You can summarize the current mood in Washington DC as “Please don’t let this be a return to the 1970s.”
For younger readers, that was a decade in which excessive government spending and money printing combined with inept foreign policy to create the impression that the US was fading into global irrelevancy. Everyone everywhere dumped their dollars, inflation spiked, interest rates soared and geopolitical chaos of various forms ensued.
And the people who presided over that mess were swept away in the 1980 elections.
This is clearly something to be avoided. And yet…our current leaders don’t have the slightest idea how to do that.
Leaving the covid and Afghanistan fiascos aside for the moment, let’s just focus on monetary policy. We’ve borrowed way too much money for way too long and run the printing presses flat-out for what seems like forever, yada yada. You know the story.
And now, faced with rising inflation of various kinds and the resulting threat of uncontained instability, the Fed is once again trying to talk the world into behaving by promising/threatening to “taper” credit-addicted financial markets off of their beloved monetary heroin.
Yesterday it directed its trial balloon specialist James Bullard to lay down some quite aggressive markers:
(CNBC) – St. Louis Federal Reserve President James Bullard said Thursday that the central bank should begin curbing its monthly stimulus efforts soon and have the process wrapped up by the end of March to prevent the U.S. economy from overheating.
Many Fed leaders believe the central bank should reduce the pace of its monthly purchases of $120 billion in Treasury bonds and mortgage-backed securities in a process known as tapering.
Bullard said the Fed’s purchases were appropriate in 2020 to support American business through the Covid-19 pandemic, but they now run the risk of creating bubbles in financial markets and runaway inflation.
“We do have a new framework we did say that we would allow inflation to run above target for some time, but not this much above target,” Bullard said of recent price increases in the U.S. economy.
“So for that reason I think we want to get going on taper. Get the taper finished by the end of the first quarter next year,” he continued. “And then we can evaluate what the situation is and we’ll be able to see at that point whether inflation has moderated and if that’s the case we’ll be in great shape. If it hasn’t moderated, we’re going to have to be more aggressive to contain inflation.”
Bullard, who spoke with CNBC’s Steve Liesman for an interview that aired on “Squawk Box,” said there’s some evidence that the Fed’s bond-buying blitz has started to create bubbles in the U.S. housing market.
“I think that there is worry that we’re doing more damage than helping with the asset purchases because there is an incipient housing bubble in the U.S. The median house price, at least the number I saw, was approaching $400,000,” he said. “We got into a lot of trouble in the mid-2000s by being too complacent about housing prices, so I think we want to be very careful.”
The Fed is of course bluffing, because the central truth of the situation hasn’t changed:
You cannot addict financial markets to a continuous flow of new credit and then just turn off the spigot. All the assets that are supported by “greater fool” expectations of new hot money will instantly collapse, blowing up the leveraged speculating community and all who depend on it. Which is to say pretty much every equity portfolio manager, home builder, money center bank, pension fund, non-short hedge fund, and Reddit GameStop trader. In short, the world as we know it implodes like that Miami beachfront condo.
The only question is whether the markets will stage a pre-taper tantrum or wait for a bit of actual tightening before going into withdrawal. Would-be “Big Short” speculators should note this timing uncertainty when designing their strategies.