WHY INFLATION IS A HOT TOPIC

The most popular question on everyone’s mind is not whether a major correction will ever occur but when will it actually arrive. The answer to that mystery is as predictable as it is elusive.

To put it plainly, the proverbial shit will hit the fan as soon as inflation heats up to the point it pressures yields to move higher without the Fed’s consent, at which time the Wall Street establishment will wake up at the wheel doing eighty in the wrong direction. After the crash, again, experts will face the music with shocked faces and stiff upper lips having to admit that crisis once again snuck-up and caught them off guard. They had thought the Fed had inflation under control – but no, it was too much too fast, and surprisingly too widespread.

Like Tony Fauci, Wall Street and Federal Reserve gurus have a long history of errors and omissions and politically driven blind conclusions.

Some consider inflation to be a problem right now and others need proof beyond the $90 cost for a sheet of half-inch plywood. Federal Reserve chairman Jerome Powell is in line with the latter mentality. He describes oncoming inflation as “transitory” while projecting things will return to pre-Covid norms in a short due course – a stance that neglects to appreciate how government Covid-19 policies dramatically interrupted operations and altered business models and supply chain metrics at every corner of the global market economy – something with no choice but to significantly and permanently disrupt cost structures and pricing levels.

Not to mention it appears the Fed chair is unable to comprehend the inordinate amount of currency his printing facilities have created and injected into the economy since the Wuhan flu blew into town a little more than a year ago – and how that currency is contributing to today’s inflation.

It also seems Powell fails to appreciate the fiscal and monetary impact a Joe Biden budget plan that maintains Covid-crisis spending levels for at least two more years will have – again, something with no choice but to feed inflation and further economic pressure.

Let’s get back to basics to get a better handle on what’s going on…

Central government deficit occurs when spending exceeds tax receipts. Deficits create the need for more government debt (bonds) issued by the U.S. Treasury.

Like bond values, yields are tied to the laws of supply and demand. When demand for bonds is high and there is little supply, yields move lower. Conversely, yields rise when there is little demand and excess supply of bonds (to encourage investors to buy bonds).

Yields are also connected to inflation because inflation is the cost money, and debt is simply borrowed money. More on that in a bit.*

In order for the Federal Reserve to keep yields artificially low it prints demand for excess bonds – a.k.a. new money – and exchanges that cash with the Wall Street establishment for some other asset. Wall Street then uses half the new money to purchase government bonds issued by the U.S. Treasury (to cover central government spending deficit) which keeps yields low (due to the newly printed demand). The other half of the new money is used as the Federal Reserve and Wall Street establishment decide (no surprise a lot of it finds its way into the stock market). This is a process called quantitative easing (QE).

QE began as a “crisis measure” to “save” the economy from a policy disaster called the “financial crisis” in 2008. It has been used and abused ever since, and is largely responsible for all the hot air inflating today’s stock market balloon.

Ever notice how crisis measures never seem to go away?

And the reason QE never went away is because it gave the entire establishment complex – the Federal Reserve, the complete U.S. government apparatus, and Wall Street establishment – grand new power, economic control and influence. So they never want to give it up.

QE is a means to finance establishment ambition and/or political agenda whether it is fiscally responsible or insane, constitutional or criminal, good for We the People or anti-American.

In a nutshell, Congress appropriates spending programs that create enormous deficits that the U.S. Treasury must finance with bonds. The Treasury issues bonds and delivers them to their middleman broker, the Wall Street establishment, who then sell the bonds to the world and return the cash to the U.S. Treasury.

But when deficits are outrageously large as they are today, especially in the Covid world, there is not enough global demand for U.S. bonds at rock bottom interest rates. Such a dynamic forces yields higher to entice investors to buy bonds but squeezes Congressional budgets and makes it harder to finance reckless spending – it is a market driven check and balance, if you will, to irrational fiscal policy.

But today’s Federal Reserve relishes big-government deficits for the reasons stated previously, and so they overrule market forces and employ quantitative easing (QE) to make financing irresponsible fiscal spending cheap and easy to fund the expansion of big-brother’s government ambition.

Massive central government deficits and an overly accommodating central bank keep QE in practice only because the American people fail appreciate what is truly happening – thanks to Covid-19 and all the bullshit politics that surround it – which halts Americans from uniting to demand QE and reckless fiscal deficits stop immediately.

Investors can’t let the smoke in the political arena cloud their view of reality.

There is an old saying around Wall Street, “You can’t fight the Fed,” because they own and control the one and only printing press for U.S. currency. However, there is one way to successfully fight the Fed’s super-power and that is with a kryptonite called inflation on your side – sadly, the only check or balance left in our modern-day system.

