Is the Fed planning slower wage growth and faster inflation? Does that make sense?

 September 17
– Wall Street Journal
(Greg Ip):
“On Wednesday it (the Fed) issued a policy statement promising to get inflation above 2% ... officials indicated that would mean keeping interest rates near zero at least until 2024 ... ”  

Jerome Powell, Federal Reserve Bank Chairman: “So, we want inflation to be 2%. And we want it to average 2%. So, if inflation averages 2%, the public will expect that and that’ll be what's built into interest rates. And that’s all we want. So we’re not looking to have high inflation. We just want inflation to average 2%."


THE  BIG  PICTURE:
Markets don’t believe central banks have that much control over consumer prices. There is little confidence the Fed will generate inflation at exactly it's 2% target. 

Thanks to the Fed, the M2 money supply surged at an unprecedented 37% annualized rate, up over $3 trillion in the past 28 weeks. The Fed has reduced the cost of borrowing for leveraged speculation to near zero, aggressively promoting speculation and financial leveraging. Is that good economics? It never has been before.

The year-over-year headline Consumer Price Index (CPI) inflation averaged 1.9% over the past four years. The Fed's PCE inflation index measure at 2 percent, is roughly equivalent to CPI inflation at 3 percent.

For over a decade, the Fed has been using increasingly extreme measures to prevent financial market de-leveraging. But the Fed has only stoked greater speculative leverage -- so speculative that markets only briefly took notice of the serious COVID-10 partial lockdowns.

After World War II, many of the advanced nations had very high levels of debt, brought down a lot over the next 30 years with rapid economic growth (and growth of tax revenues) and inflation. But real GDP growth (productivity growth plus labor force growth) in the US, and EU, are now much lower than after WW II.

Higher inflation won't be tolerated well by nations with higher percentages of retired people.  Interest rates will rise to more normal levels eventually, raising the costs of this larger debt load. Borrowing and printing money, hoping for consumer price inflation to reduce the debt burden, won't create a healthy economy and prosperity in the long run.

Consumer price inflation destroys purchasing power, which mainly hurts the bottom 50% of wage earners. So income inequality, which makes many American prefer socialism, increases. More inflation increases social frustrations and income inequality, so the new Federal Reserve Bank policy of deliberately creating a higher inflation rate, is bad economics.

Central banks are supposed to prevent inflation, not create it. But the U.S. dollar, since the Fed was created in 1913, has lost over 95% of its purchasing power. Where does it all end?  

Since this spring, Fed policies have seriously worsened income and wealth inequality, increasing social tensions, which increases the desire for socialism. I hope you've noticed the Democrat party has morphed into the Democrat Socialist party, Bernie Sanders style. Some moderate Democrats are not happy with that change, so some of Biden's ads, at least here in Michigan, have recently started sounding more moderate. But a few ads read off a teleprompter don't change the Democrat Socialist party platform.


A  DEBT  PROBLEM  EXAMPLE: TURKEY
The first countries to have debt problems are those with debts denominated in foreign currency. Borrowing in dollars and euros is cheap, until it isn’t.
Turkey is a good example:.

Ten years ago, it took one and a half lira to buy a dollar. Today, it takes seven and a half.  In one decade, the currency lost about 80% of its value against he dollar, and the euro, and 90% of its value against gold. In just one decade. the Turkish lira lost over 20% of its value against the U.S. so far this year and about 26% against the euro.

The cost of insuring Turkish sovereign debt has almost doubled, after Moody's downgraded their debt by one notch to B2, FIVE levels below investment grade. Turkey’s central bank burned through over 40% of its foreign-exchange reserves, trying to unsuccessfully prop up the lira.

Turkey’s tourism industry used to boom when their currency weakened.  Today the virus crisis is halting global travel and tourism. While the Turkish government is spending more than ever, partly to counter the coronavirus crisis. The Turkish economy contracted 10% in the second quarter. Inflation, is near 1% a month. Many banks, and Turkey’s large state-owned lenders, are sitting on a growing pile of non-performing loans (NPLs). They are hidden by forbearance (extend the loans and pretend they will be repaid, rather than foreclosing) rules introduced by Erdogan’s government.


US  GDP  DETAILS:
Productivity growth plus labor force growth, adjusted for inflation, equals real GDP growth. More people working, and working people gradually getting more productive, increases the national output of goods and services,. Adjusted for inflation, that output is Real GDP.

The calculations are simplified by measuring real final sales, adjusted for changes in inventories. Growing inventories are considered good news, while shrinking inventories are considered bad news. That's often not true for businesses, but that's the methodology.

The way GDP is calculated suggests consumer spending is 70% of GDP. In fact, consumer spending is about 50% of economic output. There are intermediate transactions of businesses selling to other businesses buried within final sales -- too complicated to separate them from the 70%.

Rapid U.S. economic growth has been difficult for the past twenty years because the growth of the working age population has been slow. Blame birth control pills. perhaps, or more two wage earner families with no mother to stay at home to raise children. Some say economic growth makes people wealthier, and wealthier people tend to have smaller families. The only way to compensate for that is more immigration, but one million legal immigrants a year coming here seems to be our limit.

Whatever the reason for smaller families, the slower labor force growth subtracted almost one percentage point from the post World War ii real GDP growth rate after 2000, which had averaged about 3.2 percent growth until 2000. There was a boost of labor productivity, and the GDP growth rate, for a few years in the 1990s from the new internet, but that didn't last long.

 

So it seems that 3% economic growth is no longer possible, and that suggests slow wage growth too. Inflation won't be tolerated well with slow wage growth, yet the Chairman of the U.S. Federal Reserve Bank is promoting a higher inflation rate?

U.S. federal government debt exploded by $3.5 trillion in just eight months, and by $4.2 trillion in 12 months, to $26.7 trillion today. The good news is the current recession has brought very low interest rates, so the U.S. government is paying less interest on its debt than last year, even with a lot more debt.  Is inflation supposed to be the solution for the recent expansion of debt for the "COVID bailout"?  

Rising inflation and high economic growth worked after World War II in making the government debt (used to fund the military in WW II) easier to repay (in dollars with less purchasing power). Should the Fed try to inflate away the current large debt load?

The new high levels of debt due to the COVID-19 partial lockdowns will not be sustainable without a significant cost on economic growth in most countries. The U.S. may be least at risk, as long as our Treasury can sell Treasury bonds, notes and bills to borrow money at very low interest rates.  But we are not alone in the world.