In any market-based economy, there are key price signals derived from supply and demand that, overtime, efficiently allocate scarce resources. We know this as capitalism. Winston Churchill is often quoted as saying, “Capitalism is the worst economic system, except for all the others”. In countless examples it has created enormous wealth for those countries willing to live with the imperfections and make reasonable corrections. More than occasionally, the biggest issue is that monopolies distort those price signals and there are always consequences. The most powerful monopoly in the United States today is the Federal Reserve. It is distorting price signals, and there have been enormous consequences.
For most of its first 100 years, excluding the two world wars, the Federal reserve operated as a relatively small player in the markets. It tended to control the interest rate on the short end of the yield curve (think money market rates) and its key mandates were to avoid a depression (failed miserably in the ‘30s) and to maintain the purchasing power of the dollar. Note: In its first hundred years, the purchasing power fell by 96-99%.
Along the way, Congress also instructed the Fed to maintain full employment. Combining the official U6 unemployment measure (which excludes long-term discouraged workers) and the labor participation rate, ShadowStats estimates there is a 25.8% unemployment or underemployed rate, and it has been stubbornly above 10% for the last 27 years. Given this record, it is difficult to imagine the Fed being allowed to wield more power; but it certainly has gone for it in the last 12 years. The Fed now also price controls a lot of the longer end of the bond market (it owns 1/3 of all treasuries), the inflation expectations market (it owns over 25% of all TIPS), and the mortgage market (it owns 40% of all mortgage securities). Remember, it also recently flirted with control of the corporate bond market.
Paraphrasing ex-NYC mayor Koch, it’s fair to ask- “how are they doing?”. And the resounding answer is it depends on where you live. If you live on the Upper East Side and own a house or two and a large stock and bond portfolio, this is your type of capitalism. The low rates and record high asset prices in virtually all markets, easy credit, and plenty of ways to benefit from inflation make this a top 10% of the population bonanza of riches. Back in the Bronx, my birthplace, I would guess the answer is more what boom are you referring to? The boom in my rental payments, my food bill, or my shrinking real wages? I imagine most Federal Reserve members don’t make it to the Bronx that often.
Is this their intention? I doubt it. But the Fed operates with essentially one tool; it is blunt and has an uncertain timing response. They control interest rates and, as such, exert a price control on every transaction in the economy. Imagine building a house with an incredible set of screwdrivers but nothing else. Some parts would be beautiful, like the unprecedented liquidity at the banks, but others may have structural issues, like the inflation in assets and now, perhaps in goods and services, as well. Moreover, it may only be a matter of time before something breaks. And it may be social angst that breaks it.
Looking at some of the statistics from the recovery so far is disconcerting for the ‘working class’ as opposed to the ‘paper class’, like what I do.
· June retail sales were up a gaudy 0.6% mo/mo, but inflation was up 0.9%, so real retail sales were negative. This follows a -2.3% in May.
· Real average hourly earnings growth is negative.
· Since Dec ’19 (thru March 21), the Fed and congress have thrown nearly $9 Trillion at the economy through borrowing and money printing. The real economy is up about $170 Billion. And the stock market is up about $8.8 Trillion. Easy to see the winners there.
· Inflation, as currently measured, is at decade highs and if we measured it as we did in the 1970’s, it would be north of 12% already. The key difference is measurement of shelter costs; does anyone really think their shelter costs are only rising 2.5% per year as the current method indicates?
What about that American dream? Tangibly, investing for the future and owning your own home are two of the cornerstones of the dream from an economic perspective. How aspirational are those dreams for production and nonsupervisory employees, of which there are roughly 100 million in our country? Ned Davis Research has done the work and it’s disheartening. In 1983, it took about 15 hours of work for members of that group to buy one SP500 unit. Today they must work for 170 hours to accomplish the same dream. Fifty years ago, that group need about 175 weeks to buy the median existing single-family house; today, that extends to over 420 weeks.
Many will say it is too simplistic to lay this all at the door of the Fed and their unprecedented money printing and interest-rate control. I agree it is a complex multifaceted issue. I will, nonetheless, quote Paul Volker, who knew a thing or two about Fed policy: “Over time, an excess supply of money contributes nothing to employment, nor to real income, nor to real wealth, but only to inflation.” And it is well known through history which socio-economic groups pay the highest price for inflation.
As for the investing class, I advocate holding a substantial amount of gold and gold-related securities as diversifiers and inflation hedges. Stocks, incredibly expensive on almost every measure except in comparison to a Fed-manipulated yield curve, are fine till rates begin to normalize. I say keep an eye on the exit. As a citizen, I beg the Fed to normalize and become capitalists again as soon as possible and do the one or two tasks they can accomplish successfully with their tool. For Congress, the Fed is a monopoly that needs watching and not just a semi-annual dog and pony show.