such is where the analysis of rates and the dollar suggests a different story.

The Inflation Premise

We previously discussed that inflation might indeed be more transitory given the drivers of increased prices were artificial. (i.e., stimulus, semi-conductor shortages, and pandemic-related shutdowns.) To wit:

“Inflation is and remains an always ‘transient’ factor in the economy. As shown, there is a high correlation between economic growth and inflation. As such, given the economy will quickly return to sub-2% growth over the next 24-months, inflation pressures will also subside.”

“Significantly, given the economy is roughly comprised of 70% consumption, sharp spikes in inflation slows consumption (higher prices lead to less quantity), thereby slowing economic growth. Such is particularly when inflation impacts things the bottom 80% of the population, which live paycheck-to-paycheck primarily, consume the most.”

However, another important factor behind inflationary pressures is an individual’s actions. As noted last week by Société Générale’s Albert Edwards:

“Surveys suggest that inflation fears have become investors’ number one concern. But why look at it that way? We could equally say it is investors’ own bullishness on the strength of this economic cycle that is driving prices sharply higher in the most cyclically exposed equity sectors and industrial commodities.”

Bloomberg’s John Authers discussed the same, noting a “reflexivity” to investors’ belief in rising inflation.

“In inflation, as in many other areas of economic life, perceptions can form reality, and that is certainly true of inflation. The University of Michigan monthly survey of consumers’ expectations perennially shows shoppers foreseeing more inflation than will in fact arrive. The important factor here is the direction of travel. If they are more worried about inflation, they will do more to guard against it, which will tend to push up prices.”

(snip)

Conclusion

There is a significant difference between a “recovery” and an “expansion.” One is durable and sustainable; the other is not.

Those expecting a significant surge in inflation will likely be disappointed for the one reason which seems to get mostly overlooked.

“If the economy was growing organically, which would create stronger rates of wage growth and inflation, then there would be no need for zero interest rates, continued monetary interventions by the Federal Reserve, or deficit spending from the Government.”

The obvious problem is that not all “spending” is equal. Pulling forward consumption through stimulus is indeed short-term inflationary but long-term deflationary. Since 1980, there has been a shift in the economy’s fiscal makeup from productive to non-productive investment.

As we have pointed out previously, you can not overstate the impact of psychology on an economy’s shift to “deflation.” When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers change their primary orientation from expansion to conservation.

◾Creditors become more conservative and slow their lending.

◾Potential debtors become more conservative and borrow less or not at all.

◾Investors become more conservative, and they commit less money to debt investments.

◾Producers become more conservative and reduce expansion plans.

◾Consumers become more conservative, and save more, and spend less.

As we have been witnessing since the turn of the century, these behaviors reduce the velocity of money. Consequently, the decline in velocity puts downward pressure on prices. Given the massive increases in debt and deficits, the deflationary drag continues to increase as stimulus fades from the system.

Likely, the dollar and rates already figured this out.

[cuban leaf]

Stagflation, here we come.

[cuban leaf]

Stagflation definition:

I’m buying less and less lumber because it’s so expensive, but it keeps going up in price.

[gattaca]

bmp

[No_Mas_Obama]

I’m not so sure inflation will decline so quickly. The Fascist Leftwing US authorities are committed to destroying economic supply whether it be oil and gas, corporate after-tax profits or small business. However, demand may remain high with a record crop of Boomers enjoying retirement and Millennials entering a period of household formation. This will produce a ton of inflation.

[Alberta's Child]

There are three giant drags on our economy that will minimize any real inflation over the coming years:

1. Stagnant population growth.

2. Declining productivity (actual negative productivity growth).

3. Enormous personal, corporate and government debt (we simply have too much debt to pay a premium price for a lot of things).

[hardspunned]

I think when people are familiar with what a couple years of inflation will do to your savings, they often decide to spend it now before the cash loses more purchasing power. Of course, this actually fuels demand and inflation.

[CapnJack]

All I want to know after reading this mombo-jombo is ...
should I plan on building my new home in Florida later this year and take our a HELOC to do so?

Or wait a few more years and hope the price of materials drops like a rock?

The other factor is ... will I be around in a few more years? I have a lot more yesterdays then tomorrows.

[blam]

Can't answer your questions, Good luck though.

Going to Florida (or Texas) is probably a good idea.
NW Florida.