Tuesday, 27 September 2022 — Gold Coast, Australia

By Vern Gowdie Editor, The Daily Reckoning Australia

[8 min read]

Dear Reader,

What brilliant economic doctrine determined (somewhere in and around) 2% was the appropriate rate of inflation?

Was it devised by…Keynes? Minsky? Friedman? Schumpeter?

No. None of the above.

It was…a Kiwi politician.

During the 1980s, memory of the highly inflationary 1970s was still fresh in people’s minds. Was the inflation beast really tamed or would it go rogue again?

In 1988, NZ Finance Minister Roger Douglas (he of ‘Rogernomics’ fame) was asked in a TV interview about the appropriate level of inflation.

Roger Douglas made this off-the-cuff comment…‘[I am] aiming for inflation of around zero to 1 percent’.

The comment was not one of guidance, but of reassurance.

Don’t fret, the days of high inflation are behind us.

There was no economic science or formula to support Roger’s stated aim…the percentages were genuinely plucked out of the air.

The New York Times tells the rest of the story:

‘[In 1989] with Mr. Douglas’s figures as a starting point, Mr. Brash [NZ Reserve Bank Governor] and Mr. Caygill [the newly appointed NZ Finance Minister], agreed that it would be best to expand the range to give them more room to maneuver, but only a bit. New Zealand would aim for inflation between zero and 2 percent.

‘Not surprisingly, the passage of a law to reform the central bank governance of an archipelago of 3.4 million people received no coverage in the major American papers. But across the close-knit world of global central bankers, people started to notice the Kiwis’ monetary policy experiment.’

What was experimental is now enshrined

All major central banks have adopted the completely arbitrary 2% as the inflation target:

And the big dog of central banks ask:

To which it answers (emphasis added):

‘The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability.’

The randomly selected 2% is the Holy Grail our (clueless) inflation warriors so covet…and slavishly pursue.

Belief in this target is now so absolute, no one in the economics profession or financial industry asks the question ‘why do we have this target?’.

Even though there isn’t a shred of evidence to support its existence, society has come to accept the target as gospel.

If people were asked ‘which of the following household budget items would you like to pay more for next year and indefinitely…electricity, fuel, food, education, alcohol, housing, etc.?’…

How many would agree to voluntarily paying more?

My guess…none.

Oh, but the rising cost of living is offset by CPI wage increases.

Hmmm…dog chasing tail comes to mind.

Costs go up 2%.

Wages go up 2% BEFORE tax.

In net terms, wouldn’t it be better to have ZERO CPI and ZERO wage growth?

Unfortunately, this far better outcome fails to satisfy one very important policy agenda…it doesn’t create the illusion of growth.

Ignorance enabled the Fed

Universal acceptance (or ignorance) of this mythical target is what enabled the Fed (and other major central banks) to not only begin, but doggedly persist with the most batsh*t crazy stimulus strategy in history.

The Fed was legislated into existence in 1913.

Over the next 95 years (to 2008), US money supply (M2) grew to US$7.5 trillion.

In the space of just 14 short years (2008 to 2022), M2 did not just double…it tripled.

M2 now totals US$22 trillion.

After 2008, the Fed’s foot remained on the interest rate throat for seven long years…then the foot was lifted slightly…until COVID. Then the Fed’s foot was slammed down hard again.

Savers choked and borrowers went for broke:

This reckless and completely unhinged strategy was done all in the name of achieving…2 percent…as measured by the annual change in the price index for personal consumption expenditures [PCE].

What did yield starvation, excessive money printing, outright market manipulation, and liberating society’s inner speculative spirit actually achieve?

The use of all this financial energy got the Fed close to (but not in excess of) the desired 2% annual change in personal consumption expenditures:

This bloody-minded commitment to hitting an imaginary target, combined with an equally bloody-minded commitment to rid the world of low cost and reliable energy, unleashed inflationary forces not seen for more than four decades.

