Inflation At 8.5 Percent; Economy In Disequilibrium

The obvious bad news for the day is that prices in the United States in March 2022 are 8.5 percent higher than they were in March 2021.

The situation that is not so obvious in this information is that the U.S. economy is really in a state of disequilibrium.

That is, the economy is in a mess.

A lot is currently going on that is helping to create this disequilibrium.

There is the Covid-19 pandemic still impacting the economy and labor markets and supply chains.

There is the growing turmoil in Ukraine, with Russia now moving to up-the-cost of the “little” war it has started.

And, there are the trillions of dollars the Federal Reserve has pumped into the economy over the past couple of years.

Furthermore, there is the movement of the Federal Reserve to raise interest rates and, possibly, reduce the size of the Fed’s securities portfolio.

Then there is the government budget of the U.S., one that was aimed at a more settled and peaceful time, but one that is really out-of-place in the current times.

Obviously, there are other things that are contributing to the disorder in the world right now, and they just add to the radical uncertainty that exists within the world right now.

China is one of the bigger pieces in this picture that is contributing to the unknown future.

All-in-all, the world is a mess, and the radical uncertainty that exists at the present time means that policymakers really only have a very vague picture of what might possibly happen in the future.

And, the economic models that are being used at this time were constructed in a different world, one that is substantially different from the world we are now moving through.

Inflation

Experts talk about what is currently causing inflation and the talk all seems nice.

But, when one really tries to put things together, all one gets is a little bit of this, and a little bit of that, and something is not happening now, but other things are also going on.

The picture is one of disarray, and there seems to be no common thread going through all the talk.

There is the Covid-19 thing. And, then, there is the Russian invasion of Ukraine.

There is the supply-chain problem. And, then there is the concern over what is happening to workers, who is retiring, who is not commuting, and who is changing careers.

Wages are sharply rising,

Then, according to the New York Times, housing costs continued to increase relatively quickly, though there was some deceleration in an index of rent for primary residences.”

“Those costs are likely to be a major factor determining the course of inflation in the months ahead.”

What?

Used car prices are up! Energy prices are up? And, what about other commodity prices?

Financial Markets Face Major Problems

Then there are the discontinuities connected with the financial markets.

Just this last week, several articles emerged with the information that there are some real problems arising in the debt markets.

One of the most prominent is the market for “blank-check companies,” or “Special Purpose Acquisition Companies” ((SPACs)).

I have written about the situation in this space in a recent piece, but the picture here is not good. Lots and lots of money was pumped into SPACs over the past two years and now the future is catching up to all that was done here.

But, there are other areas that have benefitted over the past two years from the largesse of the Federal Reserve.

Take for example the market for cryptocurrencies.

Riding on the crest of the money wave created by the Federal Reserve, Bitcoin reached a historically high price of over $67,000 on November 9, 2021.

By January 27, 2022, the closing price came in under $36,000.

on Tuesday, April 12, the closing price was just above $39,000.

Debt markets seem to be getting ready to be tested as the Federal Reserve works to raise interest rates and to reduce the size of its securities portfolio.

But, the Fed has a huge battle on its hands.

As of April 6, 2022, the commercial banking system has a total of over $3.8 trillion in excess reserves on its books.

Furthermore, with the inflation rate at 8.5 percent and the nominal rate of interest on the 10-year U.S. Treasury note around 2.75 percent, you have a negative “real” rate of interest, a rate that is a long way off from being “restrictive” in an economic sense.

Policymakers are talking about raising the Fed’s policy rate of interest by 50 basis points four or five times this year, but this will get the nominal rate of interest nowhere close to the inflation rate.

Talk about an example of disequilibrium!

What Happens If Fed Really Tightens Up?

The economy and the financial markets are in a mess.

And, what happens if the Fed really does tighten up and pushes up interest rates and moves to reduce the excess reserves in the banking system?

Well, the stock market could go into a substantial decline.

it finally seems as if investors are coming to believe that the Fed will tighten up for a while, although it took several weeks for them to really believe that the Fed was going to actually change things.

But, if stock prices are going to go into a decline, what is going to happen to SPACs? What is going to happen to the price of Bitcoin, a price that now possesses a high correlation coefficient with the Standard & Poor’s 500 Stock Index?

You get those stock prices falling, and the price of Bitcoin is going to drop as well. Bitcoin at $15,000?

And, these moves could be followed by other debt markets.

The problem, here, is greater than just inflation.

There are many markets that are in disequilibrium.

Radical uncertainty reigns. We don’t know what all the possible outcomes might be. And, be sure to toss the Ukrainian situation into this.

Mr. Jerome Powell, Fed Chair, and the Federal Reserve have a real dilemma in its future. Well, so do Mr. Biden.