Inflation Is Getting Worse

An update on Unicus’s continued research into inflation and the markets.

For those who are new to our newsletter, here are our earlier insights on inflation👇

March Newsletter – Inflation Nation

22 August 2022- Idiots and Inflation

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What Should The Federal Funds Rate Be?

In February 2022, we informed our readers and clients that inflation was no longer “transitory.”

In March 2022, Unicus debunked the “excuse booth” from politicians and industry by sharing with our readers The Taylor Rule.

The Taylor Rule clearly showed that the Federal Funds Rate should be a whopping 11.328%

The Taylor Rule is a forecasting model used to determine the Federal Reserve Discount rate to shift the economy toward stable prices and full employment. Taylor's Rule suggests that the Federal Reserve should raise interest rates when inflation is high or employment exceeds full employment levels. Conversely, when inflation and employment levels are low, the Taylor rule implies that interest rates should be decreased.

A 4% to 5% unemployment rate is considered full employment. The natural unemployment rate represents the lowest unemployment rate whereby inflation is stable or the unemployment rate with non-accelerating inflation. At 3.7% unemployment and 1.7 jobs being offered for each unemployed person, the US is well beyond full employment.

The Taylor Rule  r=p+0.5y+0.5(p-2)+2

R is the Federal Funds rate

November unemployment rate is 3.7%

October inflation rate was 7.75%

GDP Growth rate last was 2.9%. On Average, for the last four quarters, it is currently 7.7%

GDP Growth rate since 2000 is 2.6%

This means the Federal Funds, according to the Taylor rule, should now be at 13.48%

The Federal Funds rates have been raised from 0.8% in February 2022 to 3.78%. as of 10 December 2022. The US is far from addressing inflation by raising the Federal Funds Rate.

Why Is Inflation So Difficult?

As Milton Friedman has famously said, "Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output." MV = PY. Money times velocity equals the price level times GDP, or income, represented by Y.

If you increase the money supply, and the U.S. has increased the money supply a lot, and the velocity doesn't change, and output doesn't change, the only thing that happens is inflation.

US Government spending is the problem.

US FY       Deficit Spending

                                                    2019            1.1 Trillion

                                                    2020            3.2 Trillion

                                                    2021            2.8 Trillion

In FY 2022, the federal government spent $6.27 trillion. This means federal spending was equal to 25% of the total gross domestic product (GDP), or economic activity, of the United States. Wow!  This is on top of the massive increase in the collection of taxes. From 2020 to 2022, the revenue from taxation went from 4 Trillion to almost 5 trillion, a 20% increase in revenue, and the US Congress managed to spend that increase and more.

Further government is a full third later than it was before COVID.  Based on historical trends, it will grow.

Total US Debt

US FY      Total Debt

                                                    2018            21 Trillion

                                                    2019            23 Trillion

                                                    2020            24 Trillion

                                                    2021            29 Trillion

                                                    2022            31 Trillion

The Balance Sheet of the Federal Reserve

In 2008 and the financial crises, the government and bankers chose to do whatever was necessary to deal with the 2008-09 financial crises. One of the actions was for the Federal Reserve to begin buying US Treasuries. It was called quantitively easing. It was supposed to be a temporary response to the 2008-09 financial crises. It has gone on to be de rigueur, a normal thing.

If you had told a banker in the early 2000s that a government would issue debt on Monday and the Central Bank would buy it on Tuesday, the banker would have asked you “What Banana Republic is doing that?”  Quantitative easing has never stopped. Quantitive Easing has grown worse and appears cancerous. With the US in debt to the tune of 31 trillion and the Federal Reserve owning over 25% of the nation's debt, the Federal Reserve can't come to the rescue.

Also – every time the Federal Reserve raises the interest rates, the overall value of the Federal Reserve’s US Government debt or any other debt– declines. The Federal Reserve has a massive conflict of interest. MASSIVE.  It could be argued that the Federal Reserve’s failure to act earlier and more aggressively could be a result of this conflict of interest.

Did the Federal Reserve see this coming for January 2022? Yes, they did.  They telegraphed their hand.  From BankRate.com:

“For nearly two years, the Federal Reserve has been entangled in what’s basically one of the world’s most important pawn shops: “the repo market.” Short for repurchase agreements, the repo market is a complicated yet important area of the U.S. financial system where firms trade trillions of dollars worth of debt for cash daily. Just as quantitative easing (Q.E.) increases the amount of bank reserves in the system, the opposite process of selling off assets vacuums them out. All in all, the Fed took about a trillion dollars out of the system. The repo market’s dysfunction showed that officials might’ve taken the process too far. “I don’t believe for a second that you can take nearly a trillion dollars out of the system and something’s not going to go bump in the night,” says Greg McBride, CFA, Bankrate's chief financial analyst. “What we saw in the repo market was a direct result of that.”

