Inflation panic is now fashionable. Hedge fund stars from Ray Dalio to Stanley Druckenmiller were in the media Tuesday warning that uncontrolled federal borrowing would lead to higher Treasury borrowing costs, and force the government to divert revenues away from spending programs to debt service.
Druckenmiller told CNBC that Bitcoin might replace the dollar as world reserve currency.(Not likely: Who is going to pay invoices in a “currency” whose value can double or halve in a few weeks?)
The news media finally caught on to the inflation train-wreck, reporting double-digit price increases for everything from restaurant meals to paper towels.
The US stock market fell sharply, but wasn’t sure where to fall. Tech shares collapsed in the morning but recovered by the end of the day, and cyclical stocks turned in the worst declines by the end of the day.
We know that the equivalent of an asteroid is about to hit the financial equivalent of the earth, but we don’t know on whom it will land.
Inflation might run out of control, buoying commodity prices, and steepening the yield curve, which is good for financials.
Or the “stag” in stagflation might predominate; consumers might balk at higher prices and stop spending. (They have already used a lot of the government’s stimulus bounty to pay down credit cards.)
Home prices might continue to soar, or interest rates might jump and crush the housing market again.
The trouble is that everything is going wrong at once.
It’s like the old joke: “If we had some ham we could have ham and eggs, if we had some eggs.”
We were inflation hawks before inflation was cool. Everything that could go wrong has. Five trillion dollars of helicopter money created demand for goods that the US economy can’t produce:
not cars (because of the global shortage of semiconductors),
not oil (because capital investment in the oil patch has collapsed),
not houses (because the price of lumber has added another $30,000 to the cost of the average single-family house),
not paint, or industrial chemicals, or much else.
Wait times for industrial orders are at the highest level in the history of the Institute for Supply Management’s purchasing managers’ survey.
There’s no capital with which to put labor to work.
But there’s no labor to work with the capital, either. Today the US government reported that more than 8 million available jobs remain unfilled, more than all the unemployed workers in the United States.
The National Federation of Independent Business reported that the index of members reporting that jobs are hard to fill hit an off-the-charts all-time high in April. Meanwhile small business’ actual hiring plans haven’t moved much, because they can’t find the labor.
The Biden Administration shrugged off accusations that a $300 per week emergency unemployment supplement had discouraged Americans from returning to work, but the facts suggest otherwise.
Helicopter money from Washington has stimulated spending while keeping people away from work. An astonishing 34% of all personal spending now comes from federal government checks – versus an almost-as-astonishing 27% before the Covid-19 crisis.
The dollar has been falling because inflation erodes the real value of the dollar. But if the Federal Reserve pushes its overnight rate up to 4.5% (as former New York Federal Reserve President William Dudley predicted recently) in response to inflation, the dollar will rise.
The market is saying that the Fed’s overnight rate will rise to only about 2% over the next two years, but if it changes its mind, the dollar will jump.
Gold isn’t a refuge against inflation, either. As we’ve observed often in the past, gold trades closely in line with the yields of inflation-indexed Treasury notes (the so-called real yield). Gold rose earlier this year because real yields collapsed, in part because the Federal Reserve was buying inflation-indexed Treasuries and reduced the supply of such instruments available to the public.
So there isn’t any surefire hedge against the train wreck that the Fed and Treasury have set in motion. Stocks that benefit from inflation, like integrated oil and financials, remain my favorites. But I also recommend buying hedges against rising Treasury yields, for example, in the form of ETF’s that trade inversely with Treasury prices.