Back in March 2020 massive cash infusions saved the economy from what could have been a deflationary spiral, the worst-case scenario at that point in time. Now it’s late 2021. Deflation is no longer the risk. Is it time to taper the infusions?
Back in March 2020, we had what was an extraordinary bipartisan response to the COVID-19 pandemic. Everything was collapsing, the lockdowns were causing a complete shutdown of the economy. This was great action. It was stunning to me, frankly, how complete, comprehensive, and fast it happened. Clearly, both parties had learned from 2008: do it now, do it quick.
But now we’re at 5% plus inflation. In fact, some sectors, the economy double digit inflation. At the same time we have supply chain shortages. Is just printing money still the best course of action? You know, in late July, the Federal Open Market Committee, FOMC announced that they’re going to start tapering asset purchases. Why do they talk about asset purchases? What they’re talking about is buying bonds off the open market: mortgage-backed securities, corporate bonds, and most treasuries. When the fed buys bonds, they put cash into the system that giving cash for the bonds and that is the mechanism for injecting cash into the economy. But is this still the right medicine? This is actually a more difficult environment in many respects, as bad as things were last year, it was pretty much cut and dry as to what the right course of action is. But now as Boston’s fed chairman, Eric Rosengren pointed out, we need to accelerate this slowdown in purchases because short-term inflation is spiking.
It’s over 5% in general, it’s over 20% in some sectors of the market. We don’t need more money in the system. What we have our supply chain bottlenecks, we can’t make enough cars because there’s not enough chips. We can’t build enough houses because there’s not enough lumber. Factories throughout the country are working reduced shifts for one of parts. Mechanics can’t get the parts for cars, planes, ships. This is not a problem solved by pouring additional gas on the fire. In addition to this quantitative easing bond asset purchases, it’s borrowed money. We’re not doing as much good as we were, but we’re still loading up on the debt. And yes, interest rates are extremely low, but a lot of this debt is not long-term debt. In fact, these elements threatened to jeopardize the economic recovery as it is right now. So, we’re in a really tricky environment.
It’s a logical step is to first throttle back the purchase of mortgage-backed securities. And the feds actually mentioned that, or at least alluded to, that would be the end of jet fuel for the property markets. We’re already seeing price peaking. We’re already seeing high prices create more inventory. People, especially retirees are like, Hey, I’ll never get a better price than now. And increasingly the evidence is at least in the intermediate term, you probably never will get a better price than right now. As interest rates start to climb and they taper these purchases, this is going to hurt the real estate market – “hurt” is a relative term. The real estate market is not crushed by any of these changes. Yes, it may put an end to the party. Home-building has failed to keep up with the demand of the population. The shock of the real estate crash in 2008, created an enormous clearing out of vendors, home builders. The qualification standards for underwriting loans has gone up and as a result, there’s far fewer homes than we need today. So even with higher interest rates and even without buying mortgage-backed securities, we’re not looking at a collapse in the real estate market. It’s just the party’s over, they’re taking away the punchbowl. In fact, if you’re looking to cash out at the top, very likely in the real estate market now is the time to be selling for that property and a cheaper market. For most people there’s no choice though, because if you sell your place where you’re going to live? So you’re buying high and you’re selling high.
We’ve also just passed a massive infrastructure bill. How much will that affect? How much will that help? There’ll be some trickledown effect, but even that may be three years down the road. However, the infrastructure bill probably will help if we do end up in a recession in the next two to three years, and probably the likelihood is greater than even. Bonds are where things are really going to happen. Real yields are going to fall. What do I mean by real yields? Inflation always gets tacked onto yields, but right now yields are two and a half percent on intermediate treasuries or lower after inflation they’re negative. They’re probably going to go further negative. For those who are living on fixed income, this is a recipe for disaster over time. And I don’t mean overnight, I mean over a 20-year horizon. There’s going to be calls for an end to the financial repression of the retirees. But there’s no easy solution, but T.I.N.A., there is no alternative, will result in people staying heavily loaded in equities and in private equity investments and even local small business investments.
That also will be a bit of an inflation hedge inflation in the long-term is not the big risk. The big risk is inflation in the short term. In fact, the financial markets think that inflation on the long term is going to be quite subdued. So it’s interesting. We’re at an inflection point where we’ve just come out of 18 months of, let’s face it financial hell, followed by surprising reasons. And it was easy. I mean, the playbook was pretty much written. Bernanki wrote it, but this is different now that play has pretty much reached the end game
Going forward though, the COVID impact on the economy may not be as disastrous as it was back then, this is going to be tricky. How do we taper without creating a severe recession? How do we take away the punchbowl without doing more harm than good? This, fortunately is not my challenge. It’s the feds’. They’ve done a wonderful job, so I’m going to give them the benefit of the doubt.
Hole, Jackson. “Central Banks Should Make Clear What QE Is for, and Then Reverse It.” The Economist, The Economist Newspaper, 21 Aug. 2021, www.economist.com/leaders/2021/08/21/central-banks-should-make-clear-what-qe-is-for-and-then-reverse-it.
Smith, Colby. “Top Fed Official Warns Massive Bond Purchases Are Ill-Suited for US Economy.” Subscribe to Read | Financial Times, Financial Times, 18 Aug. 2021, www.ft.com/content/bafad111-01e5-4600-b34c-13028c3826ea?shareType=nongift.
Torres, Craig. “Fed Minutes Show Most Officials See Taper Starting This Year.” Bloomberg.com, Bloomberg, 18 Aug. 2021, www.bloomberg.com/news/articles/2021-08-18/fed-minutes-show-most-officials-see-inflation-goal-in-hand.