Danger!!! Jerome Powell Danger!!!

In the 1960’s sci-fi adventure series Lost in Space, Will Robinson had a robot companion named “Robot” who would call out “Warning Warning!” or “Danger Will Robinson!” whenever he sensed impending trouble.

At the moment, Fed Chairman Jerome Powell could use a Robot of his own, as he is blundering into a series of aggressive rate hikes at a time when the real economy is clearly signaling “not so fast.” Here’s the background to the current danger:

Back in January of this year, in a blog post entitled “Duh!,¹” I quoted Nobel Prize recipient Milton Friedman on the timeless cause of inflation:

In a talk in India in 1963, the great Milton Friedman said “inflation is always and everywhere a monetary phenomenon.”² What did he mean by that? He argued that “one could not find inflation anywhere in the world that was not caused by a prior increase in the supply of money or in the growth rate of the supply of money.”³

I then went on to say:

Here is a chart⁴ of the U.S. money supply (M2 less Currency), from 2006 through late 2021. As you can see, up until the Federal Reserve and the U.S. government opened the money floodgates with their response to Covid in the spring of 2020, the money supply had basically increased at a 6% annual clip for the previous 19 years. During this time period, the CPI and GNP both grew roughly 2% per year, so a 6% money supply increase is generally consistent with that type of modest inflation and modest economic growth, given that our methods for calculating inflation and economic growth are not absolutely precise.

That all changed in the spring of 2020, when the government began handing out checks, and the Federal Reserve accommodated this largesse by driving down interest rates. The money supply took off like a rocket.

“The rest of the story,” as Paul Harvey used to say, played out as Friedman would have predicted, resulting in the current inflation with which we are all too painfully familiar.

Federal Reserve Chairman Jerome Powell’s response to this has been an aggressive series of Fed Funds rate hikes⁵, which has taken the rate from essentially zero to over 3%.⁶ This is the fastest 3% cumulative hike since 1980. None of the Fed’s interest rate hikes since then have gone this far this fast.

Of course, this has been the path the Fed has always taken when confronted with rising inflation: raise rates, which tightens credit and weakens the housing market, which in turn induces a recession and voila, demand slumps and prices decline.

There’s an old saying – to a man with a hammer everything looks like a nail. The Fed’s hammer is interest rates, and to them every bout of inflation looks exactly like the same nail. But what if this time around it’s different?

Below is an update of M2:⁷

As you can see, so far this year its growth has essentially flatlined. In and of itself, if this continues, it should dampen inflation significantly.

In addition, the dollar is at an almost record high against a basket of major currencies.⁸ In the past inflation has moved in the opposite direction from the dollar: rising inflation has been accompanied by a weakening dollar, and vice-versa. From March of 2020 until May of 2021 the dollar declined and inflation roared, but since then the dollar has taken off, potentially signaling lower inflation ahead.

Many commodity prices – oil, copper, raw industrials – have declined significantly from their earlier highs, along with the price of gold. These are all leading indicators of inflation, as opposed to the CPI, which tells you where inflation has been for the last 12 months, but not where its headed.⁹

Finally, the market is now expecting inflation over the next 5 years to average around 2.3%, right in line with the Fed’s target.¹⁰

If the real world is warning “Danger!!! Jerome Powell Danger!!!, then why is the Fed insisting on this aggressive course of action? I believe there are two parts to the answer:

• The economic establishment’s belief in the long-discredited Phillips’ Curve.¹¹ The Phillip’s Curve is a theory developed by A.W. Phillips in 1958 that says that there is an inverse relationship between inflation and economic growth. Strong economic growth causes inflation, so the cure for inflation is to reduce economic growth; that is, induce a recession. The stagflation of the 1970’s, which saw both high inflation and low economic growth, should have relegated the Phillips’ Curve to the ash heap of forgotten “scientific” theories like phlogiston¹², but it lives on among many economists. Hence, the Fed’s insistence on trying to subdue inflation with their interest rate hammer.
• A failure to understand the role M2 growth plays in inflation. This may be ignorance, or it may be politics: Jerome Powell has said repeatedly that the growth of M2 does not hold important implications for the economy.¹³ If he believes that the M2 explosion played little part in the subsequent inflation explosion, why would he think that this year’s M2 flatline could help to moderate inflation?

The bottom line: I occasionally watch the TV show American Pickers. If you haven’t seen it, it’s about “pickers” who travel the country looking for valuable and interesting antiques. Occasionally they come across television or movie props: Yoda prototypes, Roy Rogers’ jacket, etc. Here’s hoping that they find Robot from Lost in Space and can reprogram it to repeat “Danger!!! Jerome Powell Danger!!!" Otherwise, I believe we could be in for a much bumpier recession ride than necessary.

Don Harrison

¹ https://www.capitalistinvestment.com/blog/2022/01/13/duh
²The Hoover Institution, 5/20/21, https://www.hoover.org/research/inflation-true-and-false
³The Hoover Institution, 5/20/21, https://www.hoover.org/research/inflation-true-and-false
⁴Calafia Beach Pundit, Scott Grannis, 10/27/21, http://scottgrannis.blogspot.com/2021/10/
⁵https://www.macrotrends.net/2015/fed-funds-rate-historical-chart
⁶https://www.powerlineblog.com/archives/2022/10/the-daily-chart-is-the-fed-tightening-too-fast.php
⁷http://scottgrannis.blogspot.com/2022/09/everythings-down-except-inflation.html
⁸http://scottgrannis.blogspot.com/2022/09/the-dollars-strength-is-telling-powell.html
⁹http://scottgrannis.blogspot.com/2022/, https://www.macrotrends.net/1476/copper-prices-historical-chart-data, https://www.macrotrends.net/1369/crude-oil-price-history-chart
¹⁰http://scottgrannis.blogspot.com/2022/
¹¹https://www.investopedia.com/terms/p/phillipscurve.asp
¹²https://en.wikipedia.org/wiki/Phlogiston_theory
¹³https://www.wsj.com/articles/powell-printing-money-supply-m2-raises-prices-level-inflation-demand-prediction-wage-stagnation-stagflation-federal-reserve-monetary-policy-11645630424

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The Consumer Price Index is a measure of inflation compiled by the U.S. Bureau of Labor Studies.