J.P. Szafranski, BridgeTower Media Newswires
“This is not a story we’ve ever seen before.”
– Stanley Druckenmiller
June 2022 at Sohn
Investment Conference
We’ve reached the halftime buzzer for stock trading in 2022. Market bulls have taken a beating, with the S&P 500 Index declining by 20.6% through June 30. The tech-heavy Nasdaq Composite Index posted an even steeper 29.5% decline.
Consumers and businesses alike are grappling with inflation unlike anything the U.S. has seen in four decades, with the official Consumer Price Index (CPI) posting an 8.6% year-over-year increase in the cost of living.
The principal risk facing monetary policymakers at the Federal Reserve is for an inflationary mindset to become entrenched into the population’s future expectations, setting off a further price-upward spiral. I believe Fed Chair Jerome Powell when he evokes a desire to quell inflation just like his predecessor Paul Volcker did four decades ago, even if it involves “some pain.”
“The machinery is so highly geared, the tension and strain are so great, the effort and output have alike so increased, that there is cause to dread the ruin that would come from any great accident, from any breakdown, and also the ruin that may come from the mere wearing out of the machine itself.” – Theodore Roosevelt, speaking at the University of Berlin in 1910, courtesy Colonel Roosevelt by Edmund Morris (2010)
While Roosevelt spoke in the context of evolving international relations before World War I, it surely applies to our current geopolitics and macroeconomics alike. Speaking of “highly geared,” Powell faces a vastly different fiscal balance sheet situation than did Volcker. U.S. Federal Debt-to-GDP (i.e. government debt as a percentage of the size of the economy) was in the 30% range in the late 1970s and early 1980s. That metric now sits at over 124%, according to first-quarter data from the St. Louis Fed.
Powell’s ability to tighten monetary policy is constrained by this vastly higher level of outstanding debt. Thus far in 2022, the Fed has raised its target overnight right by just 1.5% and already the tension and strain in the global financial system is great (see: U.S. Dollar Index). Volcker pushed that target rate toward 20% in his day. Clearly, that won’t be happening.
How do things play out from here? Are we living through the beginning of a turn in the long-term debt cycle per Ray Dalio and his Economic Machine construct? Maybe? Probably?
While many commentators focus on the 1970s inflationary analog, Lyn Alden suggests a more fitting comparison for today is that of the postwar 1940s era. Sovereign debt ballooned due to wartime expenditures. What followed was an extended period where the Treasury held government bond yields far below inflation. This financial repression allowed debt-to-GDP to come back down to more sustainable levels, at the expense of bondholders.
With outright default and/or austerity in fiscal spending seemingly impossible, the inflate-your-way-out playbook seems likely to happen again. Someday soon Fed policymakers may face an unpleasant choice between higher-than-preferred inflation paired with artificially lower interest rates or, even worse, a deflationary debt collapse.
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J.P. Szafranski is CEO of Meliora Capital in Tulsa (www. melcapital.com).
