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Something Big Has Already Broken: Price Stability
Wolf Richter

The Fed will tighten “Until Something Breaks?” Wait a minute…

There is a lot of tongue-wagging on Wall Street and in the financial media to the effect that the Federal Reserve will tighten – meaning hike rates and shed assets – until something breaks.

But that’s kind of funny when you think about it. Because the biggest thing that the Federal Reserve is in charge of, the most crucial thing that underlies a healthy economy and a healthy labor market has already broken: price stability.

It broke into tiny little pieces. Instead of price stability, we have raging inflation. And now the Fed is trying to fix it.

But hedge fund gurus and bond kings and stock-fund apostles and other crybabies on Wall Street who don’t give a hoot about this raging consumer-price inflation because they’re rich and don’t mind having to pay a little extra for some stuff, but who’re losing their shirts because asset prices are skidding lower, and they do mind that, well, they’re on TV and on the internet and on Bloomberg and the Wall Street Journal bemoaning the consequences of the end of free money.

And they’re right: these asset prices have gone down in reaction to the Fed’s tightening policies this year that are beginning to reverse many years of money printing and interest rate repression.

The years of QE and near-0% interest since 2008 have created the Everything Bubble, and now the Everything Bubble is deflating.

And these hedge fund gurus and bond kings and stock-fund apostles and other crybabies on Wall Street are saying that things are already breaking, that markets are stressed, and that in x months, like in November, something big will break that will cause the Fed to pivot into cutting rates and restarting another money-printing binge.

That’s what they want: They want the Fed to cut rates and restart QE as to re-inflate the Everything Bubble so that these folks can get even richer. They have big investments, and those investments have now soured, and they want the Fed to U-turn in order to bail out their investments.

And they don’t give a hoot about this raging inflation because they’re rich and don’t even notice if they have to pay extra for consumer goods and services.

And if something breaks, meaning if some portion of the market crashes somewhere, or rates blow out somewhere, say in the repo market like it did in late 2019, that no one outside the repo market even noticed, or if something even bigger breaks, they hope that the Fed would then cut rates and restart QE to re-inflate their asset prices.

And in fact, they want something to break, they’re praying for something to break, they’re trying to scare markets so that something will break, in order to force the Fed into this pivot.

The simple fact is this: stocks, bonds, the housing market, cryptos, etc., etc., they were all hyper-inflated by years of the Fed’s money printing and interest rate repression, that started in late 2008. And after a brief pause in 2017 through 2019, the Fed went hog-wild starting in March 2020 when it printed $5 trillion in two years and threw it at the markets.

Since 2008, the Fed has printed $8 trillion and threw this money at the markets. And for most of the time since 2008, the Fed has repressed short-term interest rates to near 0%.

Big institutional investors and speculators could borrow short-term in the repo market for near 0% interest. This was as close to free money as you could get, and they borrowed this nearly free money and speculated with it, and now the interest rate in the repo market is over 3%, and it may be over 4% by year end, and higher next year, and that’s a bitter pill to swallow if you’ve gotten fat after 14 years of free money.

The free money era got started in Japan 22 years ago. And by 2008, there still wasn’t a lot of consumer price inflation in Japan. And so when the Financial Crisis broke out, the Federal Reserve saw that QE and 0% interest rates didn’t cause a lot of consumer price inflation in Japan, and so it too tried those emergency measures to bail out the banks and the hedge funds and whoever held a lot of assets. And when it didn’t cause consumer price inflation, but just asset price inflation, meaning it inflated stock prices and bond prices and housing prices, the Fed enlarged QE and extended it, and kept 0% interest rates in place for years.

And when the European Central Bank saw that these policies didn’t trigger a lot of consumer price inflation in the US and Japan, it too dove into them in 2012 in response to the euro debt crisis, and it expanded them and fattened them up over the years, and it didn’t cause a lot of consumer price inflation either, only asset price inflation.

Back then, these policies didn’t cause a lot of consumer price inflation because consumers didn’t get this money. Central banks handed this money to big investors, and they bought more investments, and asset prices continued to inflate, but little of this money got spent in the economy, and didn’t trigger consumer price inflation.

