Coronavirus and the Era of Inflation
The last time I wrote to you I created a piece about the nation of Lebanon. My article was extremely prescient, addressing the structural issues in Lebanon that had brought the country close to economic collapse and showing that change was necessary to prevent calamity. It turns out that they could not make the changes necessary and the new crisis of Covid-19 ensured that it did not really matter what Lebanon did. The crisis has severely damaged the economies of the world and now Lebanon has joined the hyper-inflation club, posting 50% inflation consecutively for the past 30 days.
Since the coronavirus triggered such a bout of inflation in Lebanon, I figured now would be an important time to cover inflation more in depth. Inflation in the West has been essentially dead in recent years. Most western nations have continued to miss their 2% inflation targets following the 2008 financial crisis. Economies want low inflation because it incentivizes investment and benefits those with loans (the real debt lessens over time), and the effects of negative inflation are tragic. This 2% inflation target, however, may soon change. For our examination we will focus our eyes onto the United States and the role of the coronavirus in stoking inflation.
Inflation can occur for a number of reasons. The primary reason I’ll be exploring today occurs when the supply of money increases at a faster rate than economic growth. For the United States this is a critical issue and extremely relevant to the current fiscal and monetary policy being pursued in this economic and social crisis. As of today, the US government has spent over $2 trillion in programs to address the coronavirus pandemic, with another potential $1-3 trillion coming as congressional Republicans and Democrats fight to secure a new rescue package by August 10th. This is big money. For comparison, the Obama Administration's 2009 stimulus package was about $1 trillion dollars.
In addition to these fiscal measures severe monetary stimulus has been applied as well. To make this comparison we will also reference the financial crisis. Under the Obama Administration the Federal Reserve used quantitative easing, or purchasing US treasuries, to inject about $4 trillion into the markets over 6 years. The Fed has now made about $3.5 trillion in purchases in just 3 months. The Fed equally stands prepared to ‘do whatever it takes’ to reinforce the economy as signaled by their recent decision to extend the duration of their emergency lending abilities till the end of this year.
Altogether, the US government has thrown not just the kitchen sink but the entire kitchen at the problem. It's even gotten to the point where Jerome Powell, the head of the Federal Reserve, is a recognized meme because of his involvement. Never before has the US government spent so much (soon to be $6.5-8.5 trillion) in so little time. The prospects for the economy are equally extraordinary in the short term. As of today the second quarter results for the US show an annualized 33% GDP contraction. To compound this effect, we are beginning to see real economic scarring from the lockdowns occurring, with some firms projecting a whopping 50% of temporarily closed establishments becoming permanently closed. All the pieces of an inflationary bout are in place. The Federal Reserve, among others, is predicting this rise of inflation, as it signalled in recent days a change in strategy that may, by the end of the year, mean the abandonment of the 2% inflation target and instead an overshooting of inflation.
Markets are following suit. Since the beginning of the pandemic, while stocks have seemed to defy gravity and ignore mounting lockdowns, safe haven assets previously uncorrelated with markets are becoming correlated. The best example of this is gold. Gold in normal times rises in value as markets decline because gold is a defensive asset, a proven store of value in times of crisis. If this is the case, why is gold rocketing up from $1,500 an oz before the crisis to nearly $2,000 an oz as of today, while markets are exploding in equal measure? The answer: the smart money is leaving.
The writing is on the wall: Markets today are being propped up by massive fiscal spending and monetary policy leading to the debasement of the dollar. The exuberance in the markets cannot mask the truth that the economy is declining and money is being printed rampantly to fix it. In the meantime, markets continue to defy normality. Stocks announcing bankruptcy go up 300%, markets refuse to move lower despite increasing cases and renewed lockdowns and there is no defined end in sight. When the music finally stops and the emperor has no clothes, all that will be left is an economy flush with cash in a period of negative growth. The Era of Inflation will soon begin.