If you’re an old movie buff like me, you love Abbott and Costello. These guys always had movie titles where they “Meet” someone, ie” Abbott and Costello meet The Wolfman or Abbott and Costello Meet The Mummy. So why have a title Abbott and Costello Meet The Killer (Jerome Powell)? To understand this inside joke, you have to listen to Abbott and Costello’s marvelous routine “Who’s on first?” The gag has the two comics naming ballplayers that all happen to have interrogative pronouns for names. Who’s on first, What’s on second, I Don’t Know’s on third etc. So when Lou Costello asks “who’s on third?” Bud Powell answers, Who’s on first, I Don’t Know is on third. Lou: “I don’t know is on third?” Bud: “Yes.” Lou: What’s the guy’s name on third?” Bud: “I don’t know’s on third. What’s on second.” And so it goes until Lou eventually says “ I don’t know,” they simultaneously point and say “Third base.” Still makes me smile just writing it. The reason I chose this story to frame the current Fed dilemma, is because no matter what the Fed does, it’s inflationary
Hindsight is 20/20, so of course we can see that The Fed should have stopped their QE bond buying long before February 2022 and they should have started raising rates mid to late 2021. Heaven knows it was patently obvious to anyone in the housing trade that inflation was running amuck. That said, raising rates sooner would have helped for sure, but it would not have substantively changed our situation. Why? Two words: War and Pandemic. (Ask Tim A Question) As much as people want to point fingers at the Fed, the reality is inflation was coming with a war in the form of energy inflation. You can’t have one of the leading producers of petroleum and natural gas, suddenly stop selling without driving the price of those energies up. In turn, higher fuel cost adds cost to everything because everything requires manufacturing or transportation and that requires energy. Adding costs to produce or deliver something is inflationary. If you recall, it was the Oil Embargo of 1973 that spurred the incredible inflation of the 1970’s and early 1980’s. Equally inflationary, the Pandemic shut down the supply chain both here and abroad, which created scarcity. Scarcity raises prices and that’s inflationary. To avert economic catastrophe resulting from the pandemic, Congress (under both administrations I might add) authorized huge fiscal stimulus and so the Treasury had to print a lot of money. This flood of dollars for scarce goods is – you got it, inflationary. None of these situations are controlled or even influenced by monetary policy. This brings us to Abbott and Costello when throughout their routine eventually Costello says, “I don’t know” and the duo respond in unison, “Third Base.” So now when you look at any action the Fed takes in order to curtail, contain or reverse inflation, like the gag, substitute inflationary for “Third base”. (Search for homes here)
For example, The Fed is raising interest rates at an unprecedented pace without waiting for the effects to manifest. But this is designed to slow the economy, right? Yes but… higher US rates make the US Dollar stronger. A stronger dollar means Europe, England and Asia have to pay more of their weakened currency to buy American goods and services. This is globally inflationary. Those nation states in turn raise the price of their goods and you got it, inflationary. The Fed bought mortgage-backed securities, US and corporate debt known as Quantitative Easing or QE, as a means to get us out of The Great Recession and again when the Pandemic forced us to shut down the economy. So how does the Fed buy debt and where do those dollars come from? They have the Treasury print more money which is… inflationary. Now they have increased their balance sheet to a whopping $9 Trillion. They need to reduce that balance sheet and sell off that debt.
This is known as Quantitative Tightening, or QT, and they began selling debt in early September. This is a good thing though, right? It puts pressure on rates as they are not only not a buyer (decreasing demand) but they are actually a net seller (increasing supply). This means more bonds in the market, which must be discounted to sell to a reduced number of buyers and this raises rates which slows the economy. This is another way to attack the demand side of inflation by effectively taking those excess pandemic dollars out of the economy. By removing dollars from the economy, the Fed is shrinking the Money Supply. Remember, inflation is too many dollars chasing too few goods. So, the Fed sells bonds in exchange for dollars and those dollars come out of circulation and are given back to the Treasury. Great news, right? Yes except… when you reduce the supply of something, in this case dollars, you make the value of the existing dollars go up, making the dollar even stronger against foreign currency which is, you guessed it, inflationary. Damned if you do, damned if you don’t. Anything the Fed tries will be inflationary so long as there’s a war in Europe and a supply chain issue. Crushing US demand will slow the economy and almost certainly drive us into a recession, but will it stop inflation? The answer is it will slow inflation and maybe reduce it some but no it won’t stop inflation. What will stop inflation is an increase in supply. You can’t stop inflation by only addressing the domestic demand side. That just punishes working Americans and American business.
So, like The Abbott and Costello routine, if you ask me: “Who’s on first?” I’ll say, “Yes”. If you ask, What’s the guy’s name on first? I’ll say, “What is on second, Who is on first.” when you say, “I don’t know!” together we say, “He’s on third.” So when Jerome Powell says, “Let’s raise rates or let’s shrink the money supply,” we say in unison: “Inflationary.”