The Fed, Tapering, and the Return of Stagflation

The Fed, Tapering, and the Return of Stagflation

It’s the moment of truth for the Fed. Actions taken today- including non-actions- will inevitably decide how the post-2008 policy experiment plays out as we reach the endgame. The endgame is now. I say now, because everything that happens later is the mere unfolding, the post-factum. The Fed, Tapering, and the Return of Stagflation- what to know.

Raising Rates- A Fed Conundrum

To tighten or not to tighten? But all is not well behind closed doors of the Federal Reserve. Well, as the old saying goes, “Damned if you do, damned if you don’t”. We’ve reached a situation where balance sheets are just so bloated, with everything inflating around you, from stocks to houses to markets of all sorts and types. Cash is so cheap and so abundant that kids are playing the stock market like a Play Station 5 console (if you can get your hand on one these days given the massive chip shortages, and very relevant to our story by the way).

In the meanwhile, the global economy is still recovering from the Covid-19 pandemic that disrupted supply chains and amplified the risks of a bursting of an inflationary debt crisis. Policymakers are trying to do so much, from stimulating the economy to supporting the labour market to investing in trillion-dollar infrastructure deals.. But the Fed can only do so much alongside its main task of controlling prices and protecting the Dollar.

The US Dollar, I emphasize. So the Fed is stuck; damned if you do, damned if you don’t. If the Fed does go ahead and taper in order to control inflation and prevent over-heating, we might well be on course towards a global recession, with endemic failures in debt markets, the stock market etc.. Remember taper tantrum? But this time we’re talking about something much bigger, given the extent of indebtedness of the US government as well as the global economy post-2008.

So How Will It Play Out?

For those in developing countries, especially the “failed-state-sort-of” developing countries, the story is all too familiar. The Venezuelas, Zimbabwes and Lebanons of the world.. Of course, they tell us, the Fed won’t taper. What the Fed will do is continue to monetize debt, allowing inflation to inevitably rise out of control. While the US is in no way comparable to Venezuela, the point is that inflation is back! And it’s back in a vulnerable world struggling to find growth and recovery. What’s funny is that once upon a time, the world debate was fixated on quantitative easing and when to wrap up the quantitative easing program (in the US and Europe for instance). Today, the debate is irrelevant, with central banks lacking the suitable firepower to address a problem of such magnitude without waking up the demons and letting hell break loose.

With inflation already rising above Fed projections, it’s about time it tapers if it does indeed intend to. However, with each day that passes, it is increasingly likely that we’re taking the other route. On a more positive note, the good news is that we’re all closer than ever to becoming millionaires! And for those willing to trade through an unprecedentedly long period of inflation ahead, I say play safe, diversify, and diversify. On a not so cheerful note, good luck if you’re a saver. Worse, good luck being an employee or wage-earner like the majority of us.

A Note on Stagflation- Lessons From the 1970s

Yes, the 1970s. It was the last time that the world- at least some very major world economies- experienced stagflation. Stagflation is a mix of 3 ingredients- rising prices, unemployment and recession. Sounds very much like the world economy today, huh? Monetary-instigated inflation is on full display. Unemployment is at record highs in the aftermath of the pandemic. And the economy is struggling to recover from the Covid-19 global recession. Add to that a stagflationary force driven by technology, climate investments and climate policy, new investments in labor as evidenced by President Biden’s trillion-dollar pay check stimuli, supply chain disruptions and even more the regionalization of the world economy.. We’re in for a wild ride.

On the policy front, how did the Fed deal with stagflation? Enter Federal Reserve Chair Paul Volcker in 1979 with the clear of objective of tightening monetary policy, in the process raising rates to double-digit levels. While the war on inflation did indeed get prices back under control, in the meanwhile, the economy plunged into recession in 1981. Since Jay Powell’s term expires soon, imagine Paul Volcker being reappointed as Federal Reserve Chair today, with a mandate to wage a new war on inflation. Can he raise rates to double-digit levels as done in the 1980s? It’s 2021, not 1979. The US debt-to-GDP ratio has ballooned since, surpassing the 100% benchmark and showing no signs of abating. Even moderate rate hikes could crash the bond market and have massive repercussions for the stock market and the entire global economy.

Have You Been To Dollar Tree Recently?

If you’re like me, then you enjoy the thrill-of-the-hunt for value products. Dollar Stores such as Dollar Tree offer plenty to hunt for. Recently, they announced that they will no longer be able to sell One-Dollar items, instead announcing $1.25, $1.5, $1.75 and $2 products.

Next time you visit your local Dollar Tree store, keep an eye on prices. Paying 25 cents more might not sound like much has changed, but think twice. If you depend on a fixed salary to pay your rent and utility bills, then you should ask yourself how you’re going to hedge against inflation. This is especially true in the US where labour unions have not succeeded in raising wages proportionately with the so-called 2% inflation over the past few decades. It worked then for many reasons, which today are beyond the scope of this article (globalization flooded your local Target store with Chinese goods, keeping prices under control- we’re talking specifically about the basket of goods demanded by the average Joe).

Anyway, it’s different today, and you’re going to feel it sooner rather than later. A $15 minimum wage won’t be enough, though a very successful PR stunt by the companies that recently adopted it across the US. Check out our article about saving here.