6.2% > 2%

6.2% > 2%

by Zach Marsh on Nov 12, 2021

The October CPI was released this week and shocked the market with a hotter than expected reading of 6.2% year over year inflation. The Fed has, up until now, believed that hotter inflation was temporary—transitory in their language. They are beginning to reassess that belief now. At the beginning of the pandemic the Fed changed its inflation target from 2% to what I would call 2%-ish. Namely, they determined that previous attempts to halt inflation at 2% had the effect of either causing economic downturns or continued deflation. They announced that they would begin to allow inflation to run “hotter for longer.” Well, mission accomplished. Now what?

It is a philosophical discussion as to what is worse: inflation or deflation. At each extreme both are extremely painful and destructive to society. On the one end we have the Great Depression of the 20’s at the other we have the Weimar Republic in Germany of the 20’s. Historically, for those in government, both of these outcomes are extremely negative, increasing the risk of societal uprising and violent governmental overthrows. But for now, we are just at 6.2%.

What I struggle to understand is why I read so many articles asking the question: What is causing rising prices? Is this really a mystery? The money supply has been growing for years. The Federal Reserve has been “printing money” for years under the label of Quantitative Easing. The problem, or rather, the adverse outcome for the Fed was that this did little to stoke the underlying economy and pull the economy out of perpetual deflation. So, what changed? Inflation is driven not by the money supply, but by the velocity of money. From 2008-2020, despite Fed pumping the increased money supply (M2) was met with ever decreasing velocity. The money in circulation wasn’t actually circulating, it was just sitting there.

This changed once the money supply increases shifted from monetary to fiscal. Trillions of dollars later, with most of it deposited directly into consumers’ bank accounts, money is circulating at a faster rate and consumers are racing each other to spend it. Surprise, surprise this causes prices to rise and rise fast.

Some are now trying to sell this phenomenon as a good thing. “Hey, look how awesome things are. Are economy must be doing great.” But to quote the movie “As Good as it Gets,” go sell crazy somewhere else we’re all filled up here. If the biggest political problem facing democracies around the world is the ever-increasing divide between the top 1% and the rest, inflation is a big negative. There is really no other way to state it, inflation is the biggest regressive tax in existence. And no one spends a bigger percentage of their salaries than the people towards the bottom of the income ladder. The impact on wage earners is clear when we see that real wages (adjusted for inflation) have declined 2.2% year over year. Clearly, this is far from awesome. But hey, we are still debating trillions more in spending right now in Congress.

I get it, a fiscal conservative is just another name for the party not in power. But, for the first time in 40 years we might have to have a “Come to Jesus” moment and get real with ourselves. We can’t keep spending without seeing massive inflation. We can’t keep seeing inflation rates in the 6 handle and keep interest rates near zero. If rates adjust to reflect inflation rates, we can’t support government programs while paying a gigantic increase in borrowing costs. If someone in government has a legitimate suggestion, now would be the time to raise your hand.

As for the stock market, after a bad day on Wednesday, the day of the CPI release, the S&P regained its footing and resumed marching back. Day to day fluctuations aside if this continues the market will be impacted. Unfortunately, the situation is painting everyone into a corner. If you sit out, you are accepting a guaranteed loss due to an erosion of purchasing power. If you jump in or increase your allocation towards riskier assets you risk large losses due to major market collapse. Perhaps adequate diversification has never been more important than it is right now.  


Thanks for reading,

Zach and Dave





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