Editor's note: Forces beyond your control are working against you...

You see, the Federal Reserve's strategy for quelling inflation has revolved around printing a lot of money – creating a bunch of new debt. This new debt has had ripple effects on various parts of the economy, ultimately making it more difficult for everyday investors to earn money...

That's why Extreme Value editor Dan Ferris says it's critical to be aware of the macroeconomic forces that are quietly working against everyday people...

In today's Masters Series, originally from the August issue of Extreme Value, Dan explains the three main macroeconomic forces that you need to understand in order to survive the ongoing chaos in the markets... details why inflation could drag on much longer than most people anticipate... and discusses the long-term implications of the Fed's aggressive rate-hike strategy...

Macro Forces Are Conspiring Against You... Here's What You Should Do About It

By Dan Ferris, editor, Extreme Value

Macroeconomic forces are conspiring against your wealth today...

They're making it harder for you to hold stocks or allocate capital to new investments of almost any kind. And let's face it – they're making it harder for you to get a good night's sleep, as well.

And today, I'll detail the three key macroeconomic forces you need to understand right now – specifically, what each of them is... and isn't – and show you how to prepare your portfolio for whatever lies ahead.

Of all the multiplying villainies of nature swarming the market right now, investors are most concerned about two of them: inflation and recession. The combination of these two macro forces, called stagflation, is at play for millions of Americans today.

Let's talk about all three, starting with the one that's at the forefront of the financial news...

At Extreme Value, we believe deeply in via negativa – or "the negative way." It requires us to consider the unspoken and the unseen. Defining things by what they are not results in a better understanding of what they are.

The via negativa approach is the perfect way to understand inflation...

You see, inflation is widely misunderstood. Ask almost anybody you know to define the term, and they'll likely say, "Rising prices." They might even say something like, "More dollars chasing relatively fewer goods and services, causing prices to rise."

Both answers are wrong. They describe what inflation does... but not what it is. Rising prices are just an effect of inflation.

To best understand the concept of inflation itself, you need to separate it from its effects. This will help you make inflation-related savings, investment, or spending decisions.

I define inflation as an increase in the supply of money and credit. So let's start by analyzing what those things are and how they work.

The majority of our money is created in the banking system through borrowing. In a wealthy, mature, developed economy like ours, more spending generally means more borrowing. That process begins at the U.S. Federal Reserve...

Since the 2008 financial crisis, the Fed has engaged in several rounds of quantitative easing. That's when it prints money and uses it to buy Treasury securities from banks. That increases the reserves of those banks. Inflation technically begins the moment money-printing takes place because it increases the supply of money. The Fed prints dollars with a computer stroke, and it increases the supply of credit by buying Treasury bonds from banks for cash, thus increasing bank reserves.

But that doesn't directly result in higher prices...

You can see the growth in the Fed's money-printing and Treasury-bond-buying activity by looking at its total assets. The Fed's assets consist almost entirely of Treasury debt, mortgage-backed securities, and so-called agency securities (Fannie Mae and Freddie Mac debt securities).

As the following chart shows, these assets rose rapidly from just below $1 trillion to more than $2 trillion during the 2008 to 2009 financial crisis. They then drifted higher during multiple rounds of quantitative easing – printing money and buying Treasury debt – to just above $4 trillion at the start of 2020.

From there, assets rose rapidly once again, this time from $4 trillion to nearly $9 trillion. Take a look...

The banks are essentially swapping Treasury debt for cash, which boosts their reserves. If these reserves are never lent and spent, the extra money the Fed creates will likely never cause the price of goods and services to rise.

In this scenario, inflation technically exists but none of its effects are felt. The moment the Fed creates more money, it creates inflation. It does not, though, necessarily create rising prices. What actually pushes prices higher is spending activity.

There's only one big spender that can both print as much new money as it wants... and spend it, thereby almost assuring that society will feel the effects of inflation: the federal government.

The federal government creates money by issuing new debt securities through the U.S. Department of the Treasury. A reasonable proxy for newly printed money is changes to the total outstanding government debt.

Over the past two and a half years, outstanding public debt rose from $23.2 trillion to more than $30 trillion...

All the new debt – roughly $7.4 trillion of it – is newly printed money that is either already spent or will soon be deposited, lent, spent, and deposited again (perhaps several times, perhaps not). The result is today's 8.3% inflation, as represented by the latest year-over-year ("YOY") increase in the monthly Consumer Price Index ("CPI") – the most widely accepted inflation proxy.

