Never Bark at the Big Dog. The Big Dog Is Always Right.
Back in January I published two issues of my subscriber-based newsletter where I predicted inflation for 2021 to reach ten percent. Virtually nobody else would touch such a radical forecast with a ten-foot pole. Most people were still speculating about whether or not inflation would even exceed the Federal Reserve’s two-percent target.
I understand them. If you are an insider, with access to mainstream media outlets, a nice position at a renowned think tank or research institution and a social reputation to think about, you don’t want to stand out from the crowd. You can draw criticism, ridicule and even be called names.
Much better to not rock the boat, and to wait for someone else to take the first step out of the mainstream center square.
Since then, mainstream economists have come around, one after the other, slowly but steadily joining a growing chorus of “higher inflation” warnings. Of course, nobody has dared to go all the way to ten percent, as I did, because the pace setters in the main stream are still reluctant to go anywhere near inflation forecasts in excess of five percent.
I, on the other hand, don’t have to worry about their social anxiety. I am independent, I do my own homework, my own quantitative and qualitative analysis, and I am not the least afraid of being ridiculed by stress-ridden mainstreamers.
I stand by my calculation that our monetized inflation gap remains big enough to produce a ten-percent inflation rate before the end of the year.
We are not there yet. So far – that is August – the consumer price index has risen 4.6 percent since the beginning of the year. This means the price increases for the rest of the year will have to be substantial if my prediction is going to come true.
I maintain that this is likely to happen. The CPI and PPI numbers for September will be out on Wednesday and Thursday, but we already have a hint of what they will tell us. Behold an October 7 analysis by Fernando Martin with the St. Louis branch of the Federal Reserve, who suggests an annualized CPI inflation rate of 6.6 percent for 2021.
Martin does a good job of discussing the technical aspects of inflation forecasting, and he eminently includes expectations as a driver of inflation. What he does not tell his readers is that expectations make inflation a self-fulfilling prophecy only when inflation has reached a certain level. When businesses and households see a need to re-negotiate or re-evaluate prices more frequently than at low inflation, by definition they build inflation into their behavior. I have made this point many times: a one-percent mark-up in prices twice a year is much less devastating over time than a one-percent mark-up four, six or 12 times per year.
A simple example demonstrates this point. A business sells its products for $10 apiece. Over the next 12 months,
- No adjustment of the price will keep it at $10 at the end of the year, thus zero percent inflation;
- A re-evaluation once every six months with a one-percent price mark up at each re-evaluation produces a 2.01 percent inflation rate for the whole year;
- Price adjustments every three months, again at one percent each time, compounds into 4.1 percent inflation; and
- Monthly increases of one percent totals an annual rate of 11.6 percent.
It is not well documented to what extent U.S. price setters have yet revised their pricing frequency, but I have reported previously on the Fed’s predictions from June, where they noted plans among America’s businesses for big price hikes in the coming months. Nevertheless, when the inflation rate changes in such a way that it disrupts regular business pricing plans, they can be expected to revise not only the size of each price change, but also the frequency by which they adjust prices.
This is the mechanism by which inflationary expectations become self-fulfilling prophecies. As hyper-inflation episodes in recent history have shown, it is extremely difficult for a government to break a trend of self-propelling inflation. The key, of course, is fiscal policy: too many hyperinflation episodes, from Weimar Germany to Bolivarian Venezuela, have their origin in fiscal policy. This is a tense topic in today’s American public discourse, because if the Federal Reserve makes too blunt a point about Congress driving inflation with its reckless deficit spending, a certain Fed chairman may find himself out of a job.
Worse: we could find proponents of Mad Monetary Theory on the Federal Open Market Committee. That would be a disastrous turn of events, for the simple reason that it would officially end the independence of U.S. monetary policy from U.S. fiscal policy. This independence has been eroded over the past 20 years, since the 9/11 attacks led Congress, President Bush and Fed Chairman Alan Greenspan to formulate an unprecedented, coordinated fiscal and monetary expansion.
While Greenspan clearly had the intention for this expansion to end – and he did his best to pull out of it a few years after the 9/11 attacks – his successor, Ben Bernanke, basically made monetary expansion a hallmark of the central bank. We got a brief intermission under Janet Yellen, but returned to de facto deficit monetization under Jerome Powell.
Now it looks like Powell has not been aggressive enough for some Democrats, with the New York Times reporting on how Senator Warren (D-MA) leads the charge. In fact, the debate over Powell’s reappointment is reaching levels unheard of for the central bank’s top officials; the New York Times gives us a clue to why:
The administration is under pressure to make a prompt decision, in part because the Fed’s seven-person Board of Governors in Washington will soon face a spate of openings. One governor role is already open. Mr. Clarida’s term ends early next year, leaving another vacancy, and Randal K. Quarles’s term as the board’s vice chair for supervision will expire next week, although his term as a governor runs through 2032.
Let’s be honest about what is going on here. The left wing of the left wing sees a chance to populate the central bank with corporate yes-men who will not object to a perpetuation of large, monetized deficits. If they can get one or two MMT proponents on the Federal Reserve Board, they will have politically conquered the central bank and made clear to future board members who are up for reappointment: we will be watching your record, and if you aren’t onboard with MMT you will be replaced.
The MMT’ers will not get what they want if Treasury Secretary Yellen gets it her way. But until President Biden makes an announcement, anything is possible. Either way, Jerome Powell’s reappointment marks a fork in the road for the Federal Reserve, with a return to monetary conservatism on the right and unrestricted MMT on the left.