Investors are bracing for sharp changes in financial
markets after nearly three decades of calm.
Inflation has exploded in advanced economies around
the world. As a result, it might be harder to find a
job soon. Forecasters think global growth is going to
stall.
American households are pretty unhappy.
And when the households are unhappy, they tend to spend
a little less.
We've had that yield curve inversion.
That's something that we're looking at.
But I wouldn't say that recession is on the horizon.
The next six, 12 months or so.
The top financial authorities in the U.S.
hope this all blows over quickly.
They're making lending more expensive to control
inflation before it becomes a self-fulfilling prophecy.
But the only tool that the Fed really has to bring
inflation down is to let interest rates rise to
whatever level it takes to cause a recession, which
then breaks the back of inflation.
Investors believe the central bank will lift
interest rates to 2.5% or higher in 2022.
This is what you have to do slow down the economy in
order to take that steam out of the system.
The steam of inflation, which eventually can burn
you really badly.
The big risk is a repeat of one of the worst chapters in
American history.
Escalating prices.
You know, the 1970s were a really hard time.
Now we're in a new mistake where inflation has lasted
longer and looks like it could risk being around for
longer than they had hoped.
Can the Fed engineer its soft landing or will
stagflation return to the U.S.?
Stagflation describes the dual threat of stagnant
economic growth and persistent inflation.
It can happen when a central bank tightens its
economy in an attempt to keep prices in check.
But an unexpected shock keeps those prices marching
upward. Inflation hit 8.5% in March 2022.
That's the fastest monthly change since 1981.
And if you ask anybody, rich or poor, they're going to
say, Yeah, I'm definitely seeing it.
My food costs, I'm definitely seeing it when
I'm putting gas in my car.
Americans haven't seen anything like stagflation
since the 1970s.
Central bankers call this era the great inflation.
That was a decade of persistent economic
mismanagement. For years and years, the Federal
Reserve attempted not very hard to control inflation
and in the end persuaded itself that it couldn't
control inflation.
Meanwhile, fiscal policy was stepping pretty hard on
the gas pedal, and that kicked off around of the
economy persistently being overheated.
As this financial crisis unfolded, funding for public
services dried up.
Cities like New York fell into disrepair and labor
unions went on strike.
Across the country, the financial problems went
mainstream. As gasoline prices ramped up.
We'd have to line up at the gas station on alternate
days, depending on what your license plate number
was, and you could get gasoline.
And that really led to a significant inflationary
spiral.
Richard Fisher led the Federal Reserve Bank of
Dallas from 2005 to 2015.
Now the chairman of the Federal Reserve then was a
man named Arthur Burns before Arthur Burns.
They just looked at all the data and then he stripped
out one or two variables gasoline, which is variable
in price, that is fuel and energy and then food.
But by the end, he was stripping out almost
everything and he turned out brilliant economists
that he was to probably be the most disgraced Federal
Reserve chairman in history.
1973 dramatized US dependance on foreign oil.
He was also struck by some exceedingly bad luck in the
form of the two oil price shocks that were delivered
by OPEC.
The Organization of Petroleum Exporting
Countries imposed its boycott and within a year
raised prices more than 300%.
That, of course, sent shock waves through the U.S.
economy in the form of higher gasoline prices.
So you had rising inflation at the same time that you
had the unemployment rate going up, which was
stagflation. It was against a backdrop of a lot of
policy mistakes.
Already inflationary environment inflation had
tripled in the 1960s during the Vietnam War, but also
was being forced.
And there are memos saying that the changes that they
were making would actually some of those policies would
result in double digit inflation.
The Fed's warning to Washington politicians came
true in 1974.
That year, prices across all categories rose more
than 10%.
A new president stepped in with a plea.
We must whip inflation right now.
The president lost his fight and prices kept rising.
Public trust in government was on the decline.
When we try to beat inflation with borrowed
money, we just make the problem worse.
President Carter appointed the economist Paul Volcker
to lead the Fed and asked him to do whatever it took
to rein in prices after a decade of explosive growth.
Mr. Volcker then began to tighten monetary policy and
took those interest rates all the way up to about 18%,
created a recession, which was the only way to solve
the problem of hyperinflation at the time.
He became immensely unpopular.
There were countless death threats against Mr.
Volcker.
The Fed uses its federal funds rate to control the
cost of loans.
Under Volcker, the federal funds rate shot to nearly
20%. High interest rates discourage investment and
job creation.
The 1970s were really the result of a two decade long
inflation, the inflation that Paul Volcker broke the
back of in a very bloody manner.
It was incredibly, excruciatingly painful.
And what they have shown central bankers, not only in
the United States, but around the globe ever since,
is the central bankers can control inflation.
And to an important extent, we've been benefiting from
the economic dividends associated with low and
stable inflation ever since.
And all of that is thanks to the leadership of Paul
Volcker.
Wages and prices often play leapfrog.
