Asphyxiating the Economy
Plus a 2022 update
On my 17th birthday, a screech of tires, shattered glass and crumpling plastic as I T-boned my father’s Chevy Citation into a car stalled on Washington D.C.’s Reno Road. Afterward, I felt rattled and, once my heart rate fell back to normal, stupid. Since then, every time I crest a hill, I still scan for that stalled car.
Trouble at Mission Control
I suspect Jerome Powell feels about the same way right now. After crashing the car once by being too easy, he may crash it a second time by being too tight. While unemployment is low, inflation looks like it is gradually falling lower. What the precise combination of tighter money, lower energy prices and easing pandemic supply chain kinks is leading to lower inflation is not 100% clear, but inflation momentum is softening.
To follow the money, follow central banks. The banks are the ultimate source, charged with the ancient task of creating just the right amount of dough. When you read about “the Fed,” it’s easy for your mind to go blank, to shelve it in the file of faceless organizations. But the Fed is people and people are wired the same where everywhere—ambitious, striving for greatness, prone to error, guilt-ridden.
When I think of the Fed, I think of my uncle, Stephen Axilrod, and his boss, Paul Volcker. Steve was an influential presence in my life and I spoke with Paul at a few family gatherings. The opening scene in my thriller, Master, Minion, came from a conversation I had with Paul.
Steve passed recently but he left us all a great book, Inside the Fed, that describes his 30+ years at the Fed. As you would expect, Fed officials struggle as hard as the rest of us to figure out what is going to happen next and in the process make lots of mistakes. That said, the Fed does have a clear, measurable objective.
“The Fed chairman is mainly judged by the extent to which inflation has been contained on his watch ... if inflation seems to have gotten out of hand, he is deemed a failure," wrote Steve.
Is that clear enough?
Powell doesn’t want to be remembered as the guy that messed up. Because the Fed was slow to respond to rising inflation, they’ve now had to move fast and hard to catch up. So far, the collateral damage from printing less money has been tech workers (fired in waves), real estate and fluff stocks, which are down 90%. But more damage is likely to come because the pipes that pump credit into the economy are narrowing as the Fed makes money scarce.
The diagram below shows how the money flows. There are three major sources of spending, households, corporations and the government and they all can, in normal times, borrow. While these borrowing pipes aren’t cut off, they are much reduced. If you are trying to save money, essentially rent out your capital, this is can be good because capital is scarce and you can fetch a higher yield.
That said, investing when income is strong but borrowing is weak can be tricky because the two forces move in opposite directions. To get the path forward right you need to figure out a) what is expected to happen (that’s in the price of whatever we buy), b) what will actually happen (income and credit moving opposite directions)) and c) and guess how key players, like Powell, will respond to what they think will happen.
Typically, a boom turns to a bust when the private sector levers up, inflation rises and the Fed tightens. That didn’t happen this time. The boom was financed mostly from income, not borrowing, or rather the government borrowed and gave the money to households. The Fed can only control the cost of credit, not wages, which is why they keep raising rates and printing less money.
But as Steve’s book makes clear, the Fed is just like the rest of us, staring at little pieces of data and trying to distill the big picture. The dominant view on Wall Street now is that inflation is “sticky” and the Fed will need to be quite tight. But it’s possible the Fed is already tight enough. It looks like the inflation spike was significantly caused by government stimulus and weird supply/demand imbalances in labor.
Part of me is sympathetic to Powell. It’s a tough job. The economy and markets are complex enough that rigid frameworks don’t work. The very best investors and central bankers follow such frameworks, but also know when not to follow them. So far, Powell seems like a guy that sticks to a rigid framework for too long.
A Look Back on 2022
Things that stand out to me in 2022.
The bubble on narcissistic, autocratic or autocratically inclined leaders popped. Putin was revealed as a psychopath with a decrepit army. Xi first locked everyone up, destroying the economy, then released them without a plan, which will lead to millions of deaths. Trump sought to tilt an election process he asserted was corrupt and his candidates mostly lost. Musk tweeted inane conspiracy theories and saw his wealth plummet. Brazil’s Bolsonaro faded. The lesson is: it can take a long time for a reputation to converge on reality, but eventually it happens and narcissistic leaders are particularly vulnerable to such a crash. The rest of us need to try to hew to the right path in our lives.
Lots of people have no idea what a real interest rate is. This is the interest rate minus inflation. In the last 12 months, real interest rates went from -1% to 1.4% (shown below) and that was enough to obliterate trillions of dollars in wealth. This is the most important rate for an investor to follow.
I don’t have all of my December numbers in yet, but it looks like I finished up about 4% in 2022. My long-only portfolios suffered and my trading portfolio had one of the best periods ever. My UNAUDITED results are below.
I don’t give investment advice. Instead, subscribers get to see what I am doing as I do it and decide for themselves what they should do. I am not affiliated with any organization or bank, so I have no product to sell other than my own survival and independence. Since I started these posts, I’ve warned you that:
From my perspective, that’s a bargain for the price I charge. In fact, it’s too much of a bargain and I should probably change the price at some point. But it’s still early days in this experiment. My goal in 2023 is to write fewer, more meaty posts and publish when the post is done, as opposed to a rigid timetable. I think that will be of more use to you.
Lastly, I want to change the name of these posts. Things I Didn’t Learn in School is a good title for the podcast. But for these posts, I want something that more closely hews to what I am mostly writing about. Below are a few possible titles. Vote your choice or mail me a better idea.