“Transitory” Inflation?

The United States Department of Labor informs us:

September consumer prices trampolined to the highest annual level in 13 years… to 5.4%.

Energy prices are 1.3% costlier — and nearly 25% costlier since September last.

Eating costs 0.9% more since last month — and 4.6% for the year.

Eggs and various meats are 10.5% dearer this year. Specific meats — beef — are 17.6% dearer this year.

If it is explanation you seek, Mr. Brian Crosby of Traub Capital Partners is the man you want:

Consumer prices continue to rise, particularly as demand driven by people returning to post-vaccination life outstrips supply that is increasingly constrained by logistics and labor shortages.

Escalating prices are so extravagant, the Social Security Administration is increasing its cost-of-living adjustment 5.9% next year.

That is its largest annual increase in nearly 40 years. For the past 10, 1.65% has been about par.

Could Inflation Actually Be 14%?

We hadn’t the heart to consult Mr. John Williams’ ShadowStats site.

That is because this fellow scatters the statistical fogs — the statistical fogs government throws up to conceal true inflation.

We feared a true accounting would fluster us, wobble us and diminish our already diminished spirits.

We therefore assigned a minion the task. From him, by way of Mr. Williams, we learn:

The official rate runs to 5.4%, it is true. Yet if government number-manglers gauged inflation as they did in 1990, the true inflation rate goes at 9%.

And if they gauged inflation by 1980’s rules?

Consumer inflation races to a galloping and dollar-devouring 14% — approximately.

The Price of Victory

In 1981, still going by 1980’s rules, inflation ran to 15%. To scotch the inflationary menace, Paul Volcker manhandled the federal funds rate to an astounding 20%.

He won his war, he vanquished his Hitler… though at horrific cost. The casualty lists were atrocious.

The ensuing 1981–82 recession was — in fact — the greatest economic tremble since the Great Depression.

Volcker’s devastating conflict nonetheless cleared the way for subsequent boom years.

Now come forward…

If John Williams gives the true inflation rate, today’s 14% rate approaches 1981’s 15%.

What if Inflation Isn’t “Transitory”?

Unlike 1981… today’s federal funds rate squats near zero. There it will likely remain deep into calendar year 2022.

A question then dangles in the air:

If inflation does not prove “transitory”… as Mr. Powell believes it will… and gallops on and on instead… how will he get his hands on it?

“The key risk here is that shortages persist for longer than we anticipate and prices rise more substantially,” warns Capital Economics’ Neil Shearing.

“We prepare for probabilities and eventualities,” says JP Morgan CEO Jamie Dimon. “And,” he continues, “one of those probabilities is that [inflation] might go higher than people think.”

Dissension in the Ranks

Even Federal Reserve officials are beginning to cough behind their hands, anxiously, nervously. They begin to harbor severe doubts concerning the “transitory” theory.

For example, Mr. Raphael Bostic, base commander of the Federal Reserve’s Atlanta garrison:

It is becoming increasingly clear that the feature of this episode that has animated price pressures — mainly the intense and widespread supply chain disruptions — will not be brief. Data from multiple sources point to these lasting longer than most initially thought. By this definition, then, the forces are not transitory.

We hazard the business would require a severe manipulation of the federal funds rate — upward.

But of course our friend Powell cannot severely manipulate the federal funds rate upward.

Trapped at Zero

Even a return to historically average rates — perhaps 5% — would send the economy heaping down, wrecked and collapsed.

Mr. Lance Roberts of Real Investment Advice:

The problem, however, between today and the 1970s is the massive debt and leverage levels in the U.S. economy. Thus, any significant rise in rates almost immediately leads to recessionary spats in the economy.

And a 20% rate? The very heavens would fall.

We must also consider long-term rates…

The United States groans under debts multiple times 1981’s debts. Servicing today’s $29 trillion debt would fracture the spine.

It is only endurable now because of rates that scarcely register.

Hobson’s Choice

But inflation cannot be allowed to go amok, to trample its way through the dollar.

What will Mr. Powell do if inflation endures?

He may find himself hanging from the hooks of a mighty dilemma…

Choke inflation… which will choke the economy… or let inflation go… which will flatten the dollar… and ultimately the economy.

But we must consider this one possibility: Deeply entrenched economic forces may take this poor fellow down from his pointy hook…

A Different World

The aforesaid Lance Roberts:

Interest rates rose during three previous periods in history. During the economic/inflationary spike in the early 1860s and again during the “Golden Age” from 19001929. The most recent period was during the prolonged manufacturing cycle in the 1950s and ’60s. That cycle followed the end of World War II where the U.S. was the global manufacturing epicenter…

Today, the U.S. is no longer the manufacturing epicenter of the world. Labor and capital flow to the lowest-cost providers to effectively export inflation from the U.S., and deflation gets imported. Technology and productivity gains ultimately suppress labor and wage growth rates over time…

This is not the situation presently obtaining:

During the current period, real economic growth remains lackluster. In addition, real unemployment remains high, with millions of individuals simply no longer counted or resorting to part-time work to make ends meet…

One crucial difference is the rate of population growth, which, as opposed to the Depression era, has been on a steady and consistent decline since the 1950s. This decline in population growth and fertility rates will potentially lead to further economic complications as the baby boomer generation migrates into retirement and becomes a net drag on financial infrastructure.

No Upward Pressure on Rates

Must we conclude, then, Mr. Roberts, that rates will remain squelched?:

Interest rates are ultimately a reflection of economic growth, inflation and monetary velocity. Therefore, given the globe is awash in deflation, caused by weak economic output and exceedingly low levels of monetary velocity, there is no pressure to push rates sustainably higher…

Rates rise in conjunction with more substantial levels of economic growth. Such is because more substantial growth leads to higher wages and inflation, causing rates to rise accordingly…

In conclusion:

Today, despite trillions of dollars of interventions, zero interest rates and numerous bailouts, the economy has yet to gain any real traction, particularly on “Main Street”…

The catalysts needed to create the economic growth required to drive interest rates substantially higher, as we saw previous to 1980, are not available today. Such will be the case for decades to come.

The Good and the Bad

Here then is the positive news, assuming this analysis holds the water in:

Inflation will go back in its cage once fractured supply chains undergo relinking. Interest rates will not go skyshooting. They will not send the economy careening along opposite trajectories.

But with the honey come the aloes, with the sweet comes the bitter…

The future may instead be a marathon run of struggling growth, of stagnating incomes, of economic languishing.

That is, we may confront a future not of sudden collapse but of gray and twilight. Of habitual malaise…

Of a dank and drizzly November… month upon month… year upon year.

Which is worse?


Brian Maher

Brian Maher
Managing Editor, The Daily Reckoning

The Daily Reckoning