Will inflation turn into stagflation? With inflation hitting 40-year highs, it’s the question of the hour.
Noisy Data, Noisy Policy
The problem so far is the data is so noisy from COVID disruptions: if governments impose, then remove, then reimpose measures according to the latest opinion poll, they have a lot of trouble statistically adjusting. Still, COVID disruptions are gradually getting smaller, meaning we’re starting to get a picture of what the underlying economy looks like. As Warren Buffett famously put it, “When the tide goes out, we see who’s swimming without a suit.” COVID restrictions are, increasingly, a tide going out. So now we see what’s left.In short, it’s not pretty. The Atlanta Fed does a nearly real-time evaluation of GDP, and they’re saying it’s now at 0.7 percent real. That’s about U.S. population growth, meaning the economy is, at the moment, at a standstill. Also known as stagnation.
Meanwhile, of course, inflation continues surprising on the upside—well, surprising Wall Street and the Fed, not necessarily surprising many of us—coming in last month at an annualized 8.0 percent for the month—a flaming 7.5 percent year-on-year.
Put those two together and you get stagflation—rising prices while the economy stagnates.
According to Atlanta Fed, we’re already there. So will it continue?
The Bear Case
The two best ways for a government to crash an economy are regulations and taxes. Both suppress growth year-in-year-out, but to really spark a crash one or both have to get much worse, ideally all of a sudden.At the moment, major tax hikes are off the table for the foreseeable future. This is because Joe Biden and Congressional Dems are unpopular and have a razor-thin majority, while D.C. consensus is the GOP will retake Congress in 2022, putting an end to Biden’s handlers’ tax-hiking dreams.
So, given those constraints, I don’t think taxes crash us unless Americans wake up one morning and decide they quite like Biden after all. I’ll let you run those odds.
What is, however, quite threatening is regulations. 1970’s-style regulation increases are, like taxes, neutered by Biden’s unpopularity and Congress’ razor-thin majority. But there is still a lot of damage that can come from Biden’s Executive Orders (EO’s). If you’re not American, or if you have a healthy disinterest in D.C., in the U.S. system EO’s are wide-ranging powers a president has to impose a variety of mandates and restrictions across the economy. Trump enthusiastically used these to minimize economic harm, and Biden’s handlers could just as enthusiastically use them to maximize economic harm.
A Great Deal of Ruin
So, yes, there are threats. But it’s important to zoom out and remember America is not the government alone—there’s 300 million of us out there, building, creating, hustling to route around the damage of government policy.This is nicely captured in Adam Smith’s famous response to a colleague panicked about policy: “My boy, there is a great deal of ruin in a country.” Policies always look horrible way out at sea, but we the people usually manage to whittle them into little waves by the time they get to shore. Not every policy—the 1970s did happen—but most of the time.
This means even a constant series of new EO’s are up against the world-moving day-in day-out hard work of those 300 million Americans the bureaucrats and politicians are trying to destroy. I recently saw a TV show where the local government closed the bridge a logger needed, and his response was to refloat a sunken barge, plug it using $10 in toilet wax, and float the logs. Multiply that by 300 million and Washington’s up against an army—many armies—when it’s trying to crash our economy.
Conclusion
Policy suggests we won’t necessarily bounce back—existing taxes, regulations, and handouts are keeping production muted, dragging out supply chain adjustments, and the idiots in Washington will likely continue both. But I don’t think the odds of a policy-induced crash are high. It’s too soon to bet on them as an investor and, anyway, your investments shouldn’t be based on economic growth—prepare for the worst, but bet on the most likely.Final point, this all comes with a huge caveat: the Federal Reserve. The Fed’s pace of money creation since COVID has been unprecedented, while the Fed itself increasingly admits its models are blind—for which it blames COVID. Put these together and the Fed is, effectively, a car driving at night, very fast, with no headlights. That is a real threat, probably to an unprecedented degree.