Yes, COVID did disrupt supply chains.

However, overly generous fiscal and monetary policy responses put in motion an unexpected and unnecessary level of demand.

Too much money was chasing too few goods.

This blinkered approach to hitting a mythical 2% inflation target meant central banks ignored the far wider picture…the speculative bubbles, the demonisation of fossil fuels filtering through to higher commodity prices, the ballooning of private and public sector debt, and the artificial creation of demand.

The Fed’s extraordinary and unprecedented efforts (using QE and interest rates) to create a sustainable, ‘healthy’, and totally meaningless 2% inflation rate failed miserably.

Which brings us to the here and now.

What on Earth makes anyone think the Fed (or any other central bank), using basically the same tools (QT and interest rates), has a ‘snowball in Hell’s chance’ of engineering a ‘soft landing’?

Central bankers are reckless

These serial bubble blowers have proven beyond a shadow of doubt they are to economics what Charles Ponzi was to value investing.

Given their inability to see anything beyond the imagined 2% target, they’re likely to go too far in the opposite direction…raising rates beyond the level needed to curb consumer buying behaviour.

Plucking a target out of thin air, on its own, is silly enough.

But to then do all in your considerable power — irrespective of how nonsensical and reckless the policies of free money and plenty of it might be — to achieve this made-up objective, qualifies as certifiably insane.

This madness is accepted (by most) as responsible economic management.

Sadly, it’s going to take a whole lot of economic and financial pain before the penny drops with the public. Central bankers are pompous, incompetent morons…and that’s being oh-so polite.

This damning commentary applies to the whole central bank cohort.

Crises in every corner of the world

Europe. China. Japan. Britain. The US.

Each one is struggling with one or more crises…energy, debt, food, housing, and/or currency.

The idiotic pursuit of a target, manufactured into existence to serve a political purpose — to soothe public concerns — has put us between a rock and a hard place.

There are no good outcomes from here.

After decades of mismanagement, central bankers have run out of easy fixes.

Pushing the cost of debt servicing higher is going to make an already bad situation a whole lot worse.

And, if they don’t push interest rates up, they’ll risk a repeat of the 1970s…persistently high inflation.

5% inflation begets a 5% pay rise, which begets another higher CPI reading.

And the dog keeps chasing its tail.

Expecting those who created this problem to have the solution is most definitely a case of hope triumphing over our lived experience.

Central bankers ARE academic blowhards whose theories have proven time and again to produce bad outcomes.

How many more bubbles need to be blown and blown up to have this statement of fact recognised?

As always, the market WILL, in the fullness of time, provide the solution.

Folks, the party is over

Anyone expecting the next decade to be anything like the last one is going to be severely disappointed.

Just as the 1930s was nothing like the 1920s, the remainder of the 2020s is going to be the polar opposite of the 2010s.

DO NOT be conned by the central banks’ words of assurance.

The same neatly calibrated economic models that prompted Bernanke to say ‘subprime will be contained’ are now indicating a soft landing ahead.

What a joke.

Central banks have no idea how this is going to play out in the world outside their academic bubble. Market forces are highly unpredictable and when harnessed, extremely powerful.

Look at the recent win/loss record…

Dotcom bubble: Markets — One, Central Banks — Zero

US housing bubble: Markets — One, Central Banks — Zero

The everything bubble?

Are you willing to bet your financial future backing a different outcome this time around?

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

Larry Summers, ex US Secretary of the Treasury, went way out on a limb on Wednesday, Fox News was there: ‘Former Treasury Secretary Larry Summers predicts there will “almost certainly” be a “downturn in the economy”’:

‘Larry Summers, who served as U.S. Treasury Secretary under President Bill Clinton and was a White House economic adviser to President Barack Obama, predicted Wednesday that the economy will experience a “downturn” in the coming months as the Federal Reserve raises interest rates to combat inflation.’

Note to Larry: that’s the idea.