When you create that much new money that quickly, it takes time for it to work its way through the economy, changing hands between various buyers and sellers over and over...

Eventually, the new money bids the price of goods and services higher... and the CPI finally goes up. That's when everyone finally catches on and yells, "Inflation is here!" Those people are late to the party, but at least they've arrived.

In addition to enormous levels of government borrowing and spending, consumer borrowing has risen by double digits this year. It rose by more than $32 billion in August. The data tend to be volatile from month to month, but borrowing appears to be in a sharp uptrend.

Despite the Fed raising interest rates to curb consumer spending and stem inflation... current credit-card balances are now higher than they were before pandemic lockdowns.

Some of this can be attributed to the fact that higher prices mean you're spending more even if you're not necessarily buying more.

Higher prices for goods and services eventually translate to higher wages as well. (After all, wages are simply the price of labor services.) Average hourly wages in the U.S. have risen from $28.43 before the pandemic to $32.46 as of September...

Congress claims that it's trying to stem inflation by passing a new spending package called the Inflation Reduction Act. The irony here is that to afford the programs promised in this package, the government will need to borrow money. In other words... it's trying to borrow and spend its way out of inflation, which, by the very definition of inflation, is impossible.

But inflation of money and credit due to government borrowing and spending will likely keep prices high... and could push them even higher. The CPI, wages, and credit-card debt are all rising at historically high rates.

Inflation and its primary effects are here... And they'll probably last longer than most folks expect.

My separation of inflation from its effects is merely a convenient mental model of how inflation works. Reality is far more complex. For example, technically speaking, inflation makes prices rise by making the value of money fall. But the value of money is a little too abstract. It's much easier to talk about the effect we can all see: the price of everything going up.

Of course, inflation isn't the only force that makes prices rise. But when the government creates $7 trillion of new money and the CPI rises higher than it has in four decades... it's a good bet inflation is the primary catalyst for elevated prices... and that you'll need to immediately prepare your portfolio for more of the same. We'll do that later, after we talk about the other two macro forces...

The White House stirred the pot on July 21, 2022, when it published a blog post claiming the long-standing definition of a recession – two consecutive quarters of falling real (or "inflation adjusted") gross domestic product ("GDP") – wasn't valid.

Folks... no matter what the White House claims, we are – according to the hard data – in a recession, and we have been for some time now.

"But," you may ask, "how can we experience inflation while the economy is in a recession?" The answer lies in a third macro force...

When inflation comes during an economic recession, it's called "stagflation."

Stagflation occurred in 15 out of 44 quarters from the early 1970s through the end of 1980.

Real GDP contracted for six consecutive quarters in 1979 and 1980. At the same time, inflation, interest rates, and the price of gold raged... peaking in 1980. High inflation was a key ingredient in generating negative real GDP. This means that inflation and contraction are not only possible, but when inflation is bad enough, they go together like peanut butter and jelly.

That's the situation we're seeing today: negative real GDP growth alongside high inflation.

Inflation and recession are too often discussed as exclusive conditions... But stagflation corresponds to a lot of folks' everyday experience, as they wind up spending more to buy the same or less stuff.

Even though it's unlikely to ever make headlines (most talking heads view it as too complicated to bother explaining), stagflation could influence your daily life for a while to come...

YOY changes in the monthly CPI – again, that's the most widely accepted inflation proxy – have been below 4% for most of the 21st century and below 2% for much of the past decade. But now, inflation is at 8.3%...

The Fed's inflation target is 2%, which means it will likely keep raising interest rates until the monthly YOY changes in the CPI fall back down to that target level.

Even if the CPI settles in around 4% to 5%, that's more than twice the level that has prevailed for most of the past decade.

Couple that with the ongoing recession, and it's clear that there's risk of continued, or perhaps recurring, episodes of stagflation over the next several years.

Throughout history, governments have all behaved the same way: When there's a war or other crisis and they start running out of money, they start printing it in excess. This is our reality right now.

The U.S. government has printed too much new money, too quickly. And the effects of this are just now hitting Americans in the form of higher rent and soaring prices for food, necessaries, and luxuries.

Good investing,

Dan Ferris

Editor's note: Dan successfully predicted the fall of Lehman Brothers... the bitcoin crash... and the top of the Nasdaq. And now, he says the biggest investing event of your life is about to unfold...

Investors have experienced a lot of pain this year. But Dan says what's coming next will be worse than anything you've experienced in your entire lifetime. That's why he's hosting a presentation where he'll reveal the names of two stocks you should sell immediately... Click here to learn more.