Many things have changed in the U.S.
since then. For example, fewer workers have their pay
tied to changes in the inflation rate.
As a result, wage growth has stagnated for four
decades in America.
Workers at Amazon warehouses, Starbucks cafes
and Apple retail stores are fighting for new benefits.
Union membership is down sharply since its heyday.
If more workers organize, that could push wages up.
Investors also seem to think this inflation is
different. In the 1970s.
That episode absolutely spooked people enough to
send money flying out of bond markets.
When was the last time inflation was actually this
high? You're looking at the early 1980s.
I think you're pushing almost 13%.
And the ten year treasury versus now, I think we're
looking at 2.6, 2.7.
Bond yield data can show how much people expect prices to
keep rising. If the yield rate is high, as it was in
the 1970s, it means investors won't fork out
cash without the promise of a big payday.
The Fed can distort these markets for safe debt, and
they have for more than a decade.
But that era is coming to an end.
I would say that over the next several months you're
going to see the Federal Reserve stick to their calls
and say you might start looking at reducing the
balance sheet. And that's also going to have an impact
on the bond market, equity market, as well as the
consumers and what they're going to feel their wallets
as far as what they're paying for.
Over time, the threat of stagflation faded as
advanced economies relied on cheaper labor abroad to
produce goods. An entire generation of investors have
enjoyed consistent returns.
As a result, this upcoming chapter could be different.
They need to tighten up on the money supply and tighten
up on the stimulus that the Fed gives to these very low
interest rates. And I believe they will and keep
us from getting out of hand for investors.
This is going to be, I think, a bit of a shock, and
that's an understatement.
Investors don't have any muscle memory of what it's
really like for the Fed to actually fight inflation
versus preempting or just adjusting rates to be in
sync with a stronger economy.
Expectations of future inflation are back on the
uptick. This puts the central bank in a tough
position. Over the past two financial crises, they
bought bonds at a scale never before seen.
Now they're scaling that stimulus back while hiking
interest rates. At the same time.
What the worry is, is that there's a lot of law of
unintended consequences that kick in as the Fed
starts both raising short term rates and then
amplifying those rate hikes by reducing their holdings
of things like Treasury bonds and mortgage backed
securities. And there is no real roadmap to do this.
Energy prices could be the source of inflation in
America for years to come.
Russia's war in Ukraine sent gasoline prices up and
that is making other products more expensive.
Well, let's think of a grocery store you go into.
It has to be air conditioned. Secondly, a lot
of frozen food that takes energy and one begins to
build on the other.
In the 1970s, the Organization of Petroleum
Exporting Countries controlled global supply.
Opec's actions drove gasoline prices sky high in
the past. Today, OPEC is a partner to Russia, a major
exporter in its own right.
The U.S. and its allies want to wean themselves off
of this supply.
During the 1970s, the U.S.
was a huge net importer of oil.
We saw dramatic growth in the volumes of energy
provided by oil and natural gas.
When the world price of oil went up, we were hit badly
in two ways.
Prices of domestic goods like gasoline went through
the roof. And secondly, it was like we were shipping
some of our income to for foreign producers.
So it was an adverse shock.
It caused unemployment to go up.
The big shift today is that we produce about as much
oil as we consume on average.
And so when the world price of oil goes up as a
nation, we don't suffer nearly to the same extent.
Many things remain unsettled when it comes to the future,
but one thing is certain.
That clean energy transition is not just coming, it is
here.
Researchers say climate regulations will introduce
new risks to the market.
The financial industry could end up favoring
sustainable assets and penalizing polluters, but
demand for both products will ebb and flow, taking
commodity prices along for the ride.
The swings could lead to a boom bust cycle that
regularly affects the finances of households in
the states and abroad.
I would say that this next decade might look different,
and with that I would expect more volatility.
So what can regular people do if rocky times are ahead?
If you're between the age of 18 and 25, the unemployment
rate in the United States is 2%.
It gives workers enormous bargaining power.
And this is what's known as a wage price spiral.
And we're in the midst of it right now.
And the Federal Reserve's job is to quell that
pressure by tightening monetary policy.
And they're just beginning.
We do have a labor market that is finally allowed some
people to stand in the sun and see their wages
increase. That said, that sort of ease with which we
find jobs is not going to be quite as easy.
This is a difficult period of time, to be sure.
Inflation is higher today than it has been for 40
years. But I think there are some reasons for
optimism. For one thing, the Federal Reserve has
credibility today, which it did not have when Paul
Volcker took office.
That credibility turns out to be a critically important
asset for a central bank because inflation, to an
important degree is a self-fulfilling prophecies.
I wouldn't want to be scared, worried about all
this uncertainty of what might unfold.
I would look at it as an opportunity where I find
people get caught and troubled.
Most is trying to live the champagne lifestyle on this
beer budget, make sure that every single dollar is
earmarked, whether it's going to an investment
account, a checking account. Rein it in that
cash for that rainy day because that rainy day will
be coming.