by Snooprematic
When covid hit, the modern market hadn’t really seen anything like it. You’ll notice the charts have quite the steep fall, indicative of market panic. Lockdowns, an unknown virus. The business landscape suddenly became very unclear and the economy ground to a halt. If someone wants more in depth understanding of what it means to be a credit economy and how it works, I recommend watching this very famous but easy to follow video.
How The Economic Machine Works by Ray Dalio
In order to prevent this from happening, the Federal Reserve, also known as the lender of last resort, stepped in with looser monetary policy (EDIT: and in tandem with the Govt providing an extraordinary amount of fiscal stimulus), and without getting into specifics of how (a lot of different complex financial tools), they essentially pumped money into the economy, providing support to financial institutions, households, employers, etc. Wrapped up under one giant umbrella, this would be called Quantitative Easing, or QE from the monetary side. As of this morning, the Federal Reserve is still injecting liquidity into the economy. This is part of the problem. They pumped so much money into the system to save it, which at the time was required, but have failed to put the brakes on QE, that the system now has so much money, and it has for some time. Edit: Paired with fiscal stimulus, the consumer had a lot of spending power.
While this fiscal stimulus paired with monetary policy initially saved the economy, what ended up transpiring was that there were was too much money, chasing too few goods. In economics it’s called Demand Pull Inflation. Things were sold out. Good luck trying to buy a pool, or workout gear, this was very evident early on. The initial notion was that this would pass eventually as the world got back to normal. Except, a supply chain crisis emerged. Sometimes I like to laugh and think that the Evergreen Ship was the start of it all, but regardless, there was too much money, now chasing even fewer goods, and this supply chain crisis has persisted. There are some that think that inflation will taper off when supply chains sort themselves out, but the economy is dynamic, and there is more than one source of inflation. Edit: When supply chains sort themselves out, this is generally seen as deflationary, which is why the Fed used the term “transitory” so often in 2021. As supply chain issues have persisted, it hasn’t been as transitory as they thought it would be. The long term projections are that this source of inflation will drop, but it still remains prolonged in the current economic environment.
This is where people were caught off guard with recent inflation readings, why is inflation still rising if supply chain induced inflation is transitory and the chain is working through its issues? Well, long term, the supply inflation will be transitory, but as it stands, it remains, and this is where we introduce another source of inflation emerging called Cost- Push inflation. This is where inflation occurs because the cost of labor and inputs (raw materials for example) go up. These have been going on for a while, and no one really thought it was an issue, until now. I had inklings that this was happening the moment I saw a sort of mini workers movement occurring, with wages being driven upwards. And, due to the prolonged nature of these supply chain issues driven by a variety of issues, paired with a still very strong consumer, and now accelerating battles for labor at ever increasing costs, many companies are passing on the costs of inflation to consumers. It’s why these companies have been able to post some crazy profits, Tyson Foods for example had a blowout earnings. It’s because meat at the market is so expensive now. The average person experiences this at the pump, or rents increasing. So, to sum it up, We got here because a confluence of bizarre events, extraordinary fiscal stimulus from the federal government empowering the consumer to consume more, and a Fed that was slow to move on reacting to “transitory” inflation, and is still pumping liquidity into a market that no longer needs it. The American economy is super heated and needs to be slowed down.
So, where does that leave us? Well, supply chains will eventually sort themselves out this is true. But the issue is will it alleviate enough to offset the rise in inflation from other sources in the immediate term? The Russia-Ukraine issue has exacerbated the energy crisis, with Biden now considering releasing Strategic Reserves to help american oil supply and alleviate some of the pain felt at the pump. The Fed has to do something about insanely high inflation, but they are hamstrung on the supply side because, well, monetary policy doesn’t solve that type of inflation. But, Cost-Push inflation is still happening, and overall inflation is still rising, so they now have to consider raising rates, not to fix supply issue related inflation, but to slow the economy down with interest rates. It’s why this year will be so tumultuous. Because if done wrong, it can lead to a recession. Too much slowing too fast, and GDP will drop as consumers consume/spend less as they borrow less since rising rates makes it more expensive to borrow. There are technical definitions for a recession but the general idea is that GDP drops. And if GDP drops, then company earnings have dropped, and thus company stock prices drop as they are not as valuable. The market is forward looking, and that’s why you’re seeing such crazy re-ratings across the board at the slightest hint of where the economy and Fed will go.
Thanks for sticking around to read this. lol.