Meanwhile, savers and yield investors saw their cash-flows crushed, and they relied on this cash-flow to spend, but that cash flow dried up and they couldn’t spend it, and that actually weighed on consumer spending.

So when the pandemic hit the markets in March 2020, central banks went hog-wild, printing huge amounts of money around the globe, and repressing interest rates to zero % or below zero %. And they figured none of this – despite the huge unprecedented magnitude – would cause consumer price inflation because it didn’t do it in the years before.

And governments issued a huge amount of new debt, and they could because central banks were buying huge amounts of government debt at the same time as part of their QE, and then governments threw this borrowed money at everything they could see: consumers, businesses, state and local governments, trillions of dollars in direct payments and subsidies flooded every aspect of the economy. And this money did get spent.

And the gains in the stock market, in cryptos, in the housing market, in the bond market were so huge that people started spending some of these gains to buy $100,000 pickup trucks, home remodels, consumer electronics of all kinds, patio furniture, you name it.

And central banks still thought these monetary and fiscal trillions – in the US close to $10 trillion – wouldn’t cause inflation. But they were wrong. Consumer price inflation suddenly took off in early 2021. The dam had broken. 40 years of price stability had broken, and inflation was washing over the globe. Even in Japan now. And massively in the US, and even more massively in Europe. The whole thing just exploded.

And central banks – still delusional back then about the idea that their radical policies would ever break price stability because it hadn’t done it in the prior years – well, they brushed off the problem, they called this inflation temporary, and kept printing vast amounts of money and repressing interest to 0%, or below 0%, even as inflation was beginning to rage, in an act of incomprehensible recklessness, and it wasn’t until earlier this year that it seriously dawned on them that something huge had broken into a million little pieces: price stability.

But now they have figured it out. Now they see it. The biggest thing they’re in charge of – price stability – has broken, and they broke it, and the government’s radical stimulus policies starting in March 2020 broke it, and there is now so much excess liquidity out there chasing after all kinds of stuff, that it will be very hard to crack down on inflation effectively, and to re-establish price stability.

Inflation dishes up lots of surprises. It has a life of its own. You think you got it whacked down, and then it rises from the ashes all over again. That happened in the 1970s and early 1980s. This is what central banks are facing.

But the Fed has now figured it out. The Fed has pointed out many times over the past few months that a healthy labor market needs price stability; that consumers need price stability; that you cannot have a healthy economy without price stability.

So OK, their version of “price stability” isn’t my version. Their version of price stability is 2% inflation as measured by the core PCE price index, which is the lowest lowball price index we have. And my version of price stability is 0% inflation based on some realistic price index. But hey, close enough given where we are – which is raging inflation.

Price stability by whatever measure has broken. It probably cracked in late 2020. By early 2021, the pieces of price stability were scattered all over the place for all to see, and I started screaming about it then. But the Fed was still hammering away at these scattered pieces with QE and 0% interest rates to break them into even smaller shards.

For the economy and the labor market to function, for consumers to earn and spend at a healthy pace, price stability needs to be fixed.

And the Fed knows that. And it’s hiking interest rates and shedding assets in order to fix the biggest thing that it is in charge of that has already broken.

A repo market blowout or a hedge fund implosion or whatever is a minor event compared to the raging inflation. And for hedge fund gurus and bond kings and stock-fund apostles and other crybabies on Wall Street to say that the Fed will tighten until something breaks is just hilarious – because apparently they totally missed that something huge has already broken, and that the Fed will need to fix that, even if it ruffles some feathers.

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Founder, Wolf Street Corp, publisher of WOLF STREET.

In his cynical, tongue-in-cheek manner, he muses on WOLF STREET about economic, business, and financial issues, Wall Street shenanigans, complex entanglements, and other things, debacles, and opportunities that catch his eye in the US, Europe, Japan, and occasionally China.

Wolf lives in San Francisco. He has over twenty years of C-level operations experience, including turnarounds and a VC-funded startup. He has a BA, MA, and MBA (UT at Austin).

In his prior life, he worked in Texas and Oklahoma, including a decade as General Manager and COO of a large Ford dealership and its subsidiaries. But one day, he quit and went to France for seven weeks to open himself up to new possibilities, which degenerated into a life-altering three-year journey across 100 countries on all continents, much of it overland, that almost swallowed him up.

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