The Federal Reserve was trying to take liquidity out of the market to stem inflation. How much? Well, take a look:

Yes, dear Weekender reader, the Federal Reserve entered the reverse repo market in the 2nd Quarter of 2021! The Fed entered the market to dry up liquidity in hopes that the reduction in liquidity would cool the potential inflation from the US Congress over spending, while at the same time not raising the Fed Funds rate and crushing the Federal Reserve’s balance sheet. Remember the Federal Reserve is a private company owned by the money center banks.

So, where is the real problem?

It is the US House, Senate, and the President.  They have spent too much and are spending even more.

CNBC 29 October 2022 – says it all.

“ Speaking to CNBC from Rome where she (Janet Yellen) is attending the G-20 conference of global leaders, Yellen renewed her push for White House spending plans that are unpopular with several factions of Congress and have yet to be approved.

“I don’t think that these investments will drive up inflation at all,” she told CNBC’s Sara Eisen during a live “Worldwide Exchange” interview.

The $1 trillion infrastructure and companion $1.8 trillion climate and social spending spending plans have been pared back considerably during negotiations with Congress. At their core is an effort to improve the nation’s infrastructure, over which the Biden administration has cast a wide umbrella of not only the traditional investments in roads and bridges, but also across a wide swath of social programs like early child care.”

Yes, “spending spending” was in the article. The US government is spending too much. The US Treasury is selling the bonds, and the Federal Reserve is buying 25% of them or more. If the Federal Reserve had quit buying the bonds, quantitative easing,  the interest rate would have risen years ago but to a lower level.  The Federal Reserve has made inflation worse, not better, through quantitative easing and the aggressive entrance into the Reverse Repo pawn shop market.

👉The Infrastructure bill is inflationary.

👉Student loan forgiveness is inflationary.

👉The social programs are inflationary.

👉Federal spending increases are inflationary

But wait, there is more.

👉Restricting supply is inflationary.

The Federal Government, with help from the state governments, is also restricting labor.  The generous befits of Federal and State governments are keeping people from the workforce. The generous tax-free benefits in some states are so good that a worker would need to earn over $60,000 a year to make after taxes the same that they pocket on tax-free benefits. Restricting the labor supply is inflationary.

Tariffs and restricting many imports – inflationary.

Restricting the importation of fuel, canceling exploration rights, canceling pipelines – inflationary.

Canceling mining permits for copper and nickel and other elements needed for the green revolution, you guessed it – inflationary.

Yet one more swipe at our leaders and the cost of inflation is the pain on the middle class and poor.

North America has been particularly hard hit; average real wage growth in the US and Canada fell to minus 3.2 percent in the first half of 2022. No wonder the hand-wringing about wage-price spirals among policymakers is so at odds with the actual experience of most North American workers.

While pandemic-related supply chain issues have mostly abated and energy markets are stabilizing, “wage increases are probably going to be an essential part of the [inflation] story going forward”, said Jerome Powell. “What you see is a real imbalance between supply and demand,” he continued, with wage inflation still too far above the Fed’s 2 percent inflation target rate for central bankers to relax.”

Yep, inflation is a cruel tax on the middle and lower-income people of the US.

FINALLY

Jerome Powell needs to go.  His errors are too significant.

Janet Yellen needs to go, her ignorance is too great, and she is, at her core, the Marie Antoinette of our inflation.

“Treasury Secretary Janet Yellen blamed consumers' excessive spending habits as a primary cause for the near 40-year-high in inflation on Wednesday.”

You can read the rest of Marie (Janet), Antoinette (Yellen) blaming the citizens of the US for inflation.

You can read the rest of the clueless and heartless ramble.

Here

So what does this mean?

The longer the bonds and/or debt, the more they will get hit. Middle-class staple retailers will be swatted. Lenders will be hard hit.  Anyone selling durable goods such as construction equipment, farm equipment, high-end medical equipment, homes, and cars will be hurt.

WEEKENDER MUSIC

Phillip Glass Koyaanisqatsi – In Hopi, the meaning is Life in Turmoil or Disintegrating.

REM – It’s the End OF Life As We Know It.

The Rolling Stones – Sympathy For The Devil

L. Burke Files CACM, DDP

Senior Researcher and Advisor to the Founder of

Unicus Research, LLC.