Powell No Volcker—Inflation Set to Continue Upwards
A note from history. Back in 1980 with US inflation heading into double digit territory, the then Fed chairman, Paul Volcker, effectively raised the Federal Funds rate to an unprecedented 20% to bring it under control. Volcker was a veritable giant of his time, both intellectually and physically (he was 6ft 7in in height) and no doubt his physical presence was an asset he utilized to his full advantage in persuading other Fed board members to follow his lead.
Although this move led to the deepest recession since the 1930s, Volcker is, in hindsight, also credited with rescuing the US economy, leading to a couple of decades of low inflation and strong economic growth.
US inflation again looks to be heading into double digits, so what does the Fed do this time around? It raises the Federal Funds rate by a modest 25 basis points, with the promise of more similarly sized rate rises to come this year and next.
True the current situation is rather different than in 1980 with the US now having to service an enormous debt build-up – arguably as a result of Fed policy over the past several years – and the Fed will no doubt claim that the inflation rate is not nearly as high as some put it.
(The US Federal Funds rate is described by Wikipedia.com as the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an uncollateralized basis.) This effectively directly influences the interest rates applied by financial institutions when they lend money to outsiders.
The effective federal funds rate (EFFR) is calculated as the effective median interest rate of overnight federal funds transactions during the previous business day. It is published daily by the Federal Reserve Bank of New York.
The federal funds target rate is determined by meetings of the members of the Federal Open Market Committee (FOMC) with the most recent such meeting held on March 15th and 16th. (The committee may also hold additional meetings and implement target rate changes outside of its normal schedule.)
Nowadays the Fed uses the Personal Consumption Expenditure Index (the PCE) as its preferred inflation measure, but this tends to track lower than other inflation data which may give the Fed perhaps undue confidence that the inflation rate may be lower than that being experienced by the consumer at large.
For example, John Williams’ Shadowstats.com site, which calculates economic data in the way it used to be before the government, as governments tend to do, started to assess this kind of data in a more favorable light, puts current inflation at around 15% and probably rising.
This kind of inflation level would probably be recognized as a more accurate measure by the person in the street and compares with the official Consumer Price Index (CPI) figure of 7.9% and also rising. The other inflation data statistic – the Producer Price Index (PPI) which looks at output price rises from the manufacturing and fabrication sectors - is already at 10% and also rising.
What is even more worrying for the US consumer is that the inflationary effect of the new economic sanctions imposed on Russia, which could be substantial, given Russia is the largest producer and exporter of a number of metals, minerals and key foodstuff-related items, has probably not yet even come into the data calculations.
The Fed could be quite hamstrung today by the fear of imposing a sufficiently high Federal Funds rate to have any impact on the current inflation rises without driving the US economy into recession and stagflation.
This would also thereby reverse downtrending unemployment levels and lead to a sharp fall in GDP, complicated by the huge additional debt servicing costs due to higher interest payments. It is thus very much caught between a rock and a hard place largely of its own making.
As I said in the title of this article, Powell is no Volcker, prepared to take the kind of enormous interest rate rise to slay the inflation beast. But to be fair the position now is very different from that of 42 years ago which probably makes such an option impossible.
The enormous US debt level, mostly built up since the Great Financial crisis of 2007/2008, makes the cost of servicing this debt at higher interest rate levels virtually out of the question.
Powell suggests that inflation will start to come down anyway in the second half of the year, but the Fed’s track record on predicting inflation trends has been poor so far.
Rising inflation was deemed to be ‘transitory’ for many months before this term was dropped last November, and since then it has soared on almost any measure thereof.
And this was before any inflationary impact of the Russian invasion of Ukraine, and the imposition of a much more severe tranche of economic sanctions on Russia. This is adding an additional severe inflation impact into the equation.
The small Federal Funds rate increases imposed and promised look likely to be ineffectual in bringing inflation down, although may be small enough to avoid recession and an equities crash. However, they will probably do little to bring real interest rates out of distinctly negative territory, which should be positive for non interest-generating assets like gold.
The Fed is thus in a very difficult position to fix the current problem. It has to hope that external factors will start to reduce the inflationary trend, but this writer believes that this is unlikely and we will most probably see inflation move onwards and upwards for the foreseeable future
by Lawrence Williams
Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.
The opinions expressed in this article are the author's own, do not necessarily reflect the opinions or views of Rosland Capital LLC or its employees, and do not constitute financial or investment advice or recommendations from the author or Rosland Capital or its employees. The author is compensated by Rosland Capital for his articles.