I read John Mauldin’s weekly essay, “Thoughts from the Frontline,” because it’s always interesting and sometimes brilliant.
“Fingers of Instability,” written in 2006, was brilliantly prescient and should be re-read today along with later essays based on the same concept.
Today’s “Thought from the Frontline” was unusually valuable.
Mauldin discusses inflation in the context of the change in the way the Bureau of Labor Statistics calculates housing costs. The 1983 introduction of “Owner’s Equivalent Rent” instead of actual home prices or mortgage payments makes inflation before and after 1983 not directly comparable.
A group including Larry Summers has recalculated CPI so they are comparable.
Mauldin shows charts from this paper. Maudin also quotes Fed Chair Arthur Burns (who presided over high inflation) in September 1979. He had left the Fed 18 months earlier.
**“American policymakers tend to see merit in a gradualist approach because it promises a return to general price stability—perhaps with a delay of five or more years but without requiring significant sacrifices on the part of workers or their employers. But the very caution that leads politically to a policy of gradualism may well lead also to its premature suspension or abandonment in actual practice.**
**“Economic life is subject to all sorts of surprises and disturbances — business recessions, labor unrest, foreign troubles, monopolistic shocks, elections, and governmental upsets. One or another such development, especially a business recession, could readily overwhelm and topple a gradualist timetable for curbing inflation. That has happened in the past and it may happen again.”** [end quote]
Maudin shows how Paul Volcker raised the fed funds rate extremely rapidly. The Volcker Fed had multiple hikes of 100 bps or more, causing the 1980 recession. Then they took fed funds 1,000 points higher in the second half of 1980. This make Jerome Powell’s 75 bps increase look puny and gradual by comparison.
Yesterday, I posted a Fed model showing a gradual increase of fed funds rate going into 2023, with a reduction of inflation and a very mild recession. The Fed appears to believe that it can pull this off.
Is the Fed right? Or are they fooling themselves with the same optimism that led them to believe that inflation was “transitory”?
As consumers and investors, we have a deep interest in this critical time of trend change. METARs who work may lose their jobs in a recession (along with many others). All of us will face higher prices if inflation remains high. (Which I think it will.) All of us will face loss of asset values as the Fed raises the fed funds and longer-duration rates.
Fed Chairman Jerome Powell caved in 2018 when the Fed raised rates and the markets had a hissy fit. Will he cave in 2022-2023 when the asset markets tank and the expected recession turns out to be unexpectedly deep?
If he caves, we will have stagflation. If he doesn’t cave, we may get a deep recession.