“The gentle response by the Fed in reaction to the rising inflation is akin to trying to clear out your snow-covered driveway with an ice cream scooper”.
That’s an attention-getter statement from David Einhorn, Founder-President of Greenlight Capital. David is a very successful opportunistic hedge fund manager who goes after bad actors in the markets. I remember meeting him once. I think he must have made tons of money shorting the Lehman brothers. That is the beauty of capitalism: a dog-eat-dog world!
Unfortunately, we as a group want to live in a permanent paradise. The governments and their supporting agencies try to achieve that without addressing the real issues. No politician or government has tried to purge past mistakes. A forest sometimes has to burn down to be fertilized for more robust and better growth to take place.
Subsequent people in power have only pursued their pet projects and have built further on the excesses created by their predecessors. For that matter, no one will vote for a leader who will reduce their social security and Medicare benefits. No one wants to spend less money on police, firefighters, and school teacher pensions. We are all looking for lower taxes too. People always vote for the candidates who will give them more free stuff. The candidates will always wave their fingers and pound their podiums and swear that they have figured out a way to make it work. It won’t and it never has.
While we are at a point of no return to fix the current financial system other than prolonging it for some more time, read Ray Dalio’s work on what happens at the end of long-term debt accumulation cycles. Five hundred years of history tells us free money printing does not work.
While many factors have contributed to the mess that the US created in the last 50 years two major events stand out and one person more than anyone is responsible for the situation that we are in now.
First, the dollar moved out of the gold standard on Aug 15, 1971, at President Nixon's directives. Second, was President Clinton's repealing of the Glass-Steagall Act in 1999. How much we have gained by abolishing these two major controls in finance is a debatable matter and we will discuss that in another letter in due course. The Fed Chairman who capitalized on both these changes to create huge debt was Alan Greenspan. Subsequent Fed Chairpersons could only build more on the debt that was created to keep the economy afloat. None could reverse what was already done.
Greenspan was a master at confusing economics in his regular testimonies to various committees and to Congress. I think he intentionally did that and most people never got a clear answer to their questions.
Chairman Powell must have been a little sloppy in taking a proactive step in containing inflation but surely he cannot be blamed for all the predicament that the country is in now.
There is no question a new world order is upon us and how that will play out is the head-scratching issue for most Fed watchers. The Ukraine-Russian war will only speed up this new money system. Checking Russia out of SWIFT and blocking access to their reserves held in dollars must have many other countries worried about their reserves. We will discuss that as time permits through future letters.
But let’s get to what the Fed is really doing now with the limited tools that they have to contain this inflation. Last Friday’s job report came much higher than the street expectations. What is important for the Fed from the report is not the number of jobs but the wage growth.
As the Fed has stated in no uncertain terms their primary objective is to reduce the leverage of the job seeker and current workforce, in demanding and commanding higher wages as this causes higher inflation. The Fed really fears an upward spiral in this.
The Fed did the unthinkable in the last two years. They added $6 trillion to the money supply in two years. Based on past history that is 10 years’ worth of money supply in two years. So there is a lot of excess money chasing a relatively stable quality of assets. So that is clearly a recipe for higher prices. While the Fed’s recent actions may help the rate of change in prices (inflation) to come down but the level of prices will not come down that easily unless this $6 trillion is sucked out of the economy.
The Fed is hoping that Quantitative tightening (QT) can achieve that but you already know what they have done on that front through my last letter. As per the last jobs report average hourly earnings grew by 0.3%. If we annualize that, we get 3.7% of wage growth. That is much lower than the year-over-year change of 5% growth meaning it is starting to trend lower.
With inflation running north of 8% and wage growth trending lower we actually have negative real wage growth which clearly should slow the economy. Finally, inflation alone should solve the inflation problem.
The market has clearly priced in a 75 basis point hike for this month but if CPI on Wednesday comes in lower, how the expectation of 50 basis points quickly changed to 75 basis points last month, we could see a reversal of that to 50 basis points after the FOMC this month. If that happens it will be a big sign like what they are doing with QT that they are really not serious about doing any meaningful tightening.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.