Why 3%-4% inflation is OK; Is the Inflation Battle Won? Not Yet; The Rule of 20; Cocktail reception this evening for Ukrainian children's art
1) One of my readers, John P., sent me this e-mail:
You come across as a kind, generous, thoughtful and caring person. It's refreshing to read your musings for that reason.
You know there is a however coming with that flowery, but still sincere, assessment, and here it is: recently, during one of your daily e-mails discussing the progress made on lowering inflation, you made a statement that seemed to negate every positive attribute I listed about you.
I'm paraphrasing, but you said you thought the Fed should give up on its target of 2% inflation and instead target 3-4% inflation.
So financial models that everyone has been using for decades to plan for retirements and pensions just gets yanked? Too bad, so sad, but your money you have been saving and investing is now going lose value at 50-100% greater rates!
The impact and devastation this would bring to responsible people's decades long plans would send many millions back to the workforce in old age just to keep from eating dog food or becoming homeless.
Your comments seem flippant, callous, and not at all well thought out!
I'm hoping you have the courage and integrity to address this serious question in one of your upcoming daily emails.
I replied: Thanks for an excellent question, John. Let me start by tossing a question back to you: Let's say the Fed's target was 1% and I wrote that 2% would be OK. Wouldn't you have sent me the exact same e-mail?
My point is that, excluding extreme inflation such as Argentina today (see this recent New York Times article: In Argentina, Inflation Passes 100% (and the Restaurants Are Packed)), it doesn't really matter if inflation is 0%, 2%, 4% or 6%. What matters is context. What is overall growth? And are wages keeping up with inflation?
According to this CPI Inflation Calculator, the value of a dollar has declined by more than 95% since 1918 thanks to inflation that has averaged 2.9% annually. But of course, we're all massively better off than we were 105 years ago...
The reason I said the Fed should learn to live with 3%-4% inflation, at least for a while, rather than its official 2% target is that several factors – like the war in Ukraine pushing up food and energy prices, ongoing supply chain disruptions, and a post-pandemic spending boom on things like travel – are pushing prices up.
Thus, for the Fed to get inflation all the way down to 2%, it would require pushing the economy into a severe recession, which is a much worse outcome than 3%-4% inflation.
2) For a thoughtful, nuanced, and data-driven look at the current inflation picture, I recommend this in-depth article in yesterday's New York Times: Is the Inflation Battle Won? Not Yet. Excerpt:
Inflation is beginning to abate meaningfully for American consumers. Gas is cheaper, eggs cost roughly half as much as they did in January and prices are no longer climbing as rapidly across a wide array of products.
But at least one person has yet to express relief: Jerome H. Powell, the chair of the Federal Reserve.
The Fed has spent the past 15 months locked in an aggressive war against inflation, raising interest rates above 5% in an attempt to get price increases back down to a more normal pace. Last week its officials announced that they were skipping a rate increase in June, giving themselves more time to see how the already enacted changes are playing out across the economy.
But Mr. Powell emphasized that it was too early to declare victory in the battle against rapid price increases.
The reason: While less expensive gas and slower grocery price adjustments have helped overall inflation to fall from its four-decade peak last summer, food and fuel costs tend to jump around a lot. That obscures underlying trends. And a measure of "core" inflation that strips out food and fuel is showing surprising staying power, as a range of purchases from dental care and hairstyling to education and car insurance continue to climb quickly in price.
Last week, Fed officials sharply marked up their forecast of how high core inflation would be at the end of 2023. They now see it at 3.9%, higher than the 3.6% they predicted in March and nearly twice their 2% inflation target.
The economic picture, in short, is playing out on something of a split screen. While the steepest price increases appear to be over for consumers – a relief for many, and a development that President Biden and his advisers have celebrated – Fed policymakers and many outside economists see continued reasons for concern.
Between the subtle signs that inflation could stick around and the surprising resilience of the American economy, they believe that central bankers might need to do more to cool growth and rein in demand to prevent unusually elevated price increases from becoming permanent.
My view is that the Fed and economists have been consistently wrong about inflation – and will continue to be. As I've said many times, the credit crunch due to turmoil in the banking sector is likely to dampen the economy and keep inflation falling the rest of this year, which means the Fed won't have to raise again, and is even likely to cut once or twice.
3) I've never heard of the "Rule of 20," but it makes sense that when both the S&P 500's P/E ratio and inflation are high (meaning the Fed is likely to start raising rates), which was the case at the end of 2021, look out below for stocks! It's interesting to see that this indicator has pulled back substantially, though it's still above its historical average:
4) A final reminder that today is the last day of the Ukrainian children's art exhibition and auction I've organized to raise money for Ukraine (see Friday's and Tuesday's e-mails).
If you're in New York City, please come by Franklin Parrasch Gallery at 19 E. 66th Street any time after 11 a.m. to see all 92 artworks in person. (I've posted close-ups of my favorites on Facebook here.)
Franklin is a close friend and is generously donating his space. Here's a picture of us yesterday:
We're hosting a cocktail reception at the close of the exhibition this evening from 6 p.m. to 8 p.m., which is open to all. Free food, free drink, great people, and a great cause – what's not to like?
If you're not in the city, you can see the artworks and bid on them here. The minimum bid is only $100. (We've already sold eight pieces for Buy It Now donations totaling $10,500.)
I hope to see you this evening!
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.