Over the past few months, there has been great debate about whether the Fed's actions will spur economic growth or just inflation without any meaningful growth.
Given the extent of the coronavirus-inflicted damage post lockdown, businesses have cut spending or shut down permanently, hurting their ability to grow and rehire workers. The U.S. central bank may have printed $3 trillion in cash to support asset markets and equities, but that is all it can do, as it cannot print jobs nor force companies to hire more people, no matter what their cash balances are.
This is where the problem lies. The Fed's thinking is that if we support equity markets, then average U.S. consumers will feel richer as their assets will be worth more, allowing them to spend and travel more, thereby raising the tax receipts for the U.S. economy, the gross domestic product. It is all linked. It is essentially buying time and pumping so much money in the economy, hoping to jump start it such that it goes back to trend growth or higher.
This is very different from traditional economic thinking that the central bank should use tools to stimulate economic growth, then markets and asset classes re-rate higher to value that accordingly. Since the 2008 financial crisis, the Fed has been working in reverse. It is boosting asset prices to then hopefully generate enough economic growth to make it all work. In theory, this makes total sense, but going back in time, the system is so leveraged with debt that each time a crisis happens, the Fed has to throw more and more money at the markets. In 2008, the Fed printed $650 billion and that was a big number at that time and did the trick. At the height of the mayhem in March, the Fed printed $650 billion a week.
It is hard to even fathom how much more money the system needs to keep it going. We are getting levered beyond recognition. The experiment from the past has not worked and the question, does monetary stimulus actually provide GDP growth, remains unanswered. Yet central bankers seem to do what they know best, just keep printing. As they have taken rates down to almost zero, and pumped system with gazillions of dollars, they are hoping that by next year, there is enough growth and inflation, such that they can then eventually raise interest rates and offset the inflation. Perfect plan and nothing can go wrong.
Inflation is going to be the problem. There is no doubt we are seeing it, and will continue to see more of it in the future. That is a fact. It will be much higher than the 2% target the Fed has talked about as its measure is not indicative of the true inflation in the economy. The big question is if it keeps the foot on the pedal to get inflation to move aggressively higher, what if all that extra money does not stimulate growth? We will be in the most dire of situations: stagflation.
If there is too much money in the system, and not enough GDP growth, the Fed will have its hands tied as it will not be able to raise rates or use any of their tools to combat that inflation. There is no way the Fed can keep going printing without any consequences. Just because we did not see a problem over the past decade, does not mean we won't be accountable for all their policy actions.
Hence, when you hear Fed Chief Jerome Powell's speech and press comments, the Fed is genuinely clueless and scared, as it does not know whether this plan will work, but is merely hoping. Fiscal stimulus has to go hand-in-hand with monetary stimulus. Right now, politicians are more worried about their ratings and getting elected than actually helping the people. On Friday, we saw the non-farm payrolls add about 1.7 million jobs, which beat consensus of 1.4 million, but this is still much slower than the June run rate of 2.5 million. The rate of change is slowing. There are enough signs that the broader economy is stalling after its initial bounce in May and June.
Asset classes are pricing in higher inflation by re-rating gold, silver and precious metals higher. But other cyclical commodities like copper and oil do not trade like them as they are dictated by demand vs. supply physical inventory balances, which are still in surplus, more so for oil. It is important to distinguish which assets should re-rate and de-rate. If the economy takes longer to recover, or we are in stagflation, then the cyclical commodities can actually de-rate and move lower here. One cannot apply the same analysis to the entire complex.