RichVintage
Credit inflation. Is it still alive?
Well, in some areas of the financial markets, it seems as if credit inflation is still going strong.
What is credit inflation?
I have defined credit inflation as an effort of the U.S. government to stimulate the economy, keeping consumer price inflation under control while the economy grows, even if only modestly.
The basic idea is for the government policy to keep stimulating the economy, causing some consumer price inflation, while unemployment is kept low.
Many will recognize this description and say that it sounds an awful lot like the idea presented by the Phillips Curve.
And, they would be right.
“Credit inflation” results from government efforts to stimulate the economy but only in a way that consumer price inflation will not be excessive.
For example, the Federal Reserve has maintained a policy goal of 2.0 percent consumer price inflation for quite some time now.
And, they have done a very good job at it over the past twenty years or so and they have been able to maintain relatively low rates of unemployment.
Unintended Consequences
Like many other government policies, there are often unintended consequences attached to these policies.
One of the unintended consequences of this policy of credit inflation is that the government stimulus flowed into asset prices, rather than into consumer prices.
That is, rather than having the price of food increase, or the price of clothing increase, or the price of energy increase, credit inflation results in the increase of the prices of gold, or the price of stocks, or the price of houses.
What seems to happen in the case of credit inflation is that the government stimulates the economy.
But, the essence of the policy of credit inflation is that the government will continue to stimulate the economy over time so that consumer prices will continue to rise by…say…2.0 percent per year.
Investors come to learn that the government is going to stick with the stimulus so that the investors can come to count on this stimulus, year after year after year.
Sounds like something you could bet on?
That is just what investors started to do. They did not bet on consumer prices that happen this year or next year and depend upon random hits.
They bet on asset prices that can rise and rise and rise over the longer term. They ceased to bet so heavily on consumer prices that tend to rise due to more short-term shocks.
Credit inflation went into play in the 1960s, as a result of the efforts of the Kennedy and Johnson administrations.
President Nixon brought the Republicans on board in 1968 as he claimed “We are all Keynesians now!”
And, as they say, the rest is history.
After Paul Volcker broke the back of consumer price inflation in 1980 and 1981, investors saw that consumer price inflation was only a short-term thing that the government stimulated and depressed over the business cycle.
Credit inflation saw the government “underwrite” lower unemployment levels over the longer term.
And, investors bought onto this “credit inflation.”
They invested heavily in it.
In the 1990s we got a lot of asset price inflation and asset price bubbles.
Again, in the 2000s, credit inflation did its job with low unemployment, low consumer price inflation, and high asset price inflation.
And, the period between the Great Recession and the 2020 recession was the “dream” result for those backing such a policy. Low unemployment, rising stock prices, rising house prices, with other asset prices doing very well.
The wealthy did very, very well during this time.
Income/wealth inequality grew to all-time levels during this time period.
And then, the pandemic hit.
Rachel Louise Ensign writes in the Wall Street Journal,
“The richest Americans got even richer during the pandemic, riding twin stock-market and real estate booms that drove up the value of their assets.”
Thank you Federal Reserve System.
Never before has the Federal Reserve pumped so much money into the economy over such a short period of time. She continued:
“Americans saved $2.7 trillion extra from January 2020 through December 2021, according to Moody’s Analytics.”
“The top 10 percent of earners held more than half of that money.”
Their cup floweth over.
Today’s Situation
The wealthy are continuing to assume that credit inflation will continue to be the way the U.S. government conducts its business.
Why not assume that?
The federal government has relied upon credit inflation for the last 40 years or so to keep the economy moving ahead.
The Federal Reserve may be raising interest rates now and is promising to reduce the size of its securities portfolio, but they will cause market losses and economic pain.
The Federal Reserve, the federal government, cannot stand losses and pain for long?
Right?
Well, Ms. Ensign writes,
“Wealthy people ramped up borrowing in the first half of the year despite rising rates and a stock market rout that hit the value of their portfolios.”
But, she continues,
“The wealth-management units at Morgan Stanley and Bank of America Corp. posted double-digit loan growth in the second quarter.”
“The increase came from well-heeled clients taking out mortgages and loans backed by assets like stock-and-bond portfolios….”
“The growth is another sign that the U.S. consumers–admittedly a wealthier subset–aren’t thundering down in preparation for a recession.”
“On earnings calls earlier this month, the leaders of the biggest U.S. banks said their customers are spending at a healthy clip and keeping up with their debt payments, all without draining their bank accounts.”
“The rich are tapping their securities-backed credit lines to scoop up assets that seem cheap in today’s turbulent markets.”
And, oh yes, the Fed is not really going to go off of their credit inflation leanings.
Oh, Hannah Mial also writes in the Wall Street Journal,
“Weak Earnings Reports Aren’t Fazing Investors After Brutal Year for Stocks.”
Why should they faze investors, especially the wealthier investors who have the means to borrow even when the Fed is tightening up on monetary policy.
But, then, the Fed is not going to be doing this for very long and stock prices will rebound as the Federal Reserve returns to its credit inflation roots.
At least, this seems to be what a lot of wealthy investors believe.
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