TSP Smart: They Said It Out Loud

At first I was half joking, then I decided it was the only way, but I never expected the Fed would come to the same conclusion.

I’ve been calling for a “reverse wealth effect” that would target the demand side of the economy where the top 20%, who feel wealthy from on-paper financial gains are pressing consumer and housing prices higher.

Since the top 10% own 90% of stocks, and the top 20% have houses that appear to have a lot more equity in the last two years, the demand side of the economy has been outstripping supply and driving inflation to the moon.

Supply, of course, is constrained and will remain so as China locks down again and WW3 heats up, so the only way to tame inflation is to reign in demand. In the early 1980s Fed Chairman Paul Vockler induced two recessions to break the inflation doom loop. He had to raise interest rates to 20% to do this back then.

Don’t worry, it will not take 20% rates this time. Maybe 5%, but the Fed does not want to go that high due to the massive debt bubbles. They would love to meet falling inflation and settle in around 3%. I think inflation will settle out at 4% for awhile if the world ever settles down, but there is too much happening to argue that point.

If Stocks Don’t Fall, the Fed Needs to Force Them 6 April 2022 Former NY Fed Governor

Yep, he said it out loud.

If you have been listening, they have all been trying to tighten via talking. The talk of a “rapid reduction of the balance sheet” yesterday was designed to halt the SP500 rally and tell the market they are serious about monetary tightening. Except what the current Fed heads can NOT say is they want to take down the stock market and bond market a bit to do the tightening.

It is important to understand that the Fed made the mistake long ago to view the stock market as part of the measure of monetary policy. And they developed a voodoo model called the “wealth effect” where if the stock market goes up and people feel wealthy they will spend more. It is Voodoo because it only helps the top 10%, create inequality, etc.

This warped model did not consider that people would borrow more money against their over-inflated assets and you know how that goes in the end. If not, you soon will.

Here are his quotes:

It’s hard to know how much the U.S. Federal Reserve will need to do to get inflation under control. But one thing is certain: To be effective, it’ll have to inflict more losses on stock and bond investors than it has so far.

…In contrast to many other countries, the U.S. economy doesn’t respond directly to the level of short-term interest rates. Most home borrowers aren’t affected, because they have long-term, fixed-rate mortgages. And, again in contrast to many other countries, many U.S. households do hold a significant amount of their wealth in equities. As a result, they’re sensitive to financial conditions: Equity prices influence how wealthy they feel, and how willing they are to spend rather than save.

Investors should pay closer attention to what Powell has said: Financial conditions need to tighten. If this doesn’t happen on its own (which seems unlikely), the Fed will have to shock markets to achieve the desired response. This would mean hiking the federal funds rate considerably higher than currently anticipated. One way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower.

My comment: We have two economies. We have the top 20% and the bottom 80%. The bottom 80% is severely impacted by consumer inflation and takes its cues from the gas pump prices and grocery bills. They see the stock market, but it does not help them. The top 20% are insulated from consumer inflation meaning they do not have to adjust spending even if they know prices are higher. They do take spending cues from the financial economy. Since they make up over 40% of retail spending, tanking the stock market will cool their big spending ways. And may bring back some retirees to the work force.

The market will start moving down sharply as people begin to understand the paradigm shift. The Fed is going from buying financial assets to selling financial assets. The Fed is going from pumping the stock market to trying to tank it. Not to mention the lack of understanding we are in WW3 that will play out in the global monetary system as well as on the ground. But that is another story.

TSP Smart & Vanguard Smart Investor serves serious and reluctant investors

by keeping an eye on the macro economic and political developments

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Categories: Perspectives