Three times so far this century, Mr Market tried to correct the nonsense and distortions caused by the Fed. In 2000 — with the Nasdaq crash. In 2008 — when the mortgage finance collapse caused a crisis on Wall Street. And then again, in 2020, when the feds panicked and shut down the economy to keep people from getting sick. 

Each time, Mr Fed rebuffed the attempt with more money and debt. The Fed refused to allow a correction. Zombie businesses that should have gone broke were kept on low-interest life support. Zombie investments that should have been wiped out were allowed to refinance at even lower rates. And the zombie feds themselves, their pockets as empty as their heads, were given trillions more dollars to spend as they saw fit. 

Then, in the beginning of 2022, the party was over. A ‘downturn in the economy’ was for real. For the first time in 40 years, it was open season on zombies.  

90 trillion reasons

It’s either inflate or…the zombies must die. Right now, the Fed’s campaign of raising the cost of borrowing is death to zombies. But it’s life to the dollar; it has made the dollar the world’s strongest currency. And it’s why the best thing you could have done with your money so far this year was simply to leave it in dollar cash.  

But in protecting the dollar, the Fed is also protecting the value of US$90 trillion worth of US debt. US$30 trillion of that is the debt of the US Government, which the feds desperately want to get rid of. And the question we left off with yesterday was how they were going to do it.

They can’t pay it — especially not at higher interest rates. And the higher rates greatly reduce their room to manoeuvre. They used to be able to spend as much as they wanted…confident that the Fed would ‘print’ enough to keep up with them. They simply issued a bond; the Fed bought it with cash it created especially for that purpose. And since interest rates were going down, their carrying costs actually went down as their debt went up.

But now…all that has changed. Now it is time for Mr Fed to be a hero again.  

The Fed claimed to have saved the economy in 2008. It aims to do it again…this time, not by reflating the economy, but by deflating it.

But the Fed-as-hero story ignores important flaws.  

Forgotten is the long period in which the villainous Fed transferred trillions of dollars to the richest and most powerful people in the country, favouring the country’s deciders with its unnaturally low interest rates. Forgotten too are the many years when the incompetent Fed failed to notice the nation’s debt reaching up to US$90 trillion…and inflation creeping up on its flank.

We will also draw a veil over the Fed’s ignorance, in which it thought inflation would be ending before it had even started…and the monumental conceit of former Fed head Ben Bernanke who tried to portray his own cowardly money-printing as ‘The Courage to Act’…and the preternatural imbecility of its former chief — now directing the US Treasury — Ms Janet Yellen:

‘Would I say there will never, ever be another financial crisis?’ she asked herself in 2017.     

‘…I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be’, she concluded.

Since then, there have been two financial crises. And she’s still alive.

Apocalypse when?

But we put all of that behind us…let bygones be bygones. Now, if we can believe it, this band of brothers and sisters is all that stands between us and the apocalypse. Either the Fed squashes inflation…or it squashes us.

The Fed’s leading man has been reborn as Paul Volcker; he will stomp on inflation with both feet.       

What remains to be seen is how our hero will resolve the apparent contradiction in the plot. He serves at the pleasure of the US Government…which is controlled by the elite.     

If he follows through on his program, and ‘normalises’ asset prices, the top 10% of the country — the elite — will lose as much as US$50 trillion in stock, bond, and real estate values. Congress, too, will be in a helluva jam, with US$30 trillion in debt and — at much higher interest rates — no way to refinance it. It will be unable to continue borrowing and spending at today’s pace. Horrors…it might even be forced to balance the budget.

Inflation destroys the economy...punishes consumers…and unsettles government and civil society. Runaway inflation is always a terrible thing for a nation to suffer. It should be stopped as quickly as possible.

But if you owe US$30 trillion…and you can’t pay it back…

…you might see things differently. You might see, for example, that inflation is not such a bad thing after all.

More to come…

Regards,

Bill Bonner,
For The Daily Reckoning Australia