Easy money Hard pains

 For the past 20 years or so, America has solved its economic problems by doing pretty much just one thing - printing new money (USD).

 

Alan Greenspan, after the burst of the dot com bubble reduced interest rates to 1%, left it there for longer and thereby causing the housing boom. Without the 1% cheap money from the FED, the housing prices wouldn't have risen. The housing boom burst in 2007 causing the financial crisis in 2008, and Ben Bernanke reduced interest rate to 0%. When growth didn't improve much until 2011 - he did multiple QE s and interest rate manipulations like operation twist. In simple English - America printed new money and funded the economy in the last 2 decades.

 

To climax that out, once the pandemic hit, printing new money was so rampant, the American tax payers just became irrelevant. The usual tax deadline of April 15 was postponed as it wasn't necessary. Some even suggested, we abolish the IRS and America can print its way out to any growth levels. Of course - it can't.

 

What was surprising during this time was - None of these new dollars caused inflation - officially. This is because of changes to the methodology of how the CPI was measured, lot of dollars ended up being outside the United States rather than within the country primarily because of import dependent economy.

 

With endless money printing, US seems to have reached the end of the rope now. Out of all the problems it can solve with money printing, one thing it cannot solve is to fix the problem of "domestic inflation".

 

Domestic inflation now in the US is 7% as per the CPI data released this week. The PPI inflation is more than 9%.

 

The Fed has come out with its reaction - they will trim the monthly Stimulus and stop it by March. Then they would raise interest rates through this year and next year. They say - we will be just under 2% Fed funds rate by end of 2023. The problem with this argument is - how come a 7% inflation problem be solved by 2% interest rate 2 years from now. It sounds really dumb. Cruelly no one is questioning that enough. Fed is clearly behind the curve here. They are trying to play catch-up. It looks too little, really late.

 

Any rolling back of easy money policy will cause economic crisis. It looks the tech-bubble and the crypto bubble have already been pricked as a result of the Fed's change of course. We need to see through 2022 to validate that.

 

If you took S&P 500 since the pandemic hit - it's up 30%. If you remove the momentum stocks FAANG out of that (meaning S&P 495) - The S&P is up 0%. That is the harsh reality of it. As stock market veteran says - The soldiers get killed first and then they come for the Generals.

 

One other clear sign of topping - Apple is a 3 trillion company in market cap. It is more than the Russel 2000 put together (all two thousand companies put together). India is a roughly 3 trillion economy. Apple, a mere cell phone/laptop making company replacing an economy of a billion people explains how big the bubble has got. So really looks the top this time.

 

The tech-savvy NASDAQ hit a correction territory already this week for a dead cat bounce. It will head down to it again soon. Of course, to go to the bear market, it needs to go to the correction territory first. Without an assurance of further easy money - I don't see how the already leveraged tech-industry can go higher still.

 

The crypto also seems to have topped. Bitcoin and Ethereum - top couples seems to be breaking down on critical levels. With the bond yields increasing - the backbone seem to be bending. What out for this one - the market seems to be crumbling down with no bottom in sight. The total recall (bond price + its remaining yields) crashed most last week, a level unseen in history.

 

Milton Freedman told inflation is completely and everywhere, a monetary phenomenon. Rising prices are consequences of monetary expansion.

 

What exposed the underlying sick US economy was the covid pandemic. With no savings in American families, the US government didn't have an option but to send people bank-checks, that they can cash in to survive the pandemic period. Without which people would have ended up in the streets without job prospects during a pandemic in play in the entire world.

 

If easy money pumped up asset prices, then by definition rolling them back would reduce asset prices.

 

The problem of inflation cannot be solved by any other means but by sucking out dollars in circulation. The trick would be to do that without causing a recession. Doing this is impossible taking into account the current outstanding debt.

 

Fast depleting worker productivity of the US worker is very concerning. No society can keep on consuming without producing the commodity. The labor productivity crashed, to a low of 60 years recently.

 

What is going to happen in 2022 is going to be interesting. This would be first year since the financial crisis - we have a really hawkish Fed with a job on its hand to solve the inflation mess. It's affecting all people and the ruling Democrats want to minimize the pain before the mid-term elections in November.

 

Doing the right thing now - is not monthly quarter percent hikes over the next couple of years. What is needed is interest rate going to a number more than the 7% inflation number, say 8%. On top of that, roll back all QE programs and Fed has to reduce its balance sheet meaning instead of being a net buyers of US Treasuries, they need to be net sellers. The sad fact is - none of this is possible without crashing the whole economy that would make 2008 great financial crisis look like a walk in the park. On the other side - what if inflation goes to 10% or 15% or 20% ? That would need a even more bitter medicine to a even sicker economy. The Fed has really trapped itself to a corner and it doesn’t have a painless option. More than anything else - the credibility of the Fed is challenged. They had to go back on the word "inflation is transitory". It was a big miss when you have 800 PHDs in your payroll. It was absolutely clear - inflation was persistent and nowhere transitory. To save a daily insult - the chairman had to go out of the way to "retire" the term transitory for everyone. Reminds us all about Ben Bernanke - who infamously told the US Congress, the subprime crisis was tiny and will not affect the housing prices - only to see the entire mortgage market was toxic to its core triggering a global financial crisis unseen in generations.

 

Overall 2022 will be the year of rampant inflation. The 7% is just the start. The FED has to raise interest rates very aggressively than they think. Every time this has happened - something broke causing a crisis. This time is no different.