The worst thing to do in a highly inflationary period (like the one approaching) is to keep injecting more new money into the market system because it devalues the currency already in circulation and pressures prices to rise further. When broader market prices rise abnormally, yields follow suit.* So it is only the power of inflation that will force the Federal Reserve to throttle back their use of QE (to arrest runaway inflation, and tame spiking yields).

That one elemental change to stock market dynamics – a world where market forces, not the Federal Reserve, controls yields – is an extremely unwanted condition for the entire establishment (hence all the fervor surrounding the inflation debate). Why?

First the obvious, when inflation controls the movement in yields it means the Federal Reserve has lost that control in a period of high inflation, a condition that scares the hell out of Wall Street banks.

Second, it stops or slows the flow of free new money via QE and transforms cheap and easy money into expensive pricing and tight credit, which squeezes profits and profit margins (especially for Wall Street banks), and lessons the establishment’s influence in a shrinking marketplace (recession).

Wall Street will hate that too.

Third, and by way of the second, any minimization of QE will force U.S. central government to cut deficit spending (thus to slow the supply of excess bonds issued to relieve pressure on rising yields), something Biden and Congress will hate.—But rest assured, programs for the little guy will be the first to fall, swiftly followed by severe cuts to middle-class programs (to reduce consumer spending in favor of government spending and central planning).

Minimization of the individual consumer will worsen the post-Covid economic picture, something that negatively affects every American.

Fourth, central planners will have to drain significant liquidity (money in the trillions) from the system to fight inflation, and knowing them, it will come from everywhere else before it affects them in the least. And while this will hurt us way more than them, the establishment gains much more by printing liquidity than by removing it. And they won’t be happy about it.

Which is the reason Biden wants to raise taxes – to remove cash (liquidity) from the free-market side of the economic equation to fund his central planning ambitions. But there’s not enough there to cover his proposed budget deficits (between $2 and $4 trillion for each of the next two years).

Your retirement account has plenty, though, and it represents another place they will steal liquidity (a.k.a. money) from the private-side of the market –because there is so much QE money already in the stock market. That’s why stock valuations remain so high.

Can you see the storm brewing?

Think about the approaching condition this way……During a period of high inflation caused by excessive monetary supply the Federal Reserve must remove currency from the system to temper prices and moderate rising yields (market interest rates).

To remove currency from the system the Federal Reserve normally sells U.S. bonds to the Wall Street establishment for cash to be held at one of the regional Federal Reserve Banks, and thus removed from circulation.

Quantitative easing (QE) was invented in ’08 to transfer “toxic assets” from the Wall Street establishment to the Federal Reserve for newly printed cash. QE increased the money supply and bank liquidity (solvency).

Quantitative tightening, or QT, would be the exact opposite transaction that would decrease the money supply and bank solvency. But the Federal Reserve would never do such a thing as to return “toxic assets” back to banks – nor would banks take them back.

So under the guise of fighting inflation, the Federal Reserve will employ a different kind of quantitative tightening (QT) to reduce the monetary base during the next financial crisis. One way will be to print new money and use it to purchase U.S. Treasury bonds (to relieve pressure to rising yields). The Fed will then sell some of those bonds to the Wall Street establishment for cash (thereby removing currency from circulation). But in order to pay for those new bonds the Fed will instruct Wall Street to raise capital by selling not bonds, but stocks (to decrease inflation there), and thereby removing significant liquidity (money) from the monetary system via the stock market (a.k.a. your retirement account).

So there you have it. During the next economic crisis central governance will be printing money to fund big-government deficits while at the same time raiding your retirement account. And they will be doing it, again, to “save” the system from failure, or so they’ll say.

But there is one problem: just as QE didn’t create inflation in the market economy QT won’t diminish it. And while it will be billed as a “crisis measure to combat inflation” it will actually be a strategy to drain investor wealth to pay for today’s government spending program, which is nothing more than a leveraged buyout of the free-market system by big-government central planners (a.k.a. communists).

And inflation will remain.

Then what will they do?

Investing is a fluid process. Investors must acknowledge and appreciate the reality occurring within their market borders. Government policy affects economic activity and the stock market like a diet influences the body. Neither happens overnight (unless locked-down and quarantined, of course).

Inflation is destined to build from where it is today (4%). And while it may be true all inflation is transitory, temporary can last for a very long and painful time. Just ask Jimmy Carter.

Besides inflation the key metric to watch is the 10-year yield, which is still historically low around 1.5%. All hell will break loose when it starts to run higher.

Third quarter GDP numbers will hit the street at the end of July and provide another piece to the puzzle. Until then,

Stay tuned…

PS: The solution to all of this is to dramatically reduce the size and scope of U.S. government by dramatically cutting their budgets and our tax rates; audit the Federal Reserve, and add term limits for Congress.

3 Responses

Leave a Reply