The U.S. pandemic, beginning in early 2020, ushered in an unmatched flood of federal government overspending and record Federal Reserve (FED) stimulus.
With a compliant Congress, the Trump Administration increased an already bloated federal deficit by $1.22 trillion in one year. Not to be outdone, the Biden Administration expanded the deficit by more than $2.1 trillion in only six months. During this period of time, the FED slashed short term interest rates from 1.75% to 0.0% and purchased $4.3 trillion of federal debt and mortgage-backed securities in order to reduce long-term interest rates to record lows. During the pandemic, these actions increased the money supply by 28.1% and reduced the value of the U.S. dollar by 3.4%. So, what were some of the other outcomes?
Inflation and asset bubbles sprouted. The year-over-year consumer price index (CPI) climbed from a pre-pandemic 2.3% to the most recent reading of 5.5%, well above the FED’s pre-pandemic target of 2%. Additionally, the record high spending, low interest rates, and surging inflation have pushed investors into riskier bets. For example, in only 12 months, the Case-Shiller national home price index soared by 14.0%, the S&P stock index rocketed by 38.6%, bitcoin ballooned by 270.1%, and gold increased by 12.6%. Meantime, the overall U.S. economy barely nudged with the inflation-adjusted GDP actually down by 0.9%.
So, what’s the problem? The FED cannot sit idly by as inflation rips through the U.S. economy. Higher Inflation and interest rates will degrade U.S. stock prices forcing stocks to a more reasonable price to earnings ratio. Meanwhile, inflation will be supportive of cryptocurrency, gold and silver prices, even as higher interest rates moderate their gains.
Despite the evidence, the FED continues to plead their case that year-over-year CPI growth was just as high in July 2008. However, they fail to also acknowledge the FED’s short-term interest rate was 2.0% in July 2008 compared to today’s 0%.
Thus, there is currently much more FED stimulus for even higher inflation. To quote Eisenhower Administration economist Herb Stein, “If something can’t go on forever, it will stop.” So, what will stop or thwart these Goldilocks investment gains? Higher interest rates as early as Q4, 2021, that’s what!
Many economists, including yours truly, expect these out-sized gains to be flattened or even reversed when the FED begins raising long-term interest rates (tapering) as early as Q4, 2021. Strap on your financial seat belt-the economic landscape will